The International Experience of Minimum Wages in an Economic Downturn

Abstract

What should governments do with the level of the minimum wage (MW) in times of recession? In an economic downturn when most workers face falling real wages is it appropriate to let the MW fall or are the positive effects of the MW on inequality enough to justify its uprating – and if so what might be the consequences on a country’s employment level? This paper reports new estimates of the employment effects of the MW by focusing on the recessionary experiences across countries. Using international data we exploit: cross‐national variation in the level and timing of the MW uprating and the exact timing of the recessionary experiences in different countries with a panel data set comprising 33 OECD over the period 1971–2009. Our panel data allow us to differentiate the effect of MWs on employment in periods of economic downturn as well as periods of economic growth. We also account for institutional and other policy related differences that might have an impact on employment other than the MW. We find that the answer depends on whether one considers adults or young people, and to some extent, on what measure of the MW is considered. The answer is also somewhat sensitive to whether one considers that the MW level is a choice option of the government which is inextricably interrelated to the determination of employment – that is, the extent to which the MW is endogenous. Using a ‘political complexion of the government’ instrumental variable (IV) we find that the MW only has a negative impact on youth employment. This leaves each government with the dilemma of raising the MW and reducing inequality or increasing the MW and accepting that this will reduce employment levels amongst young people and those on the margins of work.