The Impacts of Minimum Wage Increases on the Canadian Economy
The following are highlights from the recently released Bank of Canada report on the minimum wage increases that can be accessed in full at the end.
Bank of Canada staff – The following reviews the channels through which scheduled minimum wage increases over the coming years may affect Canadian economic activity and inflation and assesses their macroeconomic impacts. From reduced-form estimates of direct minimum wage pass-through, we find that consumer price index (CPI) inflation could be boosted by about 0.1 percentage point (pp) on average in 2018. A structural general equilibrium simulation suggests that minimum wage increases would reduce the level of gross domestic product by roughly 0.1 per cent by early 2019 and boost CPI inflation by about 0.1 pp. While the net impact on labour income would be positive, employment would fall by 60,000—a number that lies in the lower part of a range obtained from an accounting exercise (30,000 to 140,000). Consumption would decline because higher inflation would elicit a slight interest rate increase, which would more than offset the higher labour income. Potential output should remain unchanged in the short run. Longer-term effects are possible through automation, productivity gains or participation in the labour force, but the signs of these longer-term effects are ambiguous.
This report reviews the channels through which minimum wage increases can affect Canadian economic activity and inflation and assesses the macroeconomic impacts of the scheduled provincial minimum wage increases in the coming years. The key results are as follows:
- The macroeconomic impacts of these measures may be significant because about 8 per cent of employees in Canada work at the minimum wage, and estimates in the literature suggest that changes in the statutory rate have historically affected the wages of up to 15 per cent of employees with lowest wages.
- The increases in the minimum wage lead to higher real wages, which push up firms’ marginal costs, and thus inflation increases accordingly as a fraction of firms adjust their prices in the short term.
- Weaker labour demand leads to reduced employment and lower hours worked, although the net impact on labour income is positive.
- Consumption would be reduced slightly as the higher inflation would elicit a slight interest rate increase, which would more than offset the higher labour income.
Direct pass-through impact on CPI inflation (Pass costs on to the consumer)
Since a higher minimum wage raises production costs for firms, it is likely that part of the increase will be passed on to consumers. The extent of this pass-through, however, depends on firms’ ability to substitute away from the higher-cost labour inputs and preserve their margins, as well as the competitive landscape they face. To assess the direct impact of the pass-through from minimum wage to CPI inflation, we use reduced form regressions with monthly provincial CPI inflation as the dependent variable and provincial minimum wage changes as the main explanatory variable
Labour market adjustments (Same work, less workers)
The most widely studied aspect in the minimum wage literature is the impact on employment. Traditional competitive models suggest that an increase in a binding minimum wage will reduce employment, as firms substitute toward other inputs, such as capital or, perhaps, other more, productive labour. Although empirical evidence is mixed on the magnitude of minimum wage effects, most studies for Canada find that the reduction in employment is statistically significant, especially for younger workers.
In the structural model simulation, the increase in the minimum wage is captured as a negative labour supply shock that raises wages by 0.7 per cent. This shock reduces the demand for labour, leading to a decline in total hours worked of 0.3 per cent. If average hours worked remain unchanged, this would represent a loss of about 60,000 jobs by 2019.
Overall impact on real activity and inflation (Get more out of workers above minimum wage)
Minimum wage increases can boost aggregate wages through direct cost-push effects and through potential spillover effects to workers earning just above the minimum wage. In theory, the higher minimum wage raises the relative price of low-skilled workers, so employers substitute toward higher-skilled workers and bid up their wages. In addition, employers may adjust wages throughout the distribution to restore former wage differentials for reasons related to recruiting, retention and morale. However, the literature suggests that effects on wages tend to taper off further up the distribution.
Net impact on inflation (Prices go up, inflation goes up)
The first channel of importance is the direct impact of higher minimum wages on CPI inflation. In the model, an increase in aggregate wages raises firms’ marginal costs, which triggers an increase in prices in the economy.
Implications on potential output (More automation, more competition, less humans)
We assume that potential output does not change in the short run in our simulations. However, it is possible that changes in the minimum wage may affect long-run employment and investment. These long-run effects may be substantially larger than the short-run effects. As the minimum wage increases, firms may decide to substitute labour for capital by investing more heavily in automation, and this may even affect what types of firms enter and exit the market.
An minimum wage increases may also affect labour supply and demand in the long run. Under standard models with perfectly competitive labour markets, higher wages would induce more workers into the labour force. However, the presence of search frictions creates two opposing effects: higher wages raise the payoff from searching for work but weaken firms’ incentives to create jobs, making it more difficult to find work and thus discouraging search efforts
Read the full Impacts of Minimum Wage report by clicking on the link.