OECD Washington Press Release - Week of 15 January 2007

US Only OECD Country with Real Minimum Wage Decline

Earlier this week, the House of Representatives approved a gradual increase in the minimum wage, from its current level of $5.15 to $7.25 an hour in 2009. If enacted into law, this would represent the first increase in the federal minimum wage since 1997. Some argue that an increase in the minimum wage is long overdue, since inflation has eroded its the purchasing power by approximately 20% over the past 10 years, even as overall pay levels in the economy have risen. Others caution that such a move would backfire by reducing the number of available jobs, sometimes adding that the government has better tools to fight poverty.

Recent experience in other countries can help to inform the American debate about the appropriate level for the minimum wage. Most OECD countries (30 of the most industrialised economies) have statutory wage floors, but they have set their minima at very different levels. Expressed in US dollar equivalents, minimum wages in OECD countries range from around 1 dollar an hour in Mexico to above 9 dollars an hour in some European countries (see graph).

At $5.15, the US minimum wage falls in the middle of this range. Yet, it is exceptional in several ways. First, the significant drop in the real value of the US minimum wage since 1997 contrasts sharply with the experience in other countries, where the wages of the lowest paid workers have at least kept pace with inflation. Second, the US minimum wage is much less generous by comparison with other countries when measured relative to the median wage (i.e. the wage received by a worker in the middle of the earnings distribution). A minimum wage worker in the United States earned only 32% of the median wage in 2005 – one of the lowest levels in OECD countries. At the top of the range, minimum wages are close to 60% of the median in Australia and France.

The process through which the US minimum wage is set also differs from that in other countries. For example, most countries have established a uniform minimum wage for the entire country, whereas many US states (and some municipalities) have set minima that exceed the federal standard. Indeed, 29 states, representing more than 70% of the national work force, have legislated minimum wages above $5.15. In many of these states, minimum wages would stay the same, even if the federal minimum increased.

Another difference relates to timing. Most OECD countries (and several US states) review minimum wage levels on a regular basis – usually every year. This can take different forms, such as recommendations by expert panels, as in Australia and the UK, or automatic “indexation” as in some European countries. These measures seek to adjust public policy automatically to a changing economic environment. Such practices help to explain why no country besides the United States saw the real level of their minimum wage decline during the past decade.

Finally, the United States makes much less use of special, lower minimum wages for groups of workers who might not be hired at the regular minimum. There are some provisions in US law for employers to pay young workers a sub-minimum wage during a short initial period on the job, but they are not much used. In other countries, such differentiated minima play a much larger role.

Would a higher minimum wage cost jobs? Simple economic reasoning says that a high minimum wage will harm employment for low-productivity workers. But a closer look reveals that a moderate minimum wage may have little or no effect on employment. Indeed, the impact of minimum wages on employment has proven to be difficult to pin down.

A recent, cross-country study conducted by the OECD finds no evidence that small increases in the minimum wage (relative to the median wage) result in higher unemployment. Some evidence does emerge that higher minimum wages may cost jobs for young adults, confirming that sub-minima may be appropriate for this group. This study also finds that the combination of high minimum wages and a high tax rate on wages is associated with higher unemployment.

What does this mean for the US debate? It confirms that proposals to raise the minimum wage should be carefully scrutinized to find out whether an unacceptably large number of jobs might be lost. But it also suggests that the modest increase being considered in the US is unlikely to result in large employment losses, even if it is not accompanied by cuts in business taxes, as some have proposed. Such a conclusion would be consistent with the recent experiences of the UK and Ireland. Neither country found much impact on employment after introducing minimum wages (in 1999 and 2000, respectively), even though they were set at levels above that proposed in the United States. Finally, the proposed increase in the US minimum wage would only recoup the real decline since 1997 and bring the federal level more in line with that in many states.

Yet, the ultimate test for a minimum wage is whether it improves the economic situation of low-wage workers. Does enforcing a wage floor in fact improve fairness in the labor market and help those facing financial hardship?

Experience shows that minimum wages, alone, are not the best way to reduce poverty. Changes in the minimum wage do not reach the poorest families, where no one has a job. In addition, many minimum-wage workers are not members of poor families. This has led some to argue against minimum wages, because it is much more “target efficient” for the government to tax families with some income to spare and give that money to the poor, for example, in the form of welfare benefits.

This reasoning is too black and white. Although the minimum wage is not a perfect tool, all other anti-poverty measures also have their drawbacks. Welfare benefits, for instance, need to be paid for by higher taxes and sometimes they do not even reach the people who need them. If levels are high, people may be discouraged from moving into jobs.

The real challenge lies in finding the best combination of policies to fight poverty while also rewarding work. Welfare programs have a role to play, as do in-work benefits, such as the Earned Income Tax Credit, which provide an income boost to low-income workers. International experience shows that an appropriately set (and maintained) minimum wage can also make a contribution, by helping to guarantee that work pays.

The Organization for Economic Cooperation and Development (OECD) groups 30 member countries sharing a commitment to democratic government and the market economy. With active relationships with some 70 other countries, NGOs, and civil society, it has a global reach. Best known for its publications and statistics, its work covers economic and social issues, macroeconomics, trade, education, development and science and innovation. The OECD produces internationally agreed instruments and recommendations to promote rules of the game in areas where multilateral agreement is necessary for individual countries to progress in the globalized economy. Dialogue, consensus, and peer review are at the very heart of the OECD.

For further information please contact Ms. Laura Creswell at the OECD Washington Center (e-mail, Tel 1-202-822-3873)