The Effects of Minimum Wage

With talk about increasing the minimum wage up to $10+/hour, the econ blogs have been alive with minimum wage chatter the last week or so, and purely coincidentally one of my students presented his senior research on the effects of minimum wage legislation last night.

And I no longer know where I stand.

I assume that labor is an ordinary good subject to the law of demand, just like shoes. That is, as the price of labor goes up, the demand for it goes down. Ceteris Paribus, of course. But the evident effects of minimum wage increases are generally shown to be rather small. Perhaps, as a grad school friend of mine used to say, ceteris ain’t paribus. That is, maybe other economic factors swamp the effects of a minimum wage increase.

Another factor, perhaps, is that the opposition to minimum wage increases generally manages to limit them. Proponents of increasing the minimum wage frequently argue that inflation has eroded the value of the minimum wage, so bringing it up to $X now simply restores it to what it was some number of years ago. If all we ever do is restore it to what it once was, rather than increasing it in real dollar terms, the effect should be fairly small.

But two things make me wonder about that. First, my student showed a graph showing job growth in Alaska before and after a minimum wage increase. In Jan 2003 Alaska increased the minimum wage, and there was an immediate dip in employment, but short-lived; by summer employment was back up to about its previous level. But the rate of increase was lower; the upward sloping curve was flatter than previously. Now, I don’t know what all was going on in Alaska in early 2003, so I can’t assert confidently that this was all due to the minimum wage increase. But I can point out that the raw employment numbers wouldn’t show much effect even if the rate of growth decreased. So just looking at the employment numbers won’t necessarily tell us the real story. Even the unemployment rate won’t necessarily tell us, because it doesn’t include people not looking for work, and if fewer jobs are made available due to higher labor costs, fewer people may be prompted to look for work even though the law of supply tells us that higher pay ought to lead more people to look for work (certainly the lack of obvious declines in unemployment rates following minimum wage increases indicates they don’t cause much influx into the labor market, and again, perhaps that’s because the increases are relatively small).

Second, Arnold Kling makes what seems to me a reasonable argument about the effects of phasing in minimum wage increases.

Giving people more time to adjust to incentives normally leads to larger adjustments, not smaller. If you suddenly raise the gas tax, for example, there is very little effect on gas consumption. But if people expect the gas tax to go up years before the higher tax kicks in, many will buy more fuel-efficient cars, leading to a large behavioral response. Minimum wage hikes should work the same way: Employers’ long-run response should exceed their short-run response…

If the minimum wage unexpectedly jumped to $12 today, the effect on employment, though relatively small, would be blatant. Employers would wake up with a bunch of unprofitable workers on their hands. Over the next month or two, we would blame virtually all low-skilled lay-offs on the minimum wage hike – and we’d probably be right to do so.

If everyone knew the minimum wage was going to be $12 in 2015, however, even a large effect on employment could be virtually invisible. Employers wouldn’t need to lay any workers off. They could get to their new optimum via reduced hiring and attrition. When the law finally kicked in, you might find zero extra layoffs, because employers saw the writing on the wall and quietly downsize their workforce in advance.

So maybe the employment effect of minimum wage increases is larger than I thought, but just less discernible?

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About J@m3z Aitch

J@m3z Aitch is a two-bit college professor who'd rather be canoeing.
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35 Responses to The Effects of Minimum Wage

  1. If, in the long run, the economy continues to experience growth, & jobs are added at a pace that matches or exceeds the rate of wage hike induced layoffs, then the wage hike is likely not a problem, even if it does have other negative effects (e.g. slowing the growth of the economy).

    However, if the economy doesn’t grow enough, or worse, suffers a contraction/recession, then the wage hike will likely do far more harm than good, as employers will not be able to afford the low skilled workers they need, and will either contract their business, fold their business, move it, or engage technology where applicable (robots, kiosks, etc.).

