October 29, 2005

On Raising the Minimum Wage

Filed under: Random Stuff — Bob Gifford @ 1:44 pm

A commenter to my last post raised an important objection to raising the minimum wage: its impact on unemployment and job growth for low-skilled workers. Our motivation for raising the minimum wage may be to help those less fortunate, but if the actual effect is to put them out of work, we haven’t done them any favors. Our efforts must be judged not only by our intent, but by their outcome.

Both the left and the right have ideological beliefs on this topic. Liberals want to believe that corporate America could easily afford to pay higher wages, and that raising the minimum wage would have no affect on unemployment or job growth. On the other hand, conservatives want to believe that an unfettered labor market will maximize employment, and an artificial minimum wage puts people out of work.

Readers of this blog will know that I don’t have much patience for ideologies. Instead of falling back on these assertions from the left or right, what is the effect of the minimum wage on employment out in the real world?

The best study to date was conducted by economists David Card and Alan Krueger. Alas, a Blog had a post this summer on the topic:

From a summary of the [Card, Krueger] study by John Schmitt (pdf link):

The study received widespread attention, not because its findings were unusual (most studies since the mid-1980s have found that moderate increases in the minimum wage have little or no impact on employments), but because its methodology was so careful and convincing. Card and Krueger surveyed 33 1 fast-food restaurants in New Jersey and 79 restaurants in eastern Pennsylvania in the two months before the April 1, 1992 increase. They then reinterviewed the same restaurants about eight months later. The study’s unique design allowed them to use the restaurants in eastern Pennsylvania, where the minimum wage did not increase, as a control group to gauge the response of the New Jersey restaurants.

By comparing changes in employment in the two states (a procedure they referred to as “differences-indifferences”), Card and Krueger were able to estimate the employment effects of the New Jersey increase. Using this approach, they found that the differences in employment growth between the two states were not statistically significant. They concluded, therefore, that the minimum-wage increase did not lower employment in New Jersey.

The post goes on to describe a refutation of the Card, Krueger study, which itself has now been refuted. The bottom line is that the economic evidence indicates that increasing the minimum wage doesn’t seem to affect unemployment.

How can this be, given what we all know as the basic law of supply and demand? The economists have theories that productivity increases with the minimum wage, which makes up for higher wage costs. It seems to me though, as an armchair economist, that it’s simpler than that. Demand for low skilled workers is inelastic, meaning it doesn’t change with rising cost, because there are no substitutes. Service jobs can’t be moved out of the country, and they can’t be automated. The only alternative is to pass the increased cost on to the consumer by raising prices.

One benefit to an increased minimum wage is the higher demand for goods and services due to more dollars in the pockets of low skilled workers, which is why it seems like such a good idea to Wal-Mart. But to me, the more important benefit is a reduction in the burden on government welfare programs. We should be careful before we intervene in a contract between two private individuals. But as a society we have decided that we are going to have a safety net. Just as the law in Leviticus instructs farmers to let the poor glean from their fields after the harvest, so we provide support to the poorest among us. The minimum wage is an effective and compassionate way to provide this support.

I don’t want to live in a society that casts the poorest aside to fend for themselves. Private charities, especially faith-based organizations, can do a great deal to help, but the problem is too large and vast for a strictly private sector response. We have decided, rightly so, that we, through our government, will provide assistance to the poor. Having decided this, it’s a shame that we don’t do so more intelligently and compassionately by raising the minimum wage.

5 Comments

  1. The bottom line is that the economic evidence indicates that increasing the minimum wage doesn’t seem to affect unemployment.

    Not to disagree with your overall point, but really the study proves that the particular minimum wage increase under study did not increase unemployment. Presumably, there is an increase that would either increase unemployment, or create enough inflation to negate much of the increase.

    Given the current Federal wage, though, lower-income wages are almost certainly depressed, since it’s harder to bargain when there’s a certain wage written into law as justification. Frankly, I’d like to see more local control of living wages, given the differences in cost of living across various areas. It might even make sense to repeal the Federal standard and force the states to come to terms with what a reasonable minimum is for each of them.

