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The first minimum wage policy for private-sector employees has been announced by the Palestinian government, it will be approved by the cabinet on the October, 15, 2012. The minimum wage level has been set at 1450 NIS monthly, which is equivalent to 65 NIS daily, and 8.5 NIS hourly. The wage level was set by the Palestinian government who in their official statement said that the level of the minimum wage was set after consultation with various private sector representatives and using the records of the Palestinian central bureau of statistics.
ILO defines the minimum wage as "the lowest level of remuneration permitted which in each country has the force of law and, which is enforceable under threat of penal or other appropriate sanctions," and it is set to and countries in general have different reasons for applying a minimum wage policy, almost all of them highlight the social aspect of the minimum wage policy, and general the reasons for applying a minimum wage. policy are:
Protection of employees and reduce poverty.
Provide a safety net for employees to be able to provide the minimum living conditions for them and their families.
Fair completion among firms in the economy.
The Palestinian population faced harsh economic conditions during the last decade. After the second intifada economic condition worsened in Palestine, and after which the political instability and the Israeli restriction on movement of people and goods, played a major role in hindering economic development..
Minimum wage effects employment, income and price level. Empirical results in large number of countries during various historical periods indicate that there is no clear relationship (whether positive or negative) between minimum wage and unemployment. However, it is agreed that minimum wage effect the wage distribution in favor of the low-paid workers.
In a Keynesian paradigm, aggregated demand is the driver for equilibrium in the labor market, among other factors. The aggregate demand depends on the expectations of firms and households in the economy, on various fiscal and monetary policies implanted by the government, and also, on the distribution of income. Higher minimum wages lead to equality in the income distribution, and a positive demand effect can be anticipated as low-income households consume more of their income.
Changes in the wage distribution will lead to changes in the price structure, and will affect the price level in the economy. And hence, it is not possible for find a clear answer on the effects of minimum wage legislations on unemployment, since there will be two forces working against each other in the economy, therefore, minimum wage can have both positive and negative effects.
The neoclassical school of thought concludes that minimum wage have negative effects upon employment. Their analysis mainly focuses on the force of supply and demand in the labor market, these forces achieve equilibrium in the labor market, and the wage level and unemployment is determined by them. this analysis cover two cases; the case of a homogenous labor market, where all workers are equal, and information about the wage levels is available to all companies and workers. In this case minimum wage will raise unemployment in the whole economy. As for the case of a heterogeneous labor market, minimum wage will affect only the low-paid workers, hence, it will increase unemployment in this segment.
Minimum wage was assumed to have negative effects for decades Stigler (1946); Brown et al. (1982). It was in the 1990s were this view was argued; Card and Krueger's (1995) shows that this statement was questionable, and according to their study, minimum wage did not have negative effects, and sometimes had positive effects on employment. Neumark and Wascher (2006) show that the minimum wage effects vary from country to country, and even if there were negative effects, it was sometimes insignificant, and the results cannot be generalized. Recently, some studies have found large negative effects of minimum wage on employment Abowd et al. (2000), while others found positive effects Hyslop and Stillman (2007).
Minimum wage literature revolves around advanced countries, Hamemesh (2002). Most of the developing countries' literature is focused at Latin America countries, and these studies found that minimum wage effects have been stronger in developing countries compared with developed countries as El-Hamidi and Terrell, (2002) indicate.
Taylor and Rebitzer (1995) showed that in a conventional efficiency wage model, minimum wage legislation could reduce the level of unemployment in the low-wage jobs. The logic of their model is similar to the case of labor demand under monopsony.
Studies regarding Palestine are scarce. Since 2002, there have been two studies investigating these issues. Abu Hantash (2002) indicated that imposing a minimum wage policy in Palestine will be beneficial to the overall economic performance of the Palestinian economy, based on the increased purchasing power of a large segment of the working populations, therefore, increasing consumption. Missaglia et al. (2010), used a post Keynesian Dynamic Static General Equilibrium model, to indicate that a minimum wage policy will have negative effects on the economy, and that the neo-classical effect (higher wages, will decrease demand on labor, and reduce output) will dominate the Keynesian effect (Higher wages will increase consumption and output), and hence it is not recommended in Palestine.
The data used for this paper was obtained from the central bureau of statistics, Labor Force Survey (2012), and national account statistics. The data obtained is quarterly data starting 2002 until the second quarter of 2012. A quick plot of the data (the figure below) indicates the existence of and growing trend in the Consumer Price Index (CPI), while the unemployment rate (UN) is somewhat stable around 20% with no observable trend. The average wage plot shows a slow increasing trend in the data starting 2005, but in recent years, we can notice that the average wage has not increased significantly, and is stable around 70 NIS per day figure. The final variable of interest is the GDP, which is taken as a proxy of the private consumption figure in the Palestinian economy.
