The traditional economic take on the minimum wage is that it causes unemployment. If the law says that an employer must either pay a man $7 an hour or nothing, and the man is only worth $5 an hour to the employer, then he will pay him nothing, and the man may go jobless. Many people are skeptical of this line of reasoning. After all, the U.S. recent raised the minimum wage from $5.25 an hour to $7.15 an hour, and it’s not like unemployment is terribly high right now.
Okay, bad example. The truth is that while the theoretical case against the minimum wage is sound, it can be hard to test the theory empirically by looking at the U.S. because minimum wages here tend to be low enough as to only apply to a small portion of the population (around 3%). Given that the minimum wage applies to so few workers – and the fact that market wage for even those workers is probably not far off the legal minimum – its not surprising that whatever effect minimum wage laws have on unemployment tends to get obscured by larger trends in the economy.
The picture is different if we take a worldwide perspective rather than confining ourselves to looking at the U.S.
In absolute terms the U.S. minimum wage is fairly high. According to economic theory, however, what matters is not the nominal level of the minimum wage, but how much and how often that wage diverges from market rates. A minimum wage of $1, for example, would not be expected to have any real impact on unemployment in the U.S., because even in the absence of such a law few if any workers would take a job for that amount. By contrast, there are many places in the world where a $1 an hour minimum wage would be extremely high, and we would expect a larger effect on unemployment in that case.
To test this, I compared Wikipedia’s list of countries by unemployment rate with the level of each country’s minimum wage as a percentage of GDP (which serves as a proxy for the relative value of the wage for that society). As the chart above shows, economic theory holds up pretty well.
We get the same result if we look at a country’s labor market freedom (as determined by the Index of Economic Freedom). This ranking is based on more than just the minimum wage – it also includes other labor market regulations such as restrictions on the ability of an employer to fire workers – but economic theory predicts that many of these other regulations will also tend to increase unemployment:
As John Adams famously said, a man is entitled to his own opinions, but not his own facts. And the facts seems to indicate that higher minimum wage laws are associated with higher levels of unemployment, exactly as classical economics would predict.