Tuesday, 10 November 2015

Anticipating the effects of the new minimum wage in Portugal




Following the October elections, Portugal may be faced with an entirely new government format, led by the Socialist Party and supported by the Communist Party and the Left Bloc. While the socialists have been in power on several occasions, the last time in the six-year period just preceding the 2011 financial bailout of Portugal, the communists and their Trotskyist counterparts, the Left Bloc, have never been in power. 

Despite the three parties coming after the centre-right coalition in the polls, together they command an absolute majority in the parliament. Although the political debate before the elections and the manifestos of the three parties did not raise the prospect of an ex post coalition, they have now agreed to unite in order to overthrow the two-week old centre-right government. Should the president agree, the three parties will form the new government, coming into office some time later this month or in December.

After several internal discussions held over the last month, the left and extreme left coalition have now proposed a number of new measures. Their main goal is to reverse the austerity and structural reforms implemented over the last years, during the adjustment programme of Portugal. 

One noteworthy measure to be implemented from January next year is a 20% increase of the minimum wage over three years. Despite low by British standards (at only €590 per month), the current minimum wage corresponds to approximately 60% of the median wage. From this perspective, Portugal ranks just below France and Slovenia in terms of the relative size of the minimum wage across all the OECD countries.
In order to anticipate and understand accurately the effects of this proposal, it is important to examine in depth the Portuguese labour market and also to characterise the workers and firms for whom the minimum wage is more important. In fact, for a large number of workers and firms, even a 20% increase in the minimum wage is largely irrelevant as their salaries are much above the current and future levels.

However, for those groups where the minimum wage matters, its increase will ‘bite’ and potentially lead to unemployment. This is particularly true given that the Portuguese economy is still reeling from the recession of 2011-2013, in which its GDP fell by nearly 7pc. Unemployment is still at 12pc, despite falling from 17.5pc in 2013. The larger the size of these groups and the larger the bite of the MW increase, the greater the potential disemployment effects. In other words, an analysis of the impact of the MW needs to focus on the relevant “margins”, rather than on averages that can provide a highly misleading picture of the MW bite. A rigorous analysis has needs to take into account the specific content in which a policy is implemented – this implies that the effects of a MW increase in Portugal are likely to be very different from the same policy in the UK, for instance, given the much lower unemployment.

The following graphs (based on own calculations drawing on micro data for 2013) illustrate the vast differences in the minimum wage incidence across different workers and companies, highlighting how key sectors of the Portuguese economy may be highly sensitive to variations in the minimum wage. 

Figure 1: Minimum Wage and Worker’s Age

Figure 2: Minimum Wage and Worker’s Tenure

Figure 3: Minimum Wage and Firm size

Figure 4: Minimum Wage and Business age (idade da empresa)


From these and other results (available at http://economiadaspessoas.blogspot.com), we can conclude that: 

  1.  More than 30% of employees in small (between 1 and 4 workers) and young (less than one year old) firms are paid the minimum wage (in comparison with only 5% of employees in companies with more than 250 employees)
  2. More than 20% of all workers in specific regions and sectors (such as agriculture, some manufacturing, transport, catering and some services) earn the minimum wage.
  3. Over 60% of 18 years olds are paid the minimum wage, a percentage that falls steeply with age, stabilising at a 10% for those aged 35 and above.
  4. About 25% of employees in their first year earn the minimum wage (a statistic that compares to less than 10% of workers with 10 years or more of tenure)
  5. About 20% of workers educated up to lower secondary earn the minimum wage, in comparison with only 5% of workers with post-secondary studies.

In a nutshell, the minimum wage in Portugal has a particularly high incidence on younger and less skilled workers, on those that are in their first year at their current job, across specific regions and sectors, and especially on young and small firms. These are the most fragile economic sectors, but also the ones with greater potential for job creation. These findings also underscore the dynamic aspect of the minimum wage as an entry wage that is then subject to increases over time.

Given the evidence above, it is hard not to conclude that there is a significant risk of negative effects of further minimum wages increases at least over the short term. Portugal’s recent history also points in this direction: the previous October 2014’s minimum wage increase coincided with a six-month interruption of the steep decline in unemployment observed until then. 

Increasing the income of the low paid is an incredibly important goal. However, given the findings above, it may be wiser to focus on increasing productivity – a key factor behind living standards – rather than to go for easy but highly risky policies such as the proposed 20% minimum wage increase.  

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This article was originally published in Prof Martins’ blog “Economia das Pessoas” on 8th November 2015.

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