  2. Scott Hanley says:

    I found this an interesting interview, although I haven’t read the work itself. It’s a study of neighboring counties with different minimum wages, claiming to find few-to-no employment differences:

    http://www.therealnews.com/t2/index.php?option=com_content&task=view&id=31&Itemid=74&jumival=5650&updaterx=2010-10-07+09%3A23%3A26

  3. Dr X says:

    I’d long accepted the prevailing wisdom, which made complete sense to me, but then I started reading research that suggested that the effects aren’t following the predictions. Obviously, you can’t raise the minimum wage to any level whatsoever, but I wonder about the net effects on structural unemployment because of research such as the work cited by $c0tt Aitsch

    When it’s suggested that employers will drop their least productive workers, I think about minimum wage jobs and how often they’re almost warm body jobs, jobs that almost anyone who shows up can do. At any wage, you do them right or you get fired. What’s the economic measure of a more productive Wal-Mart greeter? Bob’s greetings lack a certain heartiness. His hellos are worth $6 but not $7 an hour. If you’re talking about performance issues such as showing up late, refusing to abide by compay policies or excessive absences, I don’t think a lower wage is going to keep that person employed anyway.

    Second, consider the person worth $13 an hour versus the one worth $8. Are there people worth $13 who are unemployed who might be pulled into the job market with a higher rate? How about those who wouldn’t work for $8, but would work for $13 because the difference makes it now worth working to supplement the family income rather than stay home?

    Another question is how much are increased labor costs covered by price increases and who bears those costs most and how much decline in quantity demanded results (and jobs lost). Jobs would get lost in that circumstance, but is it possible that consumer spending patterns could also shift toward products and services produced by higher minimum wage workers whose productivity is better leveraged by technology and efficiencies?

    I’m not suggesting that I’ve discovered the free lunch, but I wonder how much of the cost is purely a matter of increased structural unemployment versus how much involves other shifts in economic activity. No pretense to answers here. Just giving an idea of the kinds of thoughts and questions I have about how changes in minimum wage actually play out.

  4. Dr X says:

    And I’m not sure about the non-workers who come into the market being considered an offset of structural unemployment levels, just that the voluntarily unemployed (who don’t count as unemployed) might become employed.

  5. pierrecorneille says:

    Dr. X,

    I agree largely with what you’re saying in your comments, but I have some qualifications on one point you made (which I also mostly agree with):

    ” I think about minimum wage jobs and how often they’re almost warm body jobs, jobs that almost anyone who shows up can do.”

    I think even warm body jobs are more difficult and require certain skills that aren’t necessarily apparent to the person not doing them, and I think that needs to be remembered. I raise this point because I too often encounter people (not you) who speak of these employees with something approaching contempt.

    Again, I mostly agree with your point. Those jobs do require little formal training, and most people if hired could learn them quickly. I also recognize you didn’t say those jobs didn’t require certain skills or weren’t difficult in certain ways. Finally, my own point is pretty much tangential to your main points and to the question of what wage such employees should command.

  6. AMW says:

    I have an answer that is simple, but may be incorrect. Suppose labor costs to a firm fall into two basic categories: wage costs and non-wage costs. Non-wage costs would be things like snacks in the break room, employee discounts, etc. Increases in the minimum wage raise wage costs, but – to a point – employers can offset these by reducing non-wage costs by a commensurate amount. Thus, within a certain range, minimum wages only shift the composition of employee compensation toward cash, and away from in kind.

  7. J@m3z Aitch says:

    AME: No more free fountain drinks for fast food employees! And we’ll reduce the obesity epidemic! But seriously, yes, I can see businesses compensating that way.

    Pierre; I agree, there are people who can’t handle even minimum wage jobs–folks who can’t show up on time, who can’t take an order*, who can’t manage not to fight with the boss, etc. etc.
    _____
    *At our local Tim Hortons there used to be a worker whose voice I so hated to hear on the drive-through speaker that at least once I just drove off instead of ordering. She would constantly interrupt you while you were placing your order to verify the part of it you had just made, and as often as not getting it wrong. One day I snapped and said something like :”No, I want vegetable cream cheese; if you’d stop interrupting and listen maybe you’d get the order right.” When I drove up to the window I could see all the other employees looking at me and grinning–apparently they shared my views. The irritating person didn’t work there much longer, fortunately for us customers.

