RDP 2018-06: The Effect of Minimum Wage Increases on Wages, Hours Worked and Job Loss 1. Introduction

The effect of minimum wages on employment has been widely debated. Despite a vast research effort, economists remain divided on the issue. In Australia, these effects have been particularly difficult to quantify, in part due to Australia's complex system for setting minimum wages. Due to this lack of evidence, policymakers have tended to rely on the evidence for the United States and United Kingdom. However, as the Productivity Commission (2015b, p 190) has argued, we should be cautious in drawing lessons from the US and UK experiences, due to the ‘significantly different institutional wage setting arrangements and lower minimum wages’ in those countries compared to Australia.

This paper uses some of the unique institutional features of wage setting in Australia as an identification strategy to estimate the effects of minimum wage rises on wages, hours worked and the job destruction rate. To my knowledge, these are the first causal estimates of the effect of minimum wages on hourly wages in Australia. My analysis also adds to the limited evidence base on the effects of minimum wages on hours worked and the job destruction rate. I also make a methodological contribution, by proposing an identification strategy that is arguably better suited to Australian wage-setting institutions than those used in previous research. Finally, I use a new job-level dataset that provides several important advantages over other datasets that have been used previously in the Australian and international literatures.

The impact of minimum wages on employment remains contentious in the international literature. The empirical evidence often differs depending on the methodologies and datasets used. Economic theory also makes no clear predictions. Although the traditional competitive model of the labour market suggests that a minimum wage rise will reduce employment – if set above the market clearing wage – other theoretical models can predict the opposite. For example, an increase in the minimum wage could increase employment in a monopsony labour market (e.g. Card and Krueger 1994). Thus, there is a need for further empirical evidence on the relationship between minimum wages and employment, and in particular, credible evidence for Australia.

In Australia, up to 40 per cent of employees are directly or indirectly affected by the Fair Work Commission's (FWC) annual wage review.^[1],[2] In part, this reflects that Australian minimum wages are high relative to other nations – both in absolute terms and as a share of median earnings (Leigh 2007). However, the large share of employees influenced by FWC decisions also reflects Australia's unique ‘awards’ system for setting wages, which often requires minimum wages that are higher than the national minimum wage (NMW). This paper provides estimates of several key parameters that are important in gauging the effects of these policy decisions.

Australia provides a useful laboratory for studying the effects of wage floors. Unlike other countries that set a single minimum wage (e.g. the United Kingdom, Germany and New Zealand) or a minimum wage that varies by state (e.g. the United States), Australia sets thousands of minimum wages that range from $18.29 per hour to as high as $165 per hour (as at 1 July 2017). These ‘award wages’ can depend on the industry, age, skill level, qualifications and location of an employee, plus a range of idiosyncratic factors.

To identify the causal effect of award wage increases on wages, hours worked and the job destruction rate, I focus on a unique period in Australian labour market history. Up until the late 2000s, the FWC was routinely announcing uniform dollar increases to all awards each year, regardless of their current level. This led to larger award wage rises in percentage terms for jobs whose award wages were relatively low, compared with those on higher award wages. Using job-level data from firms and a difference-in-differences strategy, I find that award changes are almost fully passed through to wages, and have no statistically significant effect on hours worked or the job destruction rate. These results are robust to controlling for wage group-specific shocks using a difference-in-difference-in-differences strategy and data on jobs whose pay is not set by awards.

A key advantage of my study is that I use job-level data that include both a precise measure of actual wages and an indicator for whether a job's wage is set according to a minimum or award wage. This allows me to focus on jobs directly affected by minimum wage decisions. This approach differs from much of the previous literature (particularly for the United States), which, due to data limitations, tends to focus on low-wage industries, such as the restaurant sector, or on lower-productivity employees, such as teenagers. Using low-wage groups as a proxy for employees reliant on minimum wages may lead to biased estimates of the effect of minimum wages on employment (Jardim et al 2017).

The job-level data I use also allow me to study the effect of changes to minimum wages on hourly wages themselves, which is rarely possible. The pass-through of award wages to hourly wages is a key consideration for the FWC in terms of assessing whether firms are complying with their legal obligations. The elasticity of hourly wages with respect to minimum wages is also one of the key parameters in assessing the effect of minimum wage increases on income inequality (Leigh 2007).

The remainder of this paper is structured as follows. Section 2 briefly discusses previous work on the effect of minimum wages on employment. Section 3 provides some background on Australia's system of award wages. Section 4 describes the natural experiment. The empirical strategy and data are described in Sections 5 and 6, respectively. Sections 7 and 8 present the empirical results and robustness tests, and Section 9 provides some concluding remarks.

Footnotes

Data from the survey of Employee Earnings and Hours (ABS Cat No 6306.0) suggest that 22.7 per cent of employees had their wage set according to an award wage in 2016. I refer to these as ‘award-reliant’ employees. The Award Reliance Survey for 2012/13 suggests that a further 21 per cent of employees had their wages influenced in a mechanical way by FWC decisions (Wright and Buchanan 2013). [1]

The FWC is an independent body with responsibility for adjusting minimum and award wages. The FWC began operation on 1 July 2009 (named Fair Work Australia), after assuming responsibility for award wage-setting from the Australian Fair Pay Commission (established in 2005) and the Australian Industrial Relations Commission prior to that. Throughout this paper, I use ‘FWC’ to refer to any of the various national and state industrial relations commissions with responsibility for setting award wages since the late 1990s. [2]