Monday, April 7, 2014

Myth: Australia has a $16 minimum wage with no adverse effects.

Myth: Australia has a $16 minimum wage with no adverse effects.

First of all, there is a HUGE difference between nominal and real exchange rates. Nominal exchanges rates are the exchange rates people typically think about (the number of currency units of one country it takes to purchase one currency unit of another country). In contrast, the REAL exchange rate is the ratio between the domestic price level and the price level in a different country. Different countries have different domestic prices. The real exchange rate accounts for this difference while the nominal one does not. Thus, one should be skeptical of any claim that Australia has a minimum wage of $16. In terms of nominal exchange rates, the claim is true. However, real exchange rates are what matters since they take the cost of living into account.

Another thing worth noting about Australia’s minimum wage is that there are different minimum wage rates which apply to different age groups. Using the formula Q = P d/( ε*P f) to find the real exchange rate between the US dollar and Australian dollar, I was able to find how much the minimum wage is actually worth in Australia in 2013 (when the minimum wage was raised) for varying age groups:

Real Australian Minimum Wage (2013): [Data from citations 1 and 2]
Age 21+: $10.63
Age 18: $7.27
Age 16: $5.03
Under 16: $3.92

For Comparison:
United States real minimum wage (2013): $7.25

It appears as though while the Australian minimum wage in 2013 was greater than the minimum wage in the United States, it is still almost $6 lower than the figure minimum wage proponents cite. To be fair, since 2014 the real minimum wage for people aged 20+ in Australia has risen to $12.61 due to a rapid fall in the cost of living. Australia’s cost of living has changed randomly from year to year.

The unemployment rate in Australia when the minimum wage was raised (July 2013) was 5.7% and since then has risen to 6.0% [3]. Minimum wage proponents cite this relatively low unemployment rate as proof that raising the minimum wage will not increase unemployment. First, we should already expect Australia’s unemployment rate to be low based off the fact that it was one of the few developed countries not to suffer badly from the 2009 recession (their economy contracted 0.2% in contrast to the US economy which contracted 3.7%) [4]. Additionally, there are many reasons to expect that raising the minimum wage wouldn’t affect the overall unemployment rate. For one, most people earn more than the minimum wage. According to one article, only 2% of the workers in Australia are covered by the minimum wage [5].

Also, a low unemployment rate can be maintained simply because people have dropped out of the labor force and thus stopped looking for work. Indeed, a startling but superficial observation is that the labor force participation rate in Australia dropped steadily from 65.3% in June 2013 (the month before the minimum wage increase) to 64.5% in January 2014 (see below) [6]. Since then labor participation has slightly recovered. Was the minimum wage raise the cause of this decline in labor force participation?

As noted earlier, only a small amount of workers are covered by the minimum wage so it’s hard to say for certain (also other factors could be at play). However, as our friends over at Unbiased America have pointed out, minimum wage increases in the US have coincided with significant drops in labor force participation. The fact that the same thing occurred in Australia is intriguing.
In order to measure the effect of the minimum wage, researchers must examine employment and labor participation among low skilled workers and account for numerous other confounding variables. While there is no research on Australia’s current minimum wage to my knowledge, past research from Harvard University on Australia’s minimum wage has stated: “[F]or each 1 percent increase in the minimum wage we can expect... [to lose] 96,000 jobs" in Australia" [7].  

In conclusion, the minimum wage in Australia is much lower than its proponents state, but it is still much higher than the United States’ minimum wage. The low unemployment rate in Australia relative to other countries is due to the fact that it largely escaped the global recession when most developed countries didn’t. Additionally, we can’t expect to deduce the effects of a minimum wage increase on employment by solely looking at the unemployment rate. While more research on this issue is warranted, past research suggests that raising the minimum wage in the past has not benefitted Australia.

This myth is based off the wrong exchange rate and makes deductions based off superficial data. Thus, it shouldn’t even be considered a valid argument.
Parting notes: It’s worth mentioning that Australia has very admirable economic policies. They have relatively low government spending compared to other rich democracies and rank very highly on the Economic Freedom Indices. Their economy is so free in fact, that they are ranked as the third freest economy in the entire world [8]. Any negative effects that their minimum wage imposes on their economy are most definitely outweighed by the positive effects of economic freedom.

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