    On the other hand I always remember when Oregon’s economy boomed and the familiar employees at the local Dairy Mart convenience store all left to be replaced by people who appeared to have never held a job before. They were so incompetent it was just awful. But over the course of two-three months they got better, until I found the service wholly satisfactory again. So a lot of these unproductive people are only initially unproductive. But they are costly during their learning curve, so naturally an employer prefers to hire someone who’s productive from the start, I would think.

  8. D. C. Sessions says:

    Just about every economist — including those often considered extreme such as Stiglitz — agree that increases in the minimum wage should reduce employment rates. And, in fact, the data (H/T JH above) says that they do — but only to the tune of 1-3% for large increases in the minimum [1]. This is the best kind of evidence: it tells you what you don’t expect.

    Possible explanations abound. My list starts with the idea that most minimum-wage jobs just don’t reduce worth mentioning: if you want a taco stand, you’re going to have people running it, and you can’t cut back the number of people and still keep the customers fed. So as long as your taco stand is making money, you’ll pay what it takes to keep it open, and if that means you make less profit, well, some is better than none. It’s not that the marginal workers drop out, it’s that the marginal businesses do.

    [1] For some reason this inelastic demand surprises people with labor but not with other goods like gasoline and health care. The word of the day is “substitution.”

  9. pierrecorneille says:

    James,

    What you say isn’t exactly what I intended with my comment, but it is a logical extension of it. I guess I was speaking more to the people who have the jobs and do perform them passably well. But I certainly don’t condemn employers for hiring only those who they think will fit the bill (speaking generally, of course….if “fitting the bill” implies some standard that in a given situation might be irrelevant, like gender, race, religion, etc., then I’m critical).

    Re your Tim Horton’s anecdote: I do admit that my knee jerks a little bit, just remembering the way customers sometimes (probably less frequently than I remember) treated me harshly when I (probably) didn’t deserve it. (At the same time, I could aggress passively and be rude as much as anyone, given the right circumstances.) It’s not that I don’t deep down actually believe that workers can do no wrong or that I myself don’t get impatient with (apparently, to me and from my vantage point) incompetent workers. It’s just that I’m a little sensitive, sometimes condescendingly so, to how service workers sometimes get treated.

    By the way, until recently I hadn’t realized that Tim Horton’s had stores in the US.

  10. Troublesome Frog says:

    I think that the whole “wage = marginal product” thing is a pretty spherical horse in a lot of cases. When there’s a lot of unemployed low-skill labor available, it’s pretty likely that employers get a decent amount of surplus at the equlibrium wage. You obviously can’t push that wage floor up to infinity without having real effects, but unskilled labor is pretty darned productive in this country, so it wouldn’t be too surprising to me if only a very small percentage of minimum wage workers actually have a marginal product very near minimum wage. For example, if you need N people to run your fast food shop, N+1 is a near total waste and N-1 is a customer service nightmare, so the Nth worker doesn’t hit wage=MP, but the N+1th worker is definitely at wage > MP.

    The other thing is that even if you have a worker whose marginal product is very close to minimum wage, it’s often hard to figure out exactly what his marginal product is. Unless they’re factory line workers with a very easily measurable output or people working in a highly optimized shop designed for N workers, there’s likely a pretty large hysteresis around those numbers in favor of “we don’t have enough information to make any changes.” In that case, it seems like any ill effects would come from failure to hire a new worker instead of downsizing the current set.

    In any case, none of the economists I’ve known seemed to think that adjusting the minimum wage up or down at the small margins we usually discuss was a major issue one way or another. It’s a lot like tax policy in that sense–we know that taxes alter incentives and the direction of the curve’s slope is a no-brainer, but it’s very hard to empirically measure the downward sloping curve you’d expect in theory unless you make crazy big changes. I’ve always liked the idea of dumping the minimum wage and making it up in some sort of subsidy. Aside from eliminating a minor distortion, the actual equilibrium wage for different types of jobs would be really interesting data.

