The debate on increasing minimum wage has been gaining momentum around the world in the recent years. In developing economies such as Chile and Brazil, for example, high inequality and low standards of living have led to wage recovery policies, while four states in the wealthy United States recently raised the minimum wage, in some cases to US$15 an hour.
Did the impact of economist Thomas Picketty’s best-selling book Capital in the 21st Century cause this? Or perhaps it’s international migration and political polarisation. Either way, the notion that workers deserve a “living wage” is now a global trend.
Mexico is no exception. In 2016, the national minimum wage was increased 4.2% to 73 pesos a day (less than US$4). Even so, it is insufficient to buy what we economists call the “basic basket of goods” for one person – such as beans, tortillas, eggs and a bit of meat – much less to support even a small family.
Now public debate in Mexico is reaching a critical volume, with social organisations, academics, business leaders and political circles arguing that the dismally low minimum wage condemns workers to poverty.
Our 1917 Constitution (article 123), dictates:
The minimum wage that a labourer should enjoy shall be sufficient, considering the conditions of every region, to satisfy the normal necessities of the worker’s life, his education and honest pleasures, as head of a family.
From then until 2000, when the ruling PRI party lost the presidential palace for the first time in 70 years, the minimum wage was used as an economic policy instrument. From the 1930s to 1960s, Mexico established a relatively low minimum wage of 24 pesos (US$2 per day in 1969 terms) to keep labour costs low, attracting investment. But in that period wages increased more than inflation, transferring some of the business sector’s productivity gains to workers’ salaries (as opposed to increasing only as profits).
During the 1970s and 1980s, on the other hand, the minimum wage served as a tool to control high inflation. That is, by setting a low minimum wage, which has the spin-off effect of keeping other wages low as well, the government could reduce costs and thus limit inflation. However, this policy reduced the purchasing power of all wages, including the lowest earning brackets, because inflation grew faster than nominal wages.
Since the late 1990s, with the Mexican economy essentially stabilised, the minimum wage has mostly been keeping pace with low inflation. As such, it has served to signal labour market trends: increases in the minimum wage would lead the way for other wages to increase. Nor have we seen transfers of productivity gains like those of the 1950s and 1960s.
The result is a very low official minimum wage that has lost 75% of its purchasing power in the past 30 years, as the following graph demonstrates.
Official vs ‘market’ minimum wage
In reality, relatively few Mexicans actually earn the minimum wage. Official figures show that around eight million workers (more than 10% of the labour force) earn the equivalent of between one and two times the minimum wage.
That’s because there are fiscal and tax incentives to report that workers earn less than they actually do. Employer social security contributions are calculated quite progressively, so companies tend to under-declare wages and pay employees the difference in cash.
This means that the labour market’s minimum daily wage is quite a bit higher than the official minimum wage – regional differences, work characteristics and other specifics notwithstanding.
It is hard to estimate this real, if unofficial, minimum wage. But based on the fact that the lowest-paid construction worker earns more than 150 pesos a day (US$8), more than twice minimum wage, we can make some inferences.
The ‘lighthouse effect’
Given this picture, many businesses, and even banks, ask: why worry about Mexico’s national minimum wage at all?
Mexico’s Central Bank, which wants to keep inflation low, does not support increasing the minimum wage. Likewise, some in the business sector say that, as in other countries, a higher minimum wage would will also raise wages across the board, thus propelling inflationary pressures. This is called the “lighthouse effect”, and nobody wants that.
But a depressed minimum wage also propels a “reverse lighthouse effect”, meaning that businesses tend to pay low wages, because their reference point is the very low official minimum wage. That is to say, employers believe that because the wages they pay far surpass the official minimum wage, they must be sufficient for a worker’s livelihood. But that’s not necessarily the case when the comparison point isn’t enough to buy tortillas.
Additionally, Mexican economy is oligopolistic; it doesn’t have enough competition to avoid excessive profits. We also have a deficient labour market with high transaction costs and vast labour supply. Although official unemployment is at a very low 4.9%, around 65% of the workforce belong to the informal sector.
Given this excess supply of labour, there’s room for the employer to pay relatively low wages and not face labour shortages. As such, a very low official minimum wage pulls other wages downwards.
‘No money for vacations or a car’
The Consejo Nacional de Evaluación de la Política Social, which measures poverty with a multidimensional methodology, calculates that for a daily minimum basket for two people to live on, the minimum wage would need to increase more than 145%, to 178 pesos per day (US$8.75).
For a family of one earner and one dependent, that amount would cover: the rent for one small apartment; three simple meals a day; commuting costs and some basic health services. Naturally, there would be no money for vacations or buying and maintaining a car.
Clearly, an increase of that magnitude in one shot is improbable in a country whose currency just dropped 20%. And employers would resist mightily anyway.
But a rapid and significant increase would also impact other, higher-income brackets, affecting businesses in a generalised manner and consequently endangering employment. From an economic perspective, then, a high new minimum wage suddenly set above market level is undesirable.
Instead, Mexico should establish a policy of increasing the minimum wage gradually over a number of years. This would both curb possible inflationary pressures and allow businesses to adapt and manage their wage structures.
Chile, Brazil and the US are already doing this, with no significant impacts on employment and inflation. And in Mexico, when the government equalised the minimum wage in two regions, no meaningful effects were observed.
The impacts of a minimum wage increase on inequality is hard to predict. Countries such as Brazil, Mexico and Argentina have improved equality in recent decades, but not all have upped their minimum wage. Most have used conditional cash transfers to lift poor people out of poverty. So even if Mexico were to raise the minimum wage reasonably over time, the Gini coefficient, which measures inequality, could remain static.
But the lives of the country’s lowest earners would certainly improve. That’s not just an issue of basic justice; it also has the potential to improve Mexico’s economy, increase social cohesion and even reduce unwanted migration to the United States. Given the sudden shift in Mexico’s regional context, that, at least, must be a policy priority right now.