Minimum Wages and Unemployment

MiStudent ID#00001439

Advanced Economics BUZE600, CW1

Contents
Introduction ............................................................................................................................................. 2 Topicality and importance of the minimum wage effect on employment .............................................. 2 Lagged Effects of the Minimum Wage ................................................................................................... 3 Hours versus Employment Effects.......................................................................................................... 5 Employment transition effects of wage floors ........................................................................................ 6 Conclusion .............................................................................................................................................. 7 Bibliography ........................................................................................................................................... 8

1

Student ID#00001439 Introduction

Advanced Economics BUZE600, CW1

The analysis of the effect of the minimum wage on unemployment is necessary in order to evaluate whether minimum wages are effective policy tool for bettering economic state of individuals at the bottom of the income distribution – which is the fundamental objective of minimum wage policy. Topicality and importance of the minimum wage effect on employment The minimum wage has been the matter of fierce debate among policymakers and economists in the United States for much of the precedent century. The "marginalists" with the claim that minimum wage labor market was best described as a competitive market disagreed with "institutionalists" who stated it was not, stressing on the implications of the minimum wage (Leonard, 2000). For instance, though Stigler (1946) admitted the case of monopsony where increase in minimum wage could, from theoretical standpoint, cause higher employment in a labor market, he argued that competitive features of low wage industries most probably lead to displacement of low-wage labor. In response, Lester (1947) argued that “reasoning about labor markets as though they were commodity markets seems to be an important explanation for erroneous conclusions on such matters as the minimum wage” (p. 146) since he found Stigler 's model of competitive wage determination as conflicting with existing business practices. As a result, other economists started to conduct research on the effects of minimum wage, with much of collected empirical evidence implying that higher minimum wages were negatively affecting on the employment opportunities of low-wage workers (Goldfarb, 1974). In the review by senior economists of Minimum Wage Study Commission, namely, Charles Brown, Curtis Gilroy, and Andrew Kohen (1982) summarized the existing research with the statement that “time-series studies typically find that a 10 percent increase in the minimum wage reduces teenage employment by one to three percent” (p. 524). Once the publication of survey results made economists to come to an apparent consensus on this range regarding the employment effects of wage floor, economic research on this issue came to a halt till late 1980s. In early 1990s, due to renewed prominence of the issue in public policy debates, along with further evidence to investigate, the researchers started to reexamine the employment effects of minimum wage.

Though more than 100 research papers have been published since 1990s on the effects of minimum wage increases on employment, the economists and politicians fail to find unambiguous evidence on what the minimum wages says. Along with contradictory findings, the results from newer studies on 2

Student ID#00001439

Advanced Economics BUZE600, CW1

wage floors are summarized and interpreted differently in different sources. In some studies economic theory is found to fall short to detect the facts of disemployment effects. For instance, Bazen (2000) asserts that “the latest studies of the experience of the USA and the UK in general find no evidence of negative effects on youth employment” (p. 64). In contrast, Flinn (2006) asserts that “these recent studies have been particularly useful in indicating that the “textbook” competitive model of the labor market may have serious deficiencies in accounting for minimum wage effects on labor market outcomes ” (pp. 1013-4). Somewhat more cautiously, others sum up the results as more uncertain, concluding that negative effects may be as likely as positive effects. Stewart (2002), for instance, mentions that some research reveals "absent or positive" employment effects and that others come up with " significant negative effects” (p. 585), whereas Lemos (2004) notes that “there is no consensus on the direction and size of the effect on employment” (p. 219) Lagged Effects of the Minimum Wage The literature on new minimum wage raised the questions about how long it takes for minimum wages to totally affect employment. There was a belief among economists that any effects from increase in the minimum wage should be noticed quite quickly. For example, Brown et al. (1982) suggested two reasons for his argument that, theoretically, “lagged adjustments to minimum wage increases are probably less plausible than in most other contexts where such lags are routinely assumed” (p. 496). First, low-wage workforces have tendency to have high turnover rates, therefore the anticipated changes in employment could occur shortly after the minimum wage is raised, even with normal turnover. Second, policymakers usually announce any increases in minimum wages several months in advance, with the intention to inform employers so that they could adjust straightaway until the law takes effect. Similarly, Card and Krueger (1995) note that the businesses such as fast-food industries that normally employ minimum wage labor “easily vary their staffing levels by cutting back on off-peak or store hours, and by allowing longer queues” (p. 67), so any disemployment effects must be felt soon after the increase in minimum wage occurred. Nevertheless, these views do not refute the likelihood that it might take some time to fully adjust to a higher minimum wage. Despite the fact that costs such as hiring, training and firing may be insignificant for workforce with high quit rates; Hamermesh (1995) contends that firms may adjust non-labor inputs such as capital relatively slowly, which causes slow adjustment of labor inputs as well. Accordingly, non-inclusion of lagged effects may wrongly omit the feature of long run 3

