As another expected Euro crisis unravels in Cyprus, a consecutive round of critical examinations of the common currency is required. Instead of repeating the same mantras of lost independent monetary policies or severe differences in the European economies’ business cycles, another approach is needed. Perhaps the inconvenient truth and the negative unintended consequences of the common market are the fact that with one currency, fluctuations in the European Union minimum wage are inherently creating detrimental imbalances.
First, let us examine the fundamentals of minimum wage and the consequences of such to economic growth. The current discussions on minimum wage have been futile given the fact that a great majority of the arguments for increasing wages are based on emotionally attached sentiments. Admittedly, the school of Keynesian economics suggests how higher wages would produce more consumption, hence stimulate growth through higher aggregate demand. However, such reasoning is a fallacy simply because in this particular topic, we must exercise counter-intuitive thinking. One doesn’t have to be necessarily a firm adherent of the Austrian School of Economics or understand the premise of Say’s Law, but rather examine the tacit unintended consequence of increasing wages without considering overall labor productivity and added value.
How Much Are You Worth?
To put it simply, wage represents the value of one’s input, or the value of your skills. If the government sets the level of minimum wage at a certain level (let us use 5EUR/hour as an example) such decision directly implies that the least valuable skill in a given economy is worth of 5 Euros/hour. Such position seems a bit random given the fact that if some portion of labor currently do not possess skills valued at 5 Euros but 3.50 Euros, should they be employed with the current minimum wage? The followers of social equality and people with assumed knowledge of other individuals’ marginal benefits would insist on hiring such individuals simply on the basis of inaccurate motives. If the contribution of the worker does not create profit for the business, there is no reasonable justification to pay for such worker the current mandatory hourly wage. As a result, the employer cannot hire a person, whose skills are not aligned with with the required wage-level. The marginal costs of labor do not match the marginal benefits, hence the employer is better-off not hiring, unless he/she will increase the final price of the product/service. Such outcome is not efficient given that the consumers would bear the adjustment through higher prices, decreasing temporarily their purchasing power.
Differences in Europe
In 2013, 20 EU members had implemented a minimum wage legislation. With a common currency and a single-market the difference in national (monthly) minimum wages is expected to be quite small. Unfortunately the difference between the lowest (Romania, 123EUR) and the highest (Luxembourg, 1847EUR) suggests that the common currency has not delivered necessary balance in the EMU-area wages. It is all the more troublesome when one sees the wage difference relative to each Member State’s overall price level. One might ask whether such phenomenon makes much difference for the EMU’s economic growth. At first it might seem that such differences would not have spill-over effects on the overall economic performance of the Euro-zone, but once again we must peek through the veil of claims and data. With open borders for capital and people, the labor movement in the Euro-zone is something that the optimal currency area praised. However, with such vast differences in wage levels within the Euro-zone, the concentration of labor movement is directed to the higher-wage areas. For example, Estonian workers migrate to Finland or Ireland in search for higher wages, or Romanians and Bulgarians seek higher standard of living in Germany. Consequently, some people might ask naively: What could go wrong?
A Lot Can Go Wrong
Such movement towards higher wages does not necessarily result in higher productivity. With higher wages and more competition in labor markets, those who do not possess the skills worth of 5EUR/hour cannot find work. Furthermore, when Estonians migrate to Ireland for work, an actual shortage of skilled workers in Estonia causes unnecessary unemployment: since the wage levels in Estonia are not compelling for a Spaniard or youngsters from France, nobody has the incentive to replace the lost workforce in Estonia. To make the situation more detrimental, higher labor movement would mean that domestic economies are going to have severe future problems in their pension funds since less people are contributing to the domestic social security system.
What can be done? With a common currency, such differences in domestic wage levels are causing more irreversible damages. Such dilemma (adjusting the common currency or setting European wide minimum wage) is a combination of an incomplete monetary union, aggressive labor movement and broad differences in minimum wages between Member States. Since such policies are difficult to reform (thus reflecting the realities of 27 Member States), the Euro has become a mutual liability, rather than a fate or common asset.
– Henry Erti
Disclaimer: This article was originally published as Euro Is a Common Liability (Part II of III) on April 6, 2013 in The European Student Think Tank, a PB cooperation partner