Minimum wages have played a central role in reducing inequality in countries as diverse as Indonesia, the UK and Brazil. Traditionally seen as a means to ensure workers earn enough to meet their basic needs, more attention over the last two decades has been given to minimum wages as a means to help create a more equitable society.
South Africa is one of the most unequal societies in the world with a Gini coefficient (where zero is perfect equality and one is perfect inequality) of a staggering 0.66, more than double the average of OECD countries.
French economist Thomas Piketty recently stressed the potential role a national minimum wage can play in tackling these stubbornly high levels of inequality.
Wage differentials, not unemployment, is the main source of inequality in South Africa, responsible for about 56% of inequality. Unemployment is responsible for approximately 35% and differences in remittances and investment income make up the remainder.
On average the top 10% of wage earners take home 24 times more than the bottom 10%, while the top 5% earn almost 50 times more than the bottom 5%, up from 30 times in 2010. Disturbingly, inequality has increased since the fall of apartheid.
The promise of minimum wages
Given this, altering the wage distribution in South Africa through increasing wages for the working poor could have a dramatic impact. International experiences offer us imperfect but valuable insights into the potential role of a national minimum wage, set at an appropriate level above many of the low current sectoral minima.
Three questions emerge. What are the potential consequences for levels of employment? What impact do minimum wages have on the wage distribution? And what are the “spillover effects” of minimum wages?
Evidence from the developed world on the impact of minimum wages on employment is unequivocal. Minimum wage increases have very small, negligible or statistically insignificant disemployment effects. The most comprehensive meta-analyses show that employment impacts converge around zero.
Evidence from the developing world is more scarce and contradictory. But overall the findings are similar. Minimum wages tend to have small or insignificant employment effects.
Redistributive impact
The redistributive impact of the minimum wage centres on its ability to raise earnings at the bottom end of the wage distribution (that is, for poor workers) more than for those at the middle or top end of the distribution (higher earners). While not uniform, this was observed in the formal sector for 10 out of 19 Latin American countries and in the informal sector for 14 out of the 19.
In Indonesia, large increases to minimum wages were made in two phases: 1990-94 and 2000-02. Although differentiated by sector, on aggregate between 1993 and 2000 a 1% increase in the minimum wage led to a 1% increase in real wages for the lowest earners compared with a 0.5% increase for those around the 80th percentile. That increased real average wages for the poorest at a higher pace.
This corresponded with a decrease in wage inequality measured through the Gini coefficient from 0.46 in 1993 to 0.41 in 2000. Overall, between 1993 and 2007 the ratio between the 90th and 10th percentiles declined from 9.72 to 7.21.
The introduction of a national minimum wage in the UK in 1999 boosted wages for the lowest earners and accounted for 50% of the reduction of wage inequality between 1998 and 2010.
In Brazil, the national minimum wage was increased by 70% between 2004 and 2012. During this period the overall Gini coefficient fell from 0.58 to 0.52, wage inequality dropped from 0.47 to 0.40 and real average and median earnings increased by 28% and 46% respectively.
Estimates from the OECD and various academics show that increases in wages and changes in the distribution of labour earnings in Brazil accounted for between 40% and two thirds of the fall in income inequality in the 2000s. This was:
… a consequence of both declining labour and non-labour income inequality, with both having approximately equal weight.
Increases to the minimum wage were therefore central in reducing wage inequality as they consistently raised wages at the bottom end at a higher rate than those at the top.
While differences emerge across sectors and demographics similar results have been shown for Russia, India and Colombia.
On the other hand, when real national minimum wages declined in Mexico, between 1979 and 1988, and the US, between 1979 and 1988, inequality increased.
Spillover effects
The positive “spillover effects” of minimum wages are particularly strong in developing countries. A study of ten finds that average wages in the informal sector rose due to the institution or increase of minimum wages, with South Africa demonstrating the highest increases. Studies of Latin American countries show the same.
This “lighthouse effect” means that minimum wages in the formal sector serve as indicators of a fair wage in the informal sector as well as a tool for increasing the bargaining power of workers. Interestingly, in the case of Brazil, Mexico, Argentina and Uruguay minimum wages have a stronger impact on equalising wages in the informal sector than in the formal sector.
Minimum wages can also raise other forms of income if these are indexed against the national minimum wage. In Brazil 6% of workers in the formal sector, 20% in the informal sector and 5% of the self-employed earn an exact multiple of the minimum wage.
In addition, pension and welfare benefits for the elderly and disabled, as well as unemployment insurance, are linked to the level of the minimum wage. These have also been instrumental in reducing inequality.
Why Piketty is right
While differentiated, the international evidence tells us that increasing or instituting a national minimum wage, provided it is set at the right level, can significantly increase wages for the lowest paid. It can help to close wage gaps between the rich and the poor, without negative impacts on employment.
It is also most effective, in tandem with other measures, to reduce inequality.
All this indicates that Piketty is correct to argue that the national minimum wage can be “an important tool to reduce extreme wage inequality”.
This article is based on a forthcoming paper by Jana Mudronova, looking at the relationship between inequality, poverty and the national minimum wage.