Student ID#00001439

Advanced Economics BUZE600, CW1

substitution between labor and capital. Somewhat more curious, in the earlier literature, the research by Brown et al. (1982) revealed little difference in the overall approximated employment elasticities between time-series survey that excluded lagged minimum wage variables and those that included. But still, possible lagged effects did seem to matter in interpreting the results from some papers. Baker et al. (1999) in their analysis of the effects of the minimum wage on employment in Canada, started by reproducing part of the U.S. panel data estimates for teenagers with Canadian data. The authors found that first-difference estimates of minimum wage effects in Canada were positive, while longer differences and specifications with lags of the minimum wage demonstrated negative employment effects that are statistically significant. For example, in their chosen specification, the first-difference elasticity is 0.07, whereas the within-group elasticity is −0.27. The estimates are at short range (−0.23 and −0.47, accordingly) with lagged minimum wages. Baker et al. make detailed analysis of how the elasticity of employment with respect to the minimum wage differs conditional on inspecting high-frequency or low-frequency variation in the data. The authors explain how the alternative differencing operators such as the inclusion of lagged minimum wages can be interpreted while using different filters to the data, with the lengthier differences or inclusion of lags that stress more the low-frequency variation in the data. In order to decouple high-frequency and low frequency movements of variables, the authors filter the variables and estimate the minimum wage elasticities at low and high frequencies each taken separately. The results are suggestive of a positive effect on employment at high frequencies and negative effect at low frequencies. The authors at that point set forth a more conventional model with three more separate minimum wage variables: the change in the federal minimum wage, the change in a state’s effective minimum wage as a result of an increase in the federal minimum wage (provided that the state’s minimum wage initially exceeded the federal level), and the change in a state’s own minimum wage (as long as the change leads to higher than the federal, state minimum wage level). Similar to their formerly conducted research results, the only negative and noteworthy increases for both time periods are for the federal minimum wage increases. Even though the coefficients on the state minimum wage increases are also negative in both periods, they are close to zero and to the coefficient on the federal minimum wage. The coefficient on the third component varies extensively subject to the magnitude of minimum wage increases, even though it is never statistically significant. Braun et al, interpret their results noting that minor state-level increases may not have significant disemployment effects, while they acknowledge that their tests are rather weak. 4

Student ID#00001439 Hours versus Employment Effects

Advanced Economics BUZE600, CW1

Though there is an apparent consensus among economists that most of the general models of the minimum wage refer to labor input rather than to employment only. One of the suggested motives for a minor employment effect is that employers also adjust the working hours of their employees. As Couch and Wittenburg (2001) note, the use of employment instead of total hours could possibly undervalue or overvalue the effect of the minimum wage of labor input, subject to whether employers increase average hours per worker to partially compensate the reduction in employment or cut both average hours and employment. Michl (1996, 2000) conjectured that the difference between the results of two studies, regarding minimum wage effects, held by Neumark and Wascher (2000) and Card and Krueger (1994) is that the former measures total hours while the latter measures employment. To test his hypothesis, Michl compares the changes in employment and total hours in 52 observations from Neumark and Wascher’s (2000) data set with both total hours and employment reported by respondents. For these observations, the difference-in-differences estimates show a negative effect of the wage floor increase on both total and average hours and a minor positive effect on employment, even though only statistically significant coefficient is average hours per worker. He also investigates the ratio of fulltime employees to total employment in Card and Krueger’s data, which is supposed to have positive correlation with average hours. In this certain case, the results are as follows: the minimum wage has a positive effect on the fraction of employees working on the basis of full-time schedule. On the other hand, Michl rejects this result as inconsistent with the fact that most of the workers in fast-food industry are part-time employees and their reduced average hours worked could at least compensate an increase in the number of full-time employees. The minimum wage reflects on hours were also studied with the use of longer sample periods for the United States at the country level. Namely, Zavodny (2000) and Couch and Wittenburg (2001), both examined the effects of wage floor changes on average hours in the state-level panel data framework. In sharp contrast to Zavodny, Couch and Wittenburg (2001) findings suggest that minimum wages lessen both employment and teenage total working hours. These authors use the model proposed by Burkhauser et al. (2000), using month-long period data from January 1979 to December 1992 and ignoring year effects in their study. Other scholars looked at cross-sections or panels of individual-level data to find potential for being directly affected by changes in the wage floors. One of the first researchers to take this approach was 5

