Klaus F. Zimmermann
The new German government coalition has announced the introduction of a national statutory minimum wage of €8.50 per hour. The wage will be implemented as of January 1, 2015, allowing interim wage agreements until December 31, 2016.
Given that the decision to introduce a minimum wage has already been made, the discussion now needs to focus on identifying the negative consequences for the German labor market. In particular, that means proposing ways to minimize those negative effects.
Although many European countries have a minimum wage, they differ substantially in terms of the wage level, the chosen mechanism of adjustment, and the exceptions for certain labor market groups.
Minimum wages can be compared internationally by relating them to median earnings. This measure is commonly referred to as the Kaitz index. For Germany, the median hourly wage for full-time employees was €17.10 in 2012.
Thus, the proposed minimum wage amounts to 50 percent of the median income in the country, placing Germany considerably above the OECD average (see chart below). These results suggest that this asymmetry will have serious consequences for the German labor market.
Minimum wages in Europe relative to median full-time earnings (2012). Source: OECD.
* based on median wage for full-time employees (€17.10/hour)
** based on median wage for all employees (€14/hour)
*** mean of available calculations (€15.26/hour)
What Will Be the Likely Outcome?
One has to be concerned about seven negative consequences in total. First, a number of simulation studies have examined the employment effects of implementing a statutory minimum wage. Studies undertaken by researchers of the IZA for Germany have shown that at least 600,000 people – among them mainly part-time employees, women, low-skilled workers and East Germans – will lose their jobs. That is 1.38 % of the country’s labor force and could drive up the German unemployment rate from the present 7.3 % to 8.7 %.
Second, significant consequences for employment can be expected particularly in areas that have contributed strongly to recent job growth, such as the service sector and part-time employment.
Third, many small businesses and employers in East Germany will be forced to make significant upward wage adjustments. This will also affect employment and it will create incentives to circumvent minimum wages, e.g., by working unpaid overtime or by shifting employment to work contracts based on formal self-employment.
Fourth, as is common in other countries, young workers, trainees, interns and long-term unemployed individuals should be exempt from the minimum wage in order to prevent them having to face an additional barrier to labor market entry.
Fifth, past research shows that (high) minimum wages encourage adolescents to drop out of training programs. Why? A minimum wage makes even simple jobs more attractive. Instead of accumulating human capital, which is increasingly important in a global economy reliant on higher qualifications, young workers may accept unstable and low-skilled jobs. This damages their future labor market prospects.
Sixth, due to large differences in minimum wage levels across EU member states and in view of the free movement of labor within the EU, it is also possible that additional workers from countries with lower minimum wages may seek work in Germany. This would have adverse effects on Germany’s overall labor market.
Finally, the political rationale behind the introduction of a statutory minimum wage is usually dominated by social fairness considerations. Given that, it is important to look at the distributional effects.
Although a minimum wage has a positive impact on the wage distribution in a country, the interaction of minimum wages with the given country’s tax and transfer system means that there is little change in disposable income. How so? Simply because higher wage income raises tax liability and that, in turn, leads to reductions in supplemental income benefits these individuals receive.
Further, and even worse, most of those who currently qualify for the minimum wage do not live in low income households. Hence, it is not at all surprising that the income distribution across households can hardly improve. Minimum wages are known to be very inefficient tools to fight inequality.
What Should Be Done?
First, if the introduction of a minimum wage is politically desired despite its potentially negative labor market effects, a cautious approach is advisable as it was taken in the United Kingdom. Starting off at a lower level than €8.50 would allow the German government to test the impact of a minimum wage on the market. Based on the results, the minimum wage could be incrementally raised or such increases might be found inadvisable.
Second, a lower minimum wage for adolescents without training, as well as for trainees and interns, is reasonable provided that skills acquisition has priority, as it should. Moreover, an exception for the long-term unemployed helps to prevent the minimum wage from becoming a permanent hiring obstacle.
And third, what is of utmost importance after any implementation is the ongoing analysis of dynamic changes in the level of employment and wages, corporate workforces, labor demand, particularly the creation of new jobs, or the quality of employment.
It would be interesting to see how the statutory minimum wage in Germany affects the wage distribution above the minimum wage threshold.
However, the German government does not plan to establish such a careful evaluation based on independent scientific research. And it attempts to impose a strict and general implementation of the minimum wage with practically no exemptions.
However, policymakers should tread carefully. Despite the political dynamics, they should use caution and proceed in a gradual fashion – lest they accept the risk that their good intentions will result in great disappointment in the end.
After all, the road to social policy improvements is plastered with examples that ended up backfiring, not just diminishing the intended positive effects from becoming a reality, but contravening them. That is a luxury – read: waste – no country can really afford any longer.
An adapted version of this article appeared in the Wall Street Journal (April 2, 2014).