  11. D. C. Sessions says:

    I’ve always liked the idea of dumping the minimum wage and making it up in some sort of subsidy.

    I’d be happy to bill employers for the social-services subsidy that low-wage workers incur. Like SNAP, EITC, etc. All of which are basically negative externalities of paying workers less than a living wage (and which, absent the safety net, employers would have to pay since people who are starving to death, freezing in their cardboard boxes in winter, etc. aren’t worth hiring.)

  12. Dr X says:

    DC, presumably that social service subsidy would have to be profit contingent, levied independent of the number of minimum wage employees, else that would effectively increase the minimum employer paid wage. Apart from political considerations, why make this an employer tax as opposed to an additional income tax and capital gains tax, with EITC. I know this is everything Republicans would oppose, but what’s the economic rational for billing employers for the subsidy?

  13. Dr X says:

    that’s with EITC continuing.

  14. James Hanley says:

    Pierre,

    I’ve done customer service jobs, too, and been treated badly, so I normally treat those folks well. This person was an exception.

    I didn’t even say anything to the girl that had the damned fetus feet pin on her visor, although I wasn’t sorry when she left.

  15. James Hanley says:

    This NBER paper also claims larger effects than some claim.

  16. D. C. Sessions says:

    DC, presumably that social service subsidy would have to be profit contingent, levied independent of the number of minimum wage employees, else that would effectively increase the minimum employer paid wage.

    I look at it as a purely Pigouvian tax, and it would be based on the support received by the employees (match up the SSNs). No support — for whatever reason — no tax.

  17. James Hanley says:

    D.C.,
    I doubt you’re right that in the absence of gov’t support employers would have to pay more. Desperate people will take desperation wages.

    Also, are you thinking along the libes of a reverse income tax?

  18. Troublesome Frog says:

    I’m very skeptical of any proposal that seeks to make businesses bear the “real” cost of social services from their employees. If hiring somebody subjects you to an increased tax, you’ll consider those extra tax dollars as part of the cost when deciding to hire a new employee. It’s no different from raising the minimum wage. If you think about it that way, what you’re really doing is saying to low skilled workers, “I hereby demand that you go out and be worth more money.”

    It’s possible that some of them are actually worth the total cost of wages + all of their social services and are simply earning minimum wage because the extra supply is pushing wages down. But I think in the general case, we need to live with the fact that most people who earn minimum wage simply don’t produce enough output to cover a “living wage” plus health care plus other perks. Making employers pretend that they do and then eat the difference is unfair and counterproductive. If we as a society want them to have those things, we should dig into our pockets and pay for them as a society.

  19. I’ve never understood the desire to try & bill business for social services, as if somehow a business, by it’s nature, deserves to be taxed more because it uses more. Especially since a business can always just inflate the cost of their products & services, or reduce employee benefits, to cover the increase. There seems to be this idea that the extra tax will just come out of the profit margin, which ignores the fact that most businesses operate on pretty thin profit margins already, and the ones that don’t are the ones that probably don’t have a problem raising prices.

    If you want business owners to pay more, clean up the labyrinth of tax deductions people of wealth enjoy.

  20. Dr X says:

    T-Frog
    “If we as a society want them to have those things, we should dig into our pockets and pay for them as a society.”

    That’s my view. Even a scheme that matches employee SS numbers to social welfare recipients is still a wage hike. And though I’ve recently become doubtful, if the traditional thinking on this is correct, even relatively small wage hikes adversely affect employment.