Student ID#00001439

Advanced Economics BUZE600, CW1

Currie and Fallick (1996), who used longitudinal data to examine the employment effects of the increases in the federal minimum wage in years 1980-1981. Specifically, these authors estimate a wage gap for each employee as the difference between the worker’s wage in year t−1 and the minimum wage in year t for employee’s with wage ranging between the old and new minimum wage, and zero otherwise in year t−1. Then they follow a fixed-effects linear probability model to find similarities in subsequent employment rates for people who were directly affected by the increases in the minimum wage and those who were not affected directly. The results are suggestive of a negative and statistically significant disemployment effect even after adjusting for unobservable individual differences. Their findings propose that workers directly affected by the minimum wage increases in 1980 and 1981 were 3 percent less likely to be employed a year later than other workers. Given 15 percent increase in the minimum wage over those two years, this estimate is consistent with an employment elasticity of nearly −0.2, although it ignores the possible decline in employment probabilities in year t for people who were unemployed before the minimum wage increase. Card and Krueger (1995) disapprove this analysis on the basis of several concerns. One of their motives is that Currie and Fallick estimate a large negative minimum wage effect for labor categorized as not covered by the minimum wage. Still, Currie and Fallick contend that their efforts to identify uncovered workers were ineffective due to peaked nominal minimum wage for uncovered workers in both 1980 and 1981 years. Another motive, I find relevant as well, is that in the model Currie and Fallick used aboveminimum wage workers as the control group.

Employment transition effects of wage floors
In a series of papers, Abowd et al. (1999, 2000a, 2000b) use minimum wage measure to study exit and entry into employment using longitudinal data for France and the United States. For the United States, which has presence of both increases and decreases in the real minimum wage, their results are miscellaneous. Abowd et al. use data from the 1980s and discover that the steady fall in the real value of the minimum wage caused raise of transition rates from non-employment to employment, which is non-contradictory with a negative elasticity of employment with respect to increases in the minimum wage. However later, Abowd et al. (2000b) used data from 1981-1991, including both declines and rises in the real value of the federal minimum wage, and obtained little evidence of statistically significant effects of the minimum wage rates on transitions into and out of employment.

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Student ID#00001439 Conclusion

Advanced Economics BUZE600, CW1

Much of the economic debate on changes in the minimum wage is suggestive of the potential effects on employment. The review implies that there is an extensive variety of existing estimates and, as a result, a lack of consensus about the overall effects of the wage floor on low-wage employment. However, the statement that up to date research fails to approve the traditional view regarding the negative effect of minimum wage on low-wage employment is obviously incorrect. So far, most of the papers in the literature basically ignored the issue of how to address the possible endogeneity of minimum wage policy subject to political and economic circumstances. Therefore, the resulting estimates of researchers reported in the literature might be biased to some extent. A major concern is that in specifications that include cross-sectional fixed effects, the researchers do not use influential variables that vary over time. Moreover, even though abundant literature has concentrated on the employment omission effects of the wage floor, the theory covers labor input as a whole rather than employment only. A small number of studies have tried to decouple the effects for aggregate hours from those for employment, and the differences in results published in more or less analogous studies set forth this area for further research. As there is still controversy among scientists, literature should bring more direct evidence on whether to classify the low-wage labor market as monopsony model or the competitive model. The findings reported in much of the existing literature is indirect in nature, and with the ambiguous predictions of the competitive model in specific cases, more structural approaches to this problem may provide more precise and consistent results. Through the review it is evident that economic theory fails to make an unambiguous prediction about the employment outcomes of minimum wages. As it has been stated earlier, the effect of the minimum wage on employment is only small fraction of the analysis required to judge whether minimum wages are a useful policy tool for improving the economic position of low-wage employees. Specifically, a more complete review that covers the effects of the minimum wage on such factors as the levels and distributions of income, employment and hours, incomes, and human capital accumulation, along with consideration of alternative policies, is necessary to assess whether raising the minimum wage is good economic policy.