Since we are using time series data, we must check if the data used is stationary or not, this is an important step to determine the methodology that will used to answer the research question. A stationary series can't be estimated using the simple form VAR analysis; it needs a Vector Error correction Model (VEC). Before we engage in the VAR analysis, we will first test for unit root for the data at hand. This is done through the Augmented Dickey-Fuller test (ADF), which tests the data for a unit root. The following table summarizes the results of the test:
GDP: Gross Domestic Product (Constant 2004 dollars)
CPI: Consumer Price Index
ADW: Average Median Daily Wage
UN: Unemployment Rate
The test results reveal that the first three series of data have a unit roots at the level, and hence, we need to take the first difference of the data and test again. While the unemployment data, does not have a unit root and can be taken at the level. The following table summarizes the test after taking the first difference for the three stationary series:
LGDP: Log of the first difference of the Gross Domestic Product (Constant 2004 dollars)
DCPI: First difference of the Consumer Price Index
DADW: First difference of the Average Median Daily Wage
UN: Unemployment Rate
After testing unite root in the first difference in the data, we can conclude that the data doesn't have a unit root at the first difference for GDP, CPI, and ADW, and at the level of unemployment.
To measure the effects of the applying the new minimum wage policy in Palestine, we will use a model based on a Keynesian economy, where minimum wage have two opposing forces. The first of which is the demand for labor, where increasing the minimum wage will result in a decline in the demand for labor, hence decreasing the number of new job opportunities, and increasing unemployment. The second force is the consumption force, which operates by increasing the aggregate demand for goods and services, because of the increase in income for a large segment of the working population; this will result in increasing aggregate demand, and increase the demand for jobs and eventually increase employment.
To estimate the different effects of the minimum wage, we will use the Vector Auto-Regression (VAR) method, which captures the evolution and interdependencies between the selected variables. All the variables used in the model are treated systematically by estimating each variable through including its own lags, and those of the other different variables. This means that the variable might influence each other through several p lags, and each variable is explained by a separate equation. The mathematical representation of a VAR (2) with two variables is:
Yt = a11Yt-1 + a12Xt-1 + b11Yt-2 + b12Xt-2 + c1 + Îµ1t
Xt = a21Yt-1 + a22Xt-1 + b21Yt-2 + b22Xt-2 + c2 + Îµ2t
Where a11, a12, b11, b12, etc... are the coefeccient of the corresponding variables, c1 and c2 are the constant intercepts, and Îµ1t and Îµ2t are the innovations that may be correlated at the same time, but are uncorrelated with their own lagged values and uncorrelated with all of the right-hand side variables.
In order to choose the right lag length, there are several criteria that suggest the order of the VAR model that should be used, such as:
FPE (Final prediction error)
AIC (Akaike information criterion)
SC (Schwarz information criterion)
HQ (Hannan-Quinn information criterion)
Where k is the number of variables, T is the number of observations, p is the lag length and the matrix is the determinant of the variance covariance matrix of the estimated residuals.
The last two criteria (SC and HQ) are better than the first two (AIC and FPE), because the latter tend to overestimate the true lag length. In addition, the next relations are true:
We apply the lad selection criteria to our model, but since we don't have a large number of observations, the maximum lags that we can test for are 8, and the following table summarizes the test results:
VAR Lag Order Selection Criteria
Endogenous variables: DADW DCPI UN LGDPÂ
Exogenous variables: CÂ
Date: 01/06/13 Time: 09:32
Sample: 2002Q2 2012Q2
Included observations: 34
Â Â 0.205957*
Â Â 9.950923*
Â Â 26.50490*
Â Â 7.358206*
Â Â 9.134141*
Â * indicates lag order selected by the criterion
Â LR: sequential modified LR test statistic (each test at 5% level)
Â FPE: Final prediction error
Â AIC: Akaike information criterion
Â SC: Schwarz information criterion
Â HQ: Hannan-Quinn information criterion
We will use the LR test results to determine the lag structure of our VAR model, which is at 6 lags, that is we lose degrees of freedom with every added lag, and because we don't have much data, we will estimate the model using 6 lags.
In order to check the validity of a VAR model, we need to test for Granger causality, normality, serial correlation and heteroskedasticity. The stability of the VAR model is also required, implying the roots of the characteristic polynomial to lie inside the unit circle.
The table above indicates that the variable average wage and unemployment have a casual relationship between the two. This satisfies the main requirement for the VAR model to be stable.
Impulse response functions are shocks that are induced to the VAR functions, it also identifies the responsiveness of a dependent variable to a shock in the residuals, it is applied to each variable and their affects are measured over the next periods.
We found a casual relationship between unemployment and wage levels.
An increase in wage will cause an increase in the unemployment until the third forecasted period, and after that the effects will be negative and unemployment will decrease until the 7th period and it will decrease in the 8th.
An increase in unemployment will cause a decrease in unemployment in the forecasted periods until the 4th period (first year), and then the effects will stabilize and will reach zero by the 7th period.
It is found that the current minimum legislation which increase average wage by 3%, would increase the growth of unemployment by 1% in the 3rd quarter and would decrease by 0.6% by the 4th quarter. But it will need 7 quarters into the future to stabilize the shock.
This report is far from complete; I will send the final version electronically in a week's time.
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