To Index, or not to Index, That is the Question!

In Nova Scotia, the provincial government indexes the minimum hourly rate to inflation, which allows those earning it to retain their purchasing power. The issue with this approach is it places the onus on firms to solve a political problem: whereas the government is concerned with ensuring all Canadians can afford necessities, the “bottom line” for most businesses is healthy margins, productivity, and sales. To quote Thomas Sowell, an economist at the Hoover Institute, “Making it illegal to pay less than a given amount does not make a worker’s productivity worth that amount–and, if it is not, that worker is unlikely to be employed.”

If wages rise faster than productivity, the cost of labour per unit of output increases. For instance, Footwear Unlimited pays employees the minimum wage–say $10–to produce 20 shoes in an eight-hour shift. The unit labour cost, therefore, is $4, i.e. ($10*8hrs)/20 shoes = $4 per shoe. Assuming productivity remains the same, increasing the minimum wage to $10.5 raises Footwear Unlimited’s unit labour cost by five per cent–$4.2 per shoe, despite neither producing more shoes, nor generating additional revenue. The result is a net loss, and to some companies, i.e. small businesses, it can be a death knell.

Some analysts argue labour productivity has outpaced the rise in minimum hourly rates, yet, though this is true for some economic sectors, it is not for all of them. The majority of minimum wage earners work in retail trade or accommodation and food services, for example, wherein productivity gains have been disparate. Between 1997 and 2013, labour productivity (which is the ratio between real GDP and hours worked) grew by nearly 53 per cent in the Canadian retail trade sector and 9 per cent in the accommodation and food services sector; adjusted for inflation, the average rise in minimum wages throughout Atlantic Canada was 37 per cent.

Productivity vs. Minimum Wages

In other words, firms in the retail trade sector experienced productivity gains in excess of the rise in minimum wages, whereas firms in the accommodation and food services sector suffered from the opposite. This illustrates the fundamental flaw with mandated wage rates (and, in particular, indexing them): some firms must pay higher wages without workers producing more, thereby sacrificing growth, forcing them to lay off workers, or, most concerning, shut down operations. To quote Sowell again, “The real minimum wage is always zero, regardless of the laws, and that is the wage that many workers receive in the wake of the creation or escalation of a government-mandated minimum wage, because they lose their jobs or fail to find jobs when they enter the labour force.”

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One thought on “To Index, or not to Index, That is the Question!

  1. The Stateless Man says:

    May I suggest that it is not the question. Rather, the very existence of a minimum wage is the height of economic folly and busy-body paternalism gone bad. The only good minimum wage is no minimum wage.

    Right now, there are college graduates in Canada who can’t even get jobs at McDonalds, because foreign workers are more punctual, productive, and loyal. If the minimum wage and the prohibition on unpaid internships (with limited exceptions) were not around, perhaps they would have marketable skills.

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