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Student ID#00001439

Advanced Economics BUZE600, CW1

Bibliography
Abowd, John M., Francis Kramarz, and David N. Margolis. 1999. “Minimum Wages and Employment in France and the United States.” Working Paper 6996. National Bureau of Economic Research. Abowd, John M., Francis Kramarz, Thomas Lemieux, and David N. Margolis. 2000a. “Minimum Wages and Youth Employment in France and the United States.” In David Blanchflower and Richard Freeman, eds. Youth Employment and Joblessness in Advanced Countries. Pp. 427-72. Chicago: University of Chicago Press. Abowd, John M., Francis Kramarz, David N. Margolis, and Thomas Phillipon. 2000b. “The Tail of Two Countries: Minimum Wages and Employment in France and the United States.” Discussion Paper No.203. Institute for the Study of Labor (IZA). Bazen, Stephen. 2000. “The Impact of the Regulation of Low Wages on Inequality and LabourMarket Adjustment: A Comparative Analysis.” Oxford Review of Economic Policy, Vol. 16, No. 1 (Spring), pp.57-69. Brown, Charles, Curtis Gilroy, and Andrew Kohen. 1982. “The Effect of the Minimum Wage on Employment and Unemployment.” Journal of Economic Literature. Vol. 20, No. 2 (June), pp. 487528. Burkhauser, Richard V., Kenneth A. Couch, and David C. Wittenburg. 2000. “A Reassessment of the New Economics of the Minimum Wage Literature with Monthly Data from the Current Population Survey.” Journal of Labor Economics. Vol. 18, No. 4 (October), pp. 653-680. Card, David, and Alan B. Krueger. 1995. Myth and Measurement: The New Economics of the Minimum Wage. Princeton, NJ: Princeton University Press. Couch, Kenneth A., and David C. Wittenburg. 2001. “The Response of Hours of Work to Increases in the Minimum Wage.” Southern Economic Journal. Vol. 68, No. 1 (January), pp. 171-77. Couch, Kenneth A., and David C. Wittenburg. 2001. “The Response of Hours of Work to Increases in the Minimum Wage.” Southern Economic Journal. Vol. 68, No. 1 (January), pp. 171-77. 8

Student ID#00001439

Advanced Economics BUZE600, CW1

Currie, Janet, and Bruce Fallick. 1996. “The Minimum Wage and the Employment of Youth: Evidence from the NLSY.” Journal of Human Resources. Vol. 31, No. 2 (Spring), pp. 404-28. Flinn, Christopher. 2006. “Minimum Wage Effects on Labor Market Outcomes under Search, Matching, and Endogenous Contact Rates.” Econometrica, Vol. 74, No. 4, July, pp. 1013-1062. Goldfarb, Robert S. 1974. “The Policy Content of Quantitative Minimum Wage Research.” Proceedings of the Industrial Relations Research Association. Vol. 27, pp. 261-68. Hamermesh, Daniel S. 1995. “Myth and Measurement: The New Economics of the Minimum Wage: Comment.” Industrial and Labor Relations Review. Vol. 48, No. 4 (July), pp. 830-34. Lemos, Sara. 2004. “Minimum Wage Policy and Employment Effects: Evidence from Brazil.” Economia. Vol. 5, No. 1 (Fall), pp. 219-66. Leonard, Thomas C. 2000. “The Very Idea of Applying Economics: The Modern Minimum-Wage Controversy and Its Antecedents.” History of Political Economy. Vol. 32, Supplement, pp. 117-144. Lester, Richard A. 1947. “Marginalism, Minimum Wages, and Labor Markets.” American Economic Review. Vol. 37, No. 1 (March), pp. 135-48. Michl, Thomas R. 1996. “Review of Myth and Measurement.” Eastern Economic Journal. Vol. 22, No. 2 (Spring), pp. 237-39. Michl, Thomas R. 2000. “Can Rescheduling Explain the New Jersey Minimum Wage Studies?” Eastern Economic Journal, Vol. 26, No. 3, Summer, pp. 265-76. Stewart, Mark B. 2002. “Estimating the Impact of the Minimum Wage Using Geographical Wage Variation.” Oxford Bulletin of Economics & Statistics, Vol. 64, Supplement, pp. 583-605. Stigler, George J. 1946. “The Economics of Minimum Wage Legislation.” American Economic Review. Vol. 36, No. 3 (June), pp. 358-65. Zavodny, Madeline. 2000. “The Effect of the Minimum Wage on Employment and Hours.” Labour Economics. Vol. 7, No. 6 (November), pp. 729-750.