    Comment by JasonB — October 30, 2005 @ 11:02 pm

  2. Yes, I agree with you…this doesn’t mean that employment wouldn’t be affected by any amount of an increase in the minimum wage, only that within the range examined that it wasn’t affected.

    Interesting idea about the local control…makes sense to me.

    Comment by Bob — October 31, 2005 @ 9:08 am

  3. There are many ways to try and study the effect of minimum wage increases on unemployment – none of which will give you 100% of what happens and none of which are without flaws.

    Most studies that look at only wage effects find an elasticity of 0.1 to 0.3. That means that somewhere between 10% and 30% of minimum wage workers would be out of work from whatever level of increase was being studied. However, most studies that break the effect down note that the majority of these workers are teens – adults who work for minimum wage tend to be much less likely to lose a job (or to seek another one) than do teens.

    There are more things to look at than just pay, though. For example, higher labor costs are passed along to customers. Assuming that minimum wage workers shop at the same places they work (not a totally unreasonable assumption) minimum wage hikes are only minimally able to improve their lifestyle. Prices tend to rise by about 98% of the wage hike.

    However, full-time minimum wage workers may receive benefits – particularly as wages increase (because the employer has more vested interest in keeping a higher wage earner on the job to cut down on lost time due to re-training). In particular, they may be offered health insurance and, with a higher wage, they may actually be able to participate in it. As far as I know, there is not a good study that has teased out this effect, though several hint at it.

    You also have to approach it with an understanding of how statistics work. For example, more people work for under $7 than under $5. So, if you raise the minimum wage to $7 an hour, you will increase the number of people who work for minimum wage (assuming no one loses their job as a result solely of the rise in wages). Since poverty rates are somewhat related to minimum wages, this also means that you will increase the number of people living in poverty – even though they are making more money.

    As I said, it’s tricky – and that keeps economists employed and all the rest of us scratching our head to try and find some way to help people. Without a doubt, the best way is to teach them a marketable skill for which there is a demand. Yeah, I know that makes me sound like a conservative, but if we invested the money in our schools rather than in making businesses cough up more dough, it might make a bigger difference to a larger number of people.

    XT

    Comment by Xpatriated Texan — October 31, 2005 @ 4:01 pm

  4. Xpat –

    No, it doesn’t make you sound like a conservative, just a progressive that wants to do the right thing. Thanks for your great thoughts on the topic.

    On the elasticity, I wouldn’t be surprised at .1 to .3, but Card, Krueger found a 0 elasticity. It’s not just the quantity of studies, but the methodology, and I’d heard the claim that the Card, Krueger study had the most exhaustive methodology, therefore the most reliable results. But who knows…I guess all we know is that its not at all clear that there is an affect on employment, and if so, it’s smaller than conservatives would have us believe.

    On the pass-through of costs, it makes complete sense that the wage hike would all get reflected in prices. But there still would be a sizable benefit to minimum wage workers. They will only see prices rise by the percentage of the costs of goods made up by minimum wage labor. Most of the cost of production for groceries are the costs of the ingredients, farm and food processing machinery, and skilled labor, so the cost increase from raising the minimum wage would be much less than the increase in income the worker would see. So I still think it would be a big benefit to them.

    Good points about the other factors going in to assessing the ultimate impact. I guess no matter what we think the right answer is, we need to be very humble about it — there are so many hidden factors that can’t be measured that we can never be sure we understand the total impact.

    Comment by Bob — November 1, 2005 @ 8:46 am

  5. I own a restaurant and minimum wage goes up in October. I will have a new menu with higher prices ready for October.
    I have 13 employee’s now, four of them cost me money with low productivity and mistakes daily. They will be fired before
    October because I refuse to pay them any higher. Having all four of them on the same shift is less productive then to have one of my good employee’s working.

    Comment by business owner — March 16, 2006 @ 6:31 am

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