In a couple of days time, we’re going to find out the composition of our new government for the next few years, most likely in the form of a Fine Gael-Labour coalition. While a lot of media attention has been placed on the two parties’ policy disagreements over the past week, one of the few economic issues on which they agree is the reversal of the recent cut in the minimum wage to €7.65 an hour. The cut in the minimum wage was certainly an unpopular move, but with the cost of living having decreased so much in the past few years, has it really made minimum wage earners that much worse off, and is reversing it really necessary?
To investigate this, I’ve put together a simple cost of living index* for those living on minimum wage, based on my own experiences living on a similar income over the past few years. The following graph shows the real value of the minimum wage since it was brought in in April 2000, according to my cost of living index (click to see full size):
You can see that, prior to 2008, the trend in the minimum wage was quite regular; the real value of the minimum wage would gradually drop due to inflation, coupled with an increase in the nominal rate by the government every year or so, causing the overall value to slowly increase over the first 8 years of the minimum wage’s existence. Since late 2008, though, we’ve had a very different dynamic, as dropping prices (in particular the big drop in rents) have caused a big increase in the real value of the minimum wage, to the point where the €8.65 minimum wage was worth 11.3% more in January 2011 than when it was introduced in July 2007.
So, has the drop in the minimum wage (shown to the far right of the graph) made a big difference to minimum wage earners? Compared to the recent past, yes, as they’ve benefitted significantly from a large drop in the cost of living. Looking back over the past few years, though, a minimum wage of €7.65 is still very high in real terms. It’s actually worth more than €8.65 was as recently as November 2008, although it’s a little lower (by 1.5%) in real terms than when the €8.65 rate was introduced in July 2007.
The big question, though, is not so much the effect of the decrease in the minimum wage, but whether it was necessary. That is, was €8.65 an hour too high? I think we can all agree that there’s such a thing as a minimum wage that’s too high; if the minimum wage was set at a million euros an hour, no employer could afford to pay it and there’d be 100% unemployment. The question then, is how high a minimum wage can get before it starts to have negative effects. There’s no easy way to determine this, but the closest guide we can go by is by looking at the unemployment rate of the social groups most likely to work at or around minimum wage; if unemployment is high amongst these groups, it’s likely that the minimum wage is having a negative effect on employment. One group which is very likely to work at minimum wage is those under 25 years of age, so I put together the following graph of unemployment rates both of those under 25, and those over 25 for comparison (click for full size):
As you can see, there’s been a huge increase in unemployment for those under 25 over the past few years, and the unemployment rate for the group is now approaching 30%. Of course, there’s also been an increase in unemployment for those over 25, and a chunk of the male under 25s unemployment since 2008 will have been from the construction sector, which would have paid over minimum wage. Nonetheless, an unemployment rate of almost 30% for any group is still astonishingly high, and it’s very likely that the €8.65 minimum wage was having an impact on this, which would lend credence to the argument that the decrease will have a positive effect on employment, and should be left as is by the new government.
Another factor that has to be taken into account when talking about the impact of the minimum wage on employment is the similar effect of social welfare rates. Put simply, people aren’t likely to go out looking for work if they’re better off on unemployment benefits. In Ireland, this is particularly a problem when it comes to part-time work; as jobseeker’s allowance is reduced according to the number of days you work, someone working three 8-hour days at minimum wage is actually worse off than they would be if they weren’t working at all. Those working shorter shifts are in an even worse position. A smart, and relatively easy move, for the incoming government would be to link reductions in jobseekers allowance to the amount earned, rather than days worked, which would significantly increase the incentive for the unemployed to take up part-time work, and mitigate against any need for further cuts in welfare rates.
* The composition of the cost of living index is 30% rent, 20% food, 8% each for clothes, electricity and gas, and the remaining 26% being represented by the HICP (which, unlike the CPI, excludes mortgage interest). The data is from the CSO and Daft.ie, with early rental data compiled by the ever-helpful Ronan Lyons.