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Bibliography: Abowd, John M., Francis Kramarz, and David N. Margolis. 1999. “Minimum Wages and Employment in France and the United States.” Working Paper 6996. National Bureau of Economic Research. Abowd, John M., Francis Kramarz, Thomas Lemieux, and David N. Margolis. 2000a. “Minimum Wages and Youth Employment in France and the United States.” In David Blanchflower and Richard Freeman, eds. Youth Employment and Joblessness in Advanced Countries. Pp. 427-72. Chicago: University of Chicago Press. Abowd, John M., Francis Kramarz, David N. Margolis, and Thomas Phillipon. 2000b. “The Tail of Two Countries: Minimum Wages and Employment in France and the United States.” Discussion Paper No.203. Institute for the Study of Labor (IZA). Bazen, Stephen. 2000. “The Impact of the Regulation of Low Wages on Inequality and LabourMarket Adjustment: A Comparative Analysis.” Oxford Review of Economic Policy, Vol. 16, No. 1 (Spring), pp.57-69. Brown, Charles, Curtis Gilroy, and Andrew Kohen. 1982. “The Effect of the Minimum Wage on Employment and Unemployment.” Journal of Economic Literature. Vol. 20, No. 2 (June), pp. 487528. Burkhauser, Richard V., Kenneth A. Couch, and David C. Wittenburg. 2000. “A Reassessment of the New Economics of the Minimum Wage Literature with Monthly Data from the Current Population Survey.” Journal of Labor Economics. Vol. 18, No. 4 (October), pp. 653-680. Card, David, and Alan B. Krueger. 1995. Myth and Measurement: The New Economics of the Minimum Wage. Princeton, NJ: Princeton University Press. Couch, Kenneth A., and David C. Wittenburg. 2001. “The Response of Hours of Work to Increases in the Minimum Wage.” Southern Economic Journal. Vol. 68, No. 1 (January), pp. 171-77. Couch, Kenneth A., and David C. Wittenburg. 2001. “The Response of Hours of Work to Increases in the Minimum Wage.” Southern Economic Journal. Vol. 68, No. 1 (January), pp. 171-77. 8 Student ID#00001439 Advanced Economics BUZE600, CW1 Currie, Janet, and Bruce Fallick. 1996. “The Minimum Wage and the Employment of Youth: Evidence from the NLSY.” Journal of Human Resources. Vol. 31, No. 2 (Spring), pp. 404-28. Flinn, Christopher. 2006. “Minimum Wage Effects on Labor Market Outcomes under Search, Matching, and Endogenous Contact Rates.” Econometrica, Vol. 74, No. 4, July, pp. 1013-1062. Goldfarb, Robert S. 1974. “The Policy Content of Quantitative Minimum Wage Research.” Proceedings of the Industrial Relations Research Association. Vol. 27, pp. 261-68. Hamermesh, Daniel S. 1995. “Myth and Measurement: The New Economics of the Minimum Wage: Comment.” Industrial and Labor Relations Review. Vol. 48, No. 4 (July), pp. 830-34. Lemos, Sara. 2004. “Minimum Wage Policy and Employment Effects: Evidence from Brazil.” Economia. Vol. 5, No. 1 (Fall), pp. 219-66. Leonard, Thomas C. 2000. “The Very Idea of Applying Economics: The Modern Minimum-Wage Controversy and Its Antecedents.” History of Political Economy. Vol. 32, Supplement, pp. 117-144. Lester, Richard A. 1947. “Marginalism, Minimum Wages, and Labor Markets.” American Economic Review. Vol. 37, No. 1 (March), pp. 135-48. Michl, Thomas R. 1996. “Review of Myth and Measurement.” Eastern Economic Journal. Vol. 22, No. 2 (Spring), pp. 237-39. Michl, Thomas R. 2000. “Can Rescheduling Explain the New Jersey Minimum Wage Studies?” Eastern Economic Journal, Vol. 26, No. 3, Summer, pp. 265-76. Stewart, Mark B. 2002. “Estimating the Impact of the Minimum Wage Using Geographical Wage Variation.” Oxford Bulletin of Economics & Statistics, Vol. 64, Supplement, pp. 583-605. Stigler, George J. 1946. “The Economics of Minimum Wage Legislation.” American Economic Review. Vol. 36, No. 3 (June), pp. 358-65. Zavodny, Madeline. 2000. “The Effect of the Minimum Wage on Employment and Hours.” Labour Economics. Vol. 7, No. 6 (November), pp. 729-750. 9