Do Minimum Wage Increases Cause Inflation?: Evidence from Vietnam

Article excerpt

It is often argued that minimum wage increases can lead to increased inflation. This paper examines the impact of minimum wage increases on inflation in Vietnam during the 19942008 period. Inflation is measured by a monthly overall Consumer Price Index (CPI) and a monthly food CPI. It is found that the minimum wage increases did not increase inflation. Since the minimum wage increases often took place one or two months before the Vietnamese New Year festivals, observed increases in monthly inflation after the minimum wage increases were caused by increased consumption demand during the New Year festivals, not by the minimum wage increases.

Keywords: Minimum wages, inflation, CPI, Vietnam.

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I. Introduction

Minimum wages are the lowest hourly, daily or monthly wage that a government requires employers to pay to employees. The main argument for minimum wages is to increase the living standards of labourers, especially the poor. In addition, minimum wage increases can have other positive effects such as promoting labours' work effort and productivity, reducing people covered in subsidy programmes, increasing consumption, aggregate demand and generation of multiplier effects (Freeman 1994; Do wrick and Quiggin 2003; Gunderson 2005).

However, minimum wage increases can lead to negative impacts. In the traditional economic theory, firms will respond to an increase in labour cost by reducing demand for labour or increasing the output prices (Hamermesh 1986; Brown 1999). As a result, unemployment and inflation can be increased. Poor labourers, whom governments aim to protect by minimum wages, can be hurt by minimum wage increases.

Although minimum wage increases are expected to increase prices, the magnitude of price increase depends on several factors such as the demand elasticity and competition degree (Aaronson 2001). A strong effect of minimum wages on inflation is not always found in empirical studies. Several studies, for example, Card and Krueger (1995), Aaronson (2001), Macdonald and Arasonson (2000), found that a 10 per cent minimum wage increase leads to around 1-4 per cent increases in prices. However, other studies such as Fry e and Gordon (1981), Sellekaerts (1981), Katz and Krueger (1992), Card and Krueger (1995) found very small or not statistically significant effects of minimum wage increases on prices. Detailed review of studies on the effect of minimum wages on prices can be found in Lemos (2004).

Vietnam has committed itself to a "growth with equity" strategy of development. The country has achieved high economic growth, with an average annual GDP growth rate of around 6 per cent over the past ten years. The poverty rate declined remarkably from 58 per cent to 16 per cent between 1993 and 2006 (World Bank 2008). To increase living standards of labourers, especially the low -wage ones, the government of Vietnam has a policy of minimum wage increases on a regular basis. There have been nine adjustments to the minimum wage since the year 1993. The real minimum wage increased by around 118 per cent during the period 1994-2008. However, minimum wage increases lead to on-going debates about the impacts on inflation in Vietnam. A large number of advocates of the minimum wages including the government argue that reasonable minimum wage increases do not cause high inflation. Instead, increased minimum wages can lead to an increase in consumption, aggregate demand and economic growth, especially in the context of economic slowdown (see, for example, Dan Tri 2009a; Duy Tuan 2009). On the contrary, minimum wage increases are blamed for increased prices (Vneconomy 2003; Dan Tri 2009&; Bao Moi 2009). Especially, there was an increase in the minimum wage in early 2008, then followed by very high inflation in mid-2008. Certainly, high inflation reduces real minimum wages and can decrease the efficiency of the economy.

The arguments on the impact of minimum wage increases on inflation in Vietnam are often made without empirical evidence on impact evaluation of minimum wage increases. …