Stop pricing young workers out of the labour force

If the Government said that the minimum price for a new car were $50, nobody would expect it to affect sales. Neither would an increase to $65. But it would certainly start mattering if the Government applied a minimum price of $5000 to all cars, new and used.

This is the situation in New Zealand with youth minimum wages, which were abolished in 2008 in favour of adult rates for all workers over 16 years old. This increased the youth minimum wage by 25 per cent (barring the first few weeks' work for new entrants).

The latest youth unemployment figures are very bad. The unemployment rate for kids aged 15 to 19 is 27.5 per cent; worse, the youth labour force participation rate (those actually engaged in the job market) also has dropped.

Whereas the participation rate was above 50 per cent for the decade before 2009, it has since been dipping and now sits at 47 per cent.

If youths hadn't been discouraged from entering the labour market because of poor job prospects, the measured youth unemployment rate would be even higher.

This isn't just the recession. Unemployment rates for adults are higher than they were in the boom of the mid 2000s, but the recent downturn has not hit adult workers the same way that it's hit the kids. The current adult unemployment rate of 5.6 per cent is only three points higher than its low mark in the mid 2000s. Meanwhile, youth unemployment rates are a staggering 15 points higher.

Both rates usually track each other, reflecting the overall strength of the labour market. Changes in the adult unemployment rate explain a high proportion of changes in the youth rate.

But in late 2008, this relationship began to break down. Compared with a previous trend, the current youth unemployment rate is eight points higher than we could have expected given the adult unemployment rate. That's about 12,000 kids who, given the current adult unemployment rate, we would have expected to have jobs. The results aren't simply due to the Canterbury earthquake – the trend started well before last September.

Neither can they simply be due to the current downturn: when adult unemployment hit 10.2 per cent in 1992, the youth unemployment rate was 23.4 per cent – three points lower than today – and youth labour force participation rates were higher. Bear in mind that adult unemployment today is nowhere near 10.2 per cent.

No, the sharp increase in youth unemployment from late 2008 appears to have been caused by the abolition of the youth minimum wage in early 2008. Such a result isn't surprising. Economist Stephen Gordon summarised Pierre Fortin's work on this effect in relation to minimum wages: when minimum wages are below about 45 per cent of the average wage, they have little effect on employment; above that, they present a danger to employment.

By contrast, New Zealand's minimum wage of $13 an hour is about 50 per cent of the average hourly wage – well into the range in which we expect negative employment effects, particularly for young workers.

Internationally, only 13 per cent of labour economists surveyed disagree that minimum wages increase unemployment among young and unskilled workers, although some studies find contrary results.

Of these studies, the best New Zealand study, by Dean Hyslop and Steve Stillman, found that youth minimum wage changes in the early to mid 2000s had no effect on youth unemployment. It was a quality study, but it spanned a period during which overall unemployment was at record lows and businesses were desperate for any workers.

The increase in the youth minimum wage during that period had little binding effect. New Zealand labour unions also like to cite an excellent paper by Arindrajit Dube and co-authors showing no effect of minimum wages on workers in the American restaurant industry.

But it's a lot harder to outsource waitresses than call centre operators, or factory machinists, so this finding isn't likely to be representative of a country as a whole. Also, in this case, minimum wages in the United States were low compared with average wages.

SO WHY do economic studies find differing results on the employment effects of minimum wages? One reason is that, in many places, minimum wages are well below the level at which we would expect that they would have serious effects, like the $65 dollar minimum price for a car. But when minimum wages for youth jump to New Zealand's $13 an hour, you get a problem.

The effects of minimum wages on young and unskilled workers are well known. It is a shame that minimum wage "denialists" let the few contrary studies outweigh the dozens of papers finding that minimum wages hurt employment prospects for the people they're intended to help.

In 2010, the Organisation for Economic Co-operation and Development published research supporting the majority theory and pointed out that half its member countries (including Australia) had minimum youth rates.

Reinstating a youth minimum wage well below the adult rate wouldn't eliminate youth unemployment. But it would let employers start creating new jobs that young workers could productively fill while gaining experience. It's time to stop pricing young workers out of the labour force.

Dr Eric Crampton is senior lecturer in Economics at Canterbury University and Visiting Fellow at The Centre for Independent Studies. www.cis.org.nz.

Full references to reports in this piece can be found at his website www.offsettingbehaviour.blogspot.com