Minimum Wage, Inequality and Incentives to Work

According to data available in Pordata, the percentage of workers earning the minimum wage in Portugal grew from 10.5% in 2010 to about 22% in 2018. These data do not include public servants, so the real percentage should be higher. Typically, the percentage of workers earning the minimum wage is lower than 10%, as it was in Portugal from 2001 to 2009. Therefore, Portugal’s 22% in 2018 is an extremely high value and is not normal.

Data from Eurostat for 2018 also shows that as a proportion of the median wage, the minimum wage ranges from a minimum of 42% in Estonia to a maximum of 66% in France, among European Union (EU) member states which have minimum wage. The Portuguese minimum wage was 64% of the median wage, the second highest among the EU member states. On the other hand, in terms of purchasing power, also according to the data from the Eurostat, the Portuguese minimum wage ranks in an intermediate position, 12th among 21 countries

As we all know, a Portuguese worker earning the minimum wage does not have a comfortable life and everyone agrees that our minimum wage is low. However, this low minimum wage level has its origins in the low level of Portuguese wages and not in the low level of the minimum wage as compared with the median wage. As we saw above, when compared with the median wage our minimum wage is not low, in fact is one of the highest in the EU.

However, the minimum wage can have a positive role in limiting poverty; it establishes a minimum standard of life and contributes to decreasing wage inequality, although to a limited extent. In fact, when the minimum wage increases, the arguments that are announced are precisely these.

So, a natural question is: Why is an increasing percentage of workers earning the minimum wage in Portugal? In my opinion, this has been happening because firms cannot increase the wages of all workers at the same rate as the mandatory minimum wage. Why not? Simply, because the rate of growth of the productivity of firms and of the country does not allow that, and consequently, the wages of other workers are increased by the amount that is left available after the minimum wage bill. The consequence of this is that an increased percentage of workers earns the minimum wage or a wage close to that and the wage differences between workers around the minimum wage decrease.

We could be tempted to say that this is good because we are decreasing inequality and because wage inequality is high in Portugal, but we are not. In reality, wage inequality was higher in the past than it is today, as it has been decreasing since the middle of the 2000s. Moreover, inequality in Portugal is still somewhat high, mainly because there is excessive inequality between the workers’ skills – workers are different – and not because there are excessive wage differences between workers with the same or with different skills. Put simply, in general, there is no excessive wage difference between two doctors or two engineers with the same level of experience, or between a worker with a university degree and another with upper secondary education, admitting that all other skills are equal in both examples.

Having said that, is there any problem if the increase in the minimum wage continues to contribute to decreasing wage inequality? In fact there is, as we will have an increased percentage of workers of different skills earning the same wage, the minimum wage, or a wage very close to the minimum, when they should have different wages. This means that there will be workers (and we have lots of examples) of different levels of experience, responsibilities or education earning very similar wages, which erodes workers’ motivation, effort and incentives to work.

Sometimes there are news of job offers for engineers, nurses, and other skilled jobs at the minimum wage and everyone is shocked at that. One of the reasons for these offers may be the minimum wage policy followed in the last years, which put the minimum wage in a relatively high position as compared with the median wage.

So, what can be done to improve the wages and the minimum wage in particular without creating the distortions that we pointed out above? First, the real minimum wage should increase according to rate of growth of the productivity of the economy and not at a political rate as it seems to have been the case in the past. Second, the country should continue putting its effort into educating workers. This is the fundamental variable to increase workers’ productivity and wages in the medium and long run. Finally, all other policies that stimulate economic growth should also be put in place because their counterpart will be a higher wage level, including the minimum wage.