    Another matter: hasn’t the consensus been that taxes on business are ultimately paid by the consumer? I’ve read over the last couple of years that perhaps some part of business taxes are borne by shareholders/owners, but they’d bear some part of the tax anyway if it all came out of income and capital gains taxes. So I don’t see taxes on business as really shifting the tax burden away from lower income people. I see taxes on business as a way to shield people from awareness that they’re being taxed, the employer contribution to SS, being an example. The employee is really paying that tax. It’s politically convenient to hide the tax burden, but it might not be the most efficient way to tax, and it doesn’t seem as progressive as a progressive tax on income and capital gains.mm

  21. Honestly I think all employer with-holdings should be done away with. People should always have to write the check to Uncle Sam every quarter, instead of just businesses doing it.

  22. Troublesome Frog says:

    Dr. X:

    Another matter: hasn’t the consensus been that taxes on business are ultimately paid by the consumer?

    I suppose it’s accurate to say that “busines pays the tax using money from the consumer” but they each bear some cost. The business will always suffer from reduced profits either from the extra money they hand over or from reduced number of units sold because of the higher price. They’re being knocked off of their optimum pricing scheme, and that has a cost.

    madrocketscientist:

    Honestly I think all employer with-holdings should be done away with. People should always have to write the check to Uncle Sam every quarter, instead of just businesses doing it.

    I really like this idea. We know how much we pay for garbage service because it comes as an itemized bill every 2 months. I don’t know exactly how much we pay in payroll taxes every two months, but it’s roughly 100x larger. That’s not so good. If I got a bill instead, I’d be a lot more aware of my tax rate, and if it was roughly itemized by budget impact (say, the top 10 expenditures), I’d be a wiser voter.

  23. J@m3z Aitch says:

    I see taxes on business as a way to shield people from awareness that they’re being taxed

    Isn’t that the real purpose? What congressmember wants to encourage more constituent bitching?

  24. Matty says:

    On a practical level what would be the effect of moving the work of calculating tax from employers to employees. Would we see more errors as people with less experience of what is taxable or deductable have to fill in returns, and would dealing with that raise the cost of collection?

  25. Dr X says:

    The business will always suffer from reduced profits either from the extra money they hand over or from reduced number of units sold because of the higher price.

    I still wonder about net effect if we follow the money. If the increased business tax is transferred to individual recipients of aid and to the government employees who administer aid programs, they spend money, increasing aggregate demand. So it seems to me that many businesses could come out ahead at the expense of other businesses. So net, how much is the tax really extracting from business? Meantime, anyone among the general public who isn’t a recipient of the transfers pays more goods and services that aren’t offset by transfers. And there are still losers on business side.

  26. Would we see more errors as people with less experience of what is taxable or deductable have to fill in returns, and would dealing with that raise the cost of collection?

    Seems to me that would be a solid argument for radically simplifying the tax code. Part of the reason (IMHO) that our tax code is so convoluted is because the burden of compliance with the sticky bits falls upon such a minority of the citizens.

  27. Troublesome Frog says:

    matty:
    Would we see more errors as people with less experience of what is taxable or deductable have to fill in returns, and would dealing with that raise the cost of collection?

    We do a really good job of making payroll taxes evaporate automatically from paychecks, so doing the process in reverse should be pretty straightforward. Not that I’m against massively simplifying the tax code, but I that a wage subsidy can be made ot happen without much extra burden on the worker. I say “much” because it’s possible that they’d end up owing money at the end of the year when typical minimum wage workers would never have to worry about that.

    I’m totally in favor of a world where TurboTax simply doesn’t exist. Tax preparation is a multi-billion dollar deadweight loss to the economy that we could avoid if we cared to.

    Dr X:

    So net, how much is the tax really extracting from business?

    From business in general or from the business paying the tax? I’ll grant that transfers may actually increase overall economic activity under some circumstances, but I thought that the original question was whether it was a net negative for the specific business that remits the tax. To that question, I’ll say that it is a net negative in all but the most pathological of cases. They either pay the tax out of their own pockets directly, or they raise prices and reduce profits that way.

    If we’re just talking about the general effects on business as a whole, I think that’s still a good argument for making everybody pay the tax rather than focusing on the business that employs the worker.

