At COP515,000 pesos per month or roughly $278, the Colombian minimum wage is the second highest in all of Latin America in terms of GDP per capita.
At first glance, a high minimum wage may seem like a good thing, and many might say that Colombia is looking out for its workers by increasing its minimum wage year after year. However, a high minimum wage might not in fact be the best policy for the welfare of Colombia’s workers.
Fedesarrollo director Roberto Steiner has warned the government about the drastic increases in the minimum wage that Colombia has seen over the past 11 years, reminding us that the minimum wage has increased 30% more than inflation over that time period.
This is very bad news for those unemployed workers who made up 10.6% of the population in September of 2010, according to DANE statistics, because employers are much less likely to hire as their input costs increase.
Fedesarrollo said that not only have the increases in the minimum wage far outpaced inflation, they have not coincided with increases in productivity either. This translates to higher labor costs for employers but roughly the same output and, more than likely, higher unemployment in Colombia.
While Colombia proudly boasts the second highest minimum wage in all of Latin America, politicians don’t advertise that it is also burdened with one of the highest unemployment rates in the region. Whether or not they understand the correlation between the two is questionable.
Many economists and believers in free markets would suggest that a minimum wage only distorts market fundamentals and the minimum wage should be abolished in order to let the labor market reach equilibrium which, in the case of Colombia, would almost certainly result in lower unemployment.
In fact, a Fedesarrollo report by Universidad de los Andes Economist Jairo Nuñez found that for every 1% increase in the real minimum wage in Colombia, unemployment increases by 0.23%. This is not to be confused with a 1% increase in the nominal minimum wage. To calculate the increase in the real minimum wage you must account for inflation. If the government raises the minimum wage by 6% in a year that saw 3% inflation, the real increase would be just 3%. According to Mr. Nuñez’s findings, that would translate to a 0.69% increase in unemployment. Mr. Nuñez points out that in 1999, the real minimum wage increased by 6%, causing unemployment to rise by 1.4%, which represents 180,000 lost jobs.
Chile, one of the economic stars of the region, has twice the per capita income of Colombia but its minimum wage is just 31.6% of GDP per capita, compared to Colombia’s 52%. Chile’s April 2010 unemployment rate was 8.6%, while Colombia’s unemployment rate for the same month came in at 12.2%, according to the national statistics departments of the two countries. The Colombian government should take a look at these numbers and rethink its approach to protecting workers.
Setting a minimum wage will always cause disequilibrium in the labor market as long as the minimum wage is above the natural equilibrium level. For example, if minimum wage laws were abolished and the labor market was to reach equilibrium (every worker that wants a job is employed and every employer that needs an employee has one) at COP400,000 per month, any law setting a minimum wage above COP400,000 would cause unemployment. Why? The answer is simple if we look at an extreme case.
Let’s suppose the government set the minimum wage at $1 million per month. In this case, everyone in the country would be more than willing to work at the minimum wage but companies willing to pay a minimum of $1 million per month wouldn’t exist. That would create 100% unemployment. The same thing happens on a much subtler and smaller scale when governments set minimum wages above the natural equilibrium level.
How do we know that the current minimum wage is higher than the natural equilibrium minimum wage?
Besides the formal academic study that was carried out by Mr. Nuñez, we can tell just by looking at the current situation in Colombia. With one of the highest unemployment rates in all of Latin America we can say with a high degree of certainty that there are many Colombians who would be willing to work for less than COP515,000 per month. This means supply exceeds demand which causes a surplus of workers in the labor market – this is what we know as unemployment.
So what would happen if the government abolished the minimum wage? There would be both upsides and downsides.
Eliminating the minimum wage would undoubtedly cause a loss of wealth among workers who are currently earning the minimum. Many mothers and fathers who are struggling to support their families would find that their employers have just decided to offer them less money and, in most cases, they probably wouldn’t be able to do anything about it because there would almost certainly be someone else (a teenager without a family to support, for example) who would be willing to do the job for less money. Businesses would have more power to abuse the labor market which would result in many people working long hours just to survive. A minimum wage also requires that businesses share what the government decides to be a fair part of their wealth with those workers who helped to generate it; without a minimum wage, companies could exploit workers (even more) by paying them very little in comparison to the value that they generate.
Despite these downsides, abolishing the minimum wage would have real benefits for the economy as a whole. Many people who live on the streets and are barely surviving might find themselves in a situation where they were able to work and earn enough to properly feed themselves. Businesses would be able to offer goods at lower prices as their labor costs decrease and they would be able to hire more workers which, in some cases, should allow them to speed up their processes, to the benefit of consumers. Companies who rely on machinery instead of manpower might be able to hire more human beings instead of employing robots. Entrepreneurs that might not have been able to compete while having to pay the legal minimum wage might start businesses as they are able to find workers who can accept the wage that they can offer. Wages would adjust according to costs of living in the various geographical regions of the country instead of having a nationwide minimum wage that doesn’t account for these differences in living expenses.
The government must take into account all of these factors when deciding on a minimum wage. I don’t believe that they should abolish the minimum wage altogether, although there could be positive effects such as those that I have mentioned. That being said, increasing the minimum wage at a rate higher than that of inflation and productivity causes more harm than good.
Having the second highest minimum wage in Latin America might sound like a good thing, but one must consider the upsides as well as the downsides, especially in a developing nation like Colombia. It really comes down to this: would you rather have less people employed at a higher wage or more people employed at a lower wage? The politicians and voters of Colombia must decide.
Author Matthew Helm is an American who moved to Colombia where he started the website relocationcolombia.com, specialized in information for potential expats and investors.