Žilvinas Šilėnas. The Invisible Part of Minimum Wage Increases

From 2012 to 2014 Lithuania increased its minimum monthly wage by almost one third: from 800 Litas in 2012 to 1,035 Litas in 2014. There are suggestions to increase the minimum wage in 2015, and those who support it claim that companies would adapt. But is it so simple?

The Lithuanian Free Market Institute (LFMI) conducted a survey of 181 Lithuanian companies two thirds of which had up to 50 employees. According to the survey, minimum wage increases have several negative consequences.

Four negative effects

Firstly, regular minimum wage increases would have a negative impact on the companies that were not affected by the previous increases in the minimum wage. The results of the survey show that the minimum wage increases in 2012 and 2013 negatively affected every third surveyed company and that a planned increase by 58 Euros (or 200 Litas) in 2015 would negatively affect 48 percent of the companies. To put it simply, if the companies survived a blow, it does not mean that they would survive a streak of blows.

Secondly, an increase in the minimum wage is not an issue for the companies that are already paying higher wages, but, notably, not all companies with many minimum wage earners have enough resources to pay more. That is why increases in the minimum wage trigger wage cuts, job cuts and lower working hours for some employees.

Thirdly, an increase in the minimum wage today means no higher wages tomorrow. Some of the surveyed companies had to revoke their development plans (35 percent), increase prices (18 percent) and cut jobs (17 percent) as a direct consequence of the 2012 and 2013 increases in the minimum wage. Most likely, companies do the same if the minimum wage continues to grow. Plans for investment and development plans – the recipe for a real wage growth – will be scrapped.

Fourthly, about one fifth of the surveyed companies chose to raise prices to compensate for the minimum wage increases in 2012 and 2013. Reportedly, if the minimum wage were to increase by 58 Euros (or 200 Litas) this year, 28 percent of the surveyed companies would raise prices.

Let’s examine the experience of the four surveyed companies in more detail.

Number 1: Many minimum wage employees and unyielding budgetary institutions

In one of the companies under analysis, just like in many other companies in the security business, most of the employees earn the minimum wage. In recent years the minimum wage earners accounted for 80 percent of the staff so an increase in the minimum wage brought about serious financial difficulties for the company. Due to increased expenses, the company did not only have to abandon its plans to create new jobs, but reduced the number of administrative staff and increased the workload for the remaining employees.

The company partly covered these expenses by raising the prices of its services. However, while you can agree about higher prices with private customers, this is not the case with public ones. According to the pricing rules of public procurement, budgetary institutions are not allowed to pay more than indicated in the contract. Therefore, the company under analysis was forced to terminate its contracts or to provide services at a loss. What would happen if the minimum wage were to increase again? The company would have to stop providing services to the public sector or cease operation.

Number 2: Many minimum wage employees and a strong competition

Another company, in the postal and courier business, dealt with the minimum wage increases in a similar way. In recent years about half of its 150 employees earned the minimum wage. About two thirds of the company’s revenues go for paying wages. In 2012 and 2013 the company worked at a loss, so the increases in the minimum wage were really painful. The company had to cut jobs, increase the workload and reduce salaries of its long-term employees who earned more than the minimum wage.

Even a small increase in the minimum wage seriously hurts this postal service company, because fierce competition in the postal industry prevents the company from raising its prices.

Number 3: a minimum wage increase instead of investment

In yet another company that operates solely in the internal market and provides security services for a corporate group, more than two thirds of the employees earn the minimum wage. A rise in the company’s expenses following the 2012 and 2013 increases in the minimum wage prevented it from investing in modern security equipment. This shows that some companies had to cancel investments that were meant to generate higher value and improve the quality of services in the future. Moreover, re-negotiating service fees with the customers and modifying contracts mean extra work. If the minimum wage were to increase, the company would behave similarly actions, but redundancies would be unavoidable.

Number 4: artificial wage increase

The fourth company manufactures plastic products and exports the bulk of its production. Even though the number of the employees receiving the minimum wage is quite small and varies from 5 to 10, every increase in the minimum wage requires raising wages for other employees in order to maintain wage differences between more and less skilled workers. In 2012 and 2013 the company’s labour costs went up by 35 and 25 percent respectively.

Increasing wages is a natural thing when financially viable companies decide to pay more to their workers since they can afford it. However, forced increases to comply with the government’s requirements are different. They have negative effects on the customers, workers and the company per se. In order to compensate for the increase in expenses, the company in question had to raise prices and this undermined the company’s competitiveness. Furthermore, rising labour costs led the company to partly automate its work and cut jobs as a result. If the minimum wage were to increase in the future, the company would take similar actions.

The economy is ruthless. If we increase the minimum wage today, what happens tomorrow? Higher prices, more part-time workers, less investment, development and added value tomorrow. In other words, “consumed” investment and stagnating wages instead of a natural economic growth.