  28. Dr X says:

    T-Frog:

    Business in general. I was wondering whether or not, in the end, consumers as a whole pick up the business tax bill entirely, while business as a whole, ultimately contributes nothing or very little additional. I appreciate that there are individual losers and individual gainers on both the consumption and production side as a result of the business taxes and transfers to the poor.

    But that’s also true with a progressive tax on individual income and transfers to the poor, because spending still shifts to the advantage of some businesses at the expense of others. At the margins, the poor purchase different shit from the rich.

    So all my babulous maundering in this thread still comes down to my doubts about whether or not business tax is an illusory relief for individual taxpayers as whole. The individual earner may clamor for additional taxes on business thinking they’re going to come out ahead, but only the recipients of the transfers come out ahead.

  29. D. C. Sessions says:

    Related:
    http://america.aljazeera.com/opinions/2013/12/service-industryworkerslaborinequality.html

    For those whose knees jerk at aljazeera, please note:
    1) Check the author before you freak over the publisher
    2) Al Jazeera has its agenda, but it’s also often guilty of actually committing journalism.

  30. D. C. Sessions says:

    So all my babulous maundering in this thread still comes down to my doubts about whether or not business tax is an illusory relief for individual taxpayers as whole. The individual earner may clamor for additional taxes on business thinking they’re going to come out ahead, but only the recipients of the transfers come out ahead.

    No, there are serious distributional effects.

    You’re leaving out profits, for one. The ability of Wal-Mart to externalize part of the cost of labor to taxpayers doesn’t all come back to its customers (much less taxpayers in general), in part because it’s going to the Walton family and other Wal-Mart stockholders (including me.) Profits as a share of GDP are at their highest on record, which from a Smithian perspective represents a serious market failure.

  31. D. C. Sessions says:

    I was wondering whether or not, in the end, consumers as a whole pick up the business tax bill entirely, while business as a whole, ultimately contributes nothing or very little additional. I appreciate that there are individual losers and individual gainers on both the consumption and production side as a result of the business taxes and transfers to the poor.

    You need to distinguish “business taxes” between those (e.g. VATs) that are a tax on gross proceeds, and thus passed on to the consumer no matter what, and the US norm of taxes on profits, which may in the limit not get passed on at all.

    For that reason, there are theoretical benefits to taxing profits. However, as we’ve seen so much lately taxes on profits are too easy to game so I’m reluctantly inclined to accept that a VAT approach is probably a better idea that the USA might as well adopt as part of a comprehensive corporate tax reform, regardless of its regressive nature. Not least because it goes at least partway to regularizing the international picture and making it harder to have your sales in the USA (where there’s no VAT) and your profits in a country where there’s no corporate taxation.

  32. Dr X says:

    @DC,

    For those whose knees jerk at aljazeera, please note:

    http://america.aljazeera.com/opinions/2013/12/service-industryworkerslaborinequality.html

    I’m hopeful that in these parts, we don’t have much of that problem.

    service workers

    n=1, probably not typical, but I have close friends who’ve had woman working for them for about 20 years. Makes 30,000, substantial Christmas bonus every year, paid insurance, she’s free to take all the food she wants, free full-time use of car exclusively for her, a nice condo apart from their home, gave her money for down payment on mother’s home in Mexico, huge cash wedding gift, baby gifts, pay her husband generously for side work. 9-5 hours, plus occasional extra work when they need her for something special. Probably not typical, but I can easily see how full time household help can be much better off than a Walmart or McDonald’s worker.

    I recently told them I’d like to work for them if she ever quits.

  33. Dr X says:

    Didn’t intend to include the link above. Just saying I hope that we don’t have knee jerk reactions to Al Jazeera around here because I come here to get away from jerking knees.

  34. J@m3z Aitch says:

    Heh, if anyone around here jerks his/her knee to Al Jazeera, that’s their own personal problem.

  35. Dr X says:

    Heh, if anyone around here jerks his/her knee to Al Jazeera, that’s their own personal problem.

    Or a neurological problem.

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