Nova workboard

a blog from young economists at Nova SBE

Pros and Cons of Raising the Minimum Wage

In October, the minimum wage in Portugal increased from €485 to €505 after a four-year freeze. The main idea was to help workers with lower incomes by increasing their salaries. However, there are those who claim that this reform will bring adverse effects to the unemployment rate, mainly among younger people, and to the international competitiveness. In this context, this article presents the arguments surrounding these two optics.

Between 2011 and the end of 2013 the minimum wage has remained constant, however it was registered an inflation rate of 6.8%. Thus, these workers saw their purchasing power being reduced gradually. The 4.1% increase in the minimum wage partly restored the lost purchasing power, resulting in an improvement in the living standards of the less paid workers. As a rule, these low-income individuals have a high propensity to consume and a low propensity to save. This is because a good part of their basic needs are still unmet and therefore any wage increase is directed to consumption, thus stimulating the economy. To meet the increased demand in the goods market, companies will need to increase production and for this hiring more workers is a possibility.

In the supply side of the labor market, increasing the minimum wage makes the position to be working more advantageous compared to being unemployed (and receiving the appropriate benefits), which may lead to an improvement in the participation rate. In addition, according to the efficiency wage hypothesis this reform may increase the satisfaction and productivity of employees, and hence rise the productivity of the entire economy. Therefore, the turnover rate decreases and the costs associated with training new workers are reduced.

With respect to the government budget there might be a positive improvement. On one hand, social assistance provided to workers with lower incomes may be reduced; in the other, revenues from income taxes could increase.

In the other side of the coin, the minimum wage increase overburden businesses, especially smaller ones and those labor-intensive. If they have tight budgets it will not be able to bear the same number of employees and firings will become a reality. Another measure is to increase revenue by raising the prices of their products, which ultimately will result in higher inflation, a higher cost of living, and the loss of international competitiveness.

Regarding the labor supply, the minimum wage increase will bring more qualified and more experienced workers in the competition for minimum wage positions, putting aside the younger (inexperienced) and the unskilled. The unemployment rate, mainly of younger, will be stepped up. Moreover, the development of the black market will be encouraged, as this reform could increase the appearance of informal contracts with companies paying less than the legal minimum wage.

In short, this measure has a limited impact on reducing poverty and may bring negative impacts to the economy. Since the poor are often unemployed and survive only with social grants, they are not benefited by the minimum wage increase.

An alternative would be to encouraging the creation of new jobs, and thus give the opportunity to more people to support themselves from their work, instead of increasing the income of those who already have jobs. This does not mean that is not important nor beneficial to improve the standard of living of minimum wage workers, but to suggest that improve the quality of life of those who have no work is more urgent.

Helena Fernandes, nr 737

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Author: studentnovasbe

Master student in Nova Sbe

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