Cure for unemployment: increasing minimum wage?

According to an article by Jagdev Singh Sidhu on 3^rd May 2012  (http://biz.thestar.com.my/news/story.asp?file=/2012/5/3/business/11220992&sec=business), minimum wage has many benefits. Singh shares the same thoughts as our Prime Minister Datuk Seri Najib Razak, who announced earlier this year that minimum wages for labor is to be increased to RM 900 for peninsula and RM 800 for east Malaysia respectively effective January 2013.  Singh cited that the increase would bring glad tidings to the 3 million strong private sector employees; although he admits that there would also be disadvantages such as increased unemployment and a drop in investment. However, he believes that “economic growth and the investments that will take place and the promise of new jobs will be more than enough to offset those small impediments.”

Considering the rising cost of living in Malaysia, I can understand why the government sees increasing minimum wage as like the perfect solution. With an increase in minimum wage, low-skilled workers will see an increase their purchasing power. With this, they can afford to do more with their monthly salary besides paying off monthly obligations, and perhaps even set aside money for rainy days. Problem solved, right? Wrong. It would be too optimistic to think that increasing minimum wage would solve all problems. I personally see minimum wages as a good intention that will yield bad results, as it would lead to problems such as increased unemployment, crime rates, government expenditure and school dropouts. As you can see, increasing minimum wage can create even more problems, as I’ve explained before.

First things first, what is minimum wage and what are its effects? Minimum wage, or wage floors can be explained as a government-imposed regulation that makes it illegal for firms to pay wages below the specified legal amount, which in this case would be RM 900 and RM 800 in peninsular and east Malaysia respectively. To understand the effect of minimum wage, a more helpful approach would be to see what the labor market would be like without one. Without government intervention, the market forces would determine wage. With this, workers’ and firms’ surplus are maximized at the equilibrium level. (See Figure 1) A minimum wage below equilibrium won’t bring about negative changes, however, minimum wage is usually placed above equilibrium level (Figure 2), and this is where the problems start to surface.

Figure 1

                                                        Figure 2

Figure 3 shows an in increase from the previous wage floor of RM650 and RM450 to RM900 and RM800. As you can see, there is a rather drastic increase in wage floor.  From it surface, it would seem that increased minimum wage would combat unemployment, as more people will be willing to supply labor. The question is, which firm would be willing to hire labor at that cost? Those unemployed are not unemployed by choice. They are the ones who are willing to work, but no firm is willing to hire them. It could be that they lack the skills firms are looking for, or that firms don’t think their skills match up with the price they’re paying. What happens here is again a surplus of labor. As a result, both workers’ and firms’ surpluses are decreased, and a deadweight loss arises and unemployment increases.

                                                       Figure 3

Undeniably, increased minimum wage would benefit labor. But the only ones who will be benefitting from the increased minimum wage are those who manage to find employers who are willing to pay that much in wages for labor. This would be a small percentage and the rest of society would incur a potential loss from job searching as shown in Figure 4 below.

Call it minimum wage, call it a wage floor but to firms, it can only mean one thing: increased expenses. The moment these laws are enforced, firms will have to comply, like it or not. Firms would see diminishing returns in the short run as their average variable cost, marginal cost and total costs increase. Considering 99% of companies in Malaysia are Small-Medium Industries (SMIs), there is a concern on whether they’d be able to pay wages. They have voiced out their concerns saying they could be forced to retrench 4 million jobs, or close their business. Even if they retain their current labor, it is highly likely that black markets would emerge. Firms could offer wages in the illegal region and people would be more than willing to work as they have monthly obligations to meet. The severity of the wage disparity in the black market would depend on how effective government surveillance is. With tight rule enforcement and a watchful eye over firms, the black market wage would not be as drastic. However, there is a fear that there would be one too many firms to look after.

Let’s say the government does a good job in enforcing the minimum wage hike and no black markets emerge. Firms will have to pay more for low-skilled labor. This will also create a chain and push up wages for all labor regardless of their skill level. And seeing as firms still have marginal costs to cover, and what they most likely would do is hike up the prices of goods and services, and pass the cost to their customers, who are ironically also labors. It’s a never-ending cycle!

Consequently, the government would have to invest a lot of money into creating re-employment programs that would help hone the skills of these labors, as they have done with Sistem Latihan Dual Nasional (SLDN). Firms could be willing to pay higher minimum wages if they think that the skills of labors would improve the firm’s productivity. Besides that, the government might have to pay unemployment compensation in the form of medical care and general welfare of people who can’t support their own selves. Examples of countries that provide unemployment benefits are the United States of America, Italy, and Australia. If you noticed, most of them are first world countries that could afford to do all this. Can you imagine what if would be like if Malaysia followed suit? All I’m saying is it’s probably not a smart move to increase the government’s expenditure as Malaysia’s a developing country.

Unemployment would lead to a rise in crime rates, especially when left unattended for a long period. Considering the already high crime index in Malaysia, I’m sure we wouldn’t want to head in that direction. But then again, there are bills still need to be paid, mouths need to be fed and people would be driven to do things they otherwise wouldn’t. I’m talking about crimes. Let’s say proponents of increased minimum wage suggest unemployment benefits as in the previous paragraph to deter crime rates from rising, what is the guarantee that it will reach all people who are unemployed? In the countries that practice unemployment benefits, there are many tedious procedures one must go through to obtain the benefits, from being eligible, declaring yourself unemployed and constantly certify that you are eligible. People would take the easy way out and resort to crimes.

An increased minimum wage would also further encourage high school dropouts. The United Stated of America again gets a mention here; with unusually high rates of high school dropouts that it has become a national problem. Teens from struggling families that are in desperate need for money might see the increased minimum wage as a golden opportunity to set their family free from the shackles of poverty. From balancing school and part time jobs (which isn’t an easy feat), more would opt to work full time, quitting school altogether to make ends meet. However, with little to no skills to offer, firms would most likely not absorb these teens into their workforce. What will be next for these dropouts? You’ve guessed it, crime.

In conclusion, an increase in minimum wage might look attractive in the short run, but if we were to look at it in the long run, it would only create more problems rather than solve them. If you were to look at it from the perspective of equity and justice, increased minimum wage would only rob these people of their daily jobs, and there’s nothing fair about that. Therefore, I think the government must look at other ways to solve unemployment instead of combatting it by increasing minimum wage. One of the ways is by encouraging entrepreneurship so that many firms may emerge and absorb the labor force. Increasing minimum wage is not the answer.