The minimum wage, once more

In an article published in Economic Affairs Karthik Reddy argues that Britain Too Sanguine on Minimum Wage. The introduction for the article reads,

Eleven years after the implementation of the National Minimum Wage, the British political establishment has come to accept the policy as a success. Even David Cameron, who initially opposed the policy, has publicly stated that it ‘turned out much better than many people expected’. This cautious acceptance of the minimum wage among policy-makers is reflected throughout the developed world, where few countries remain without a statutory wage floor. Unfortunately, this shift in opinion does not reflect the economic reality of the minimum wage.

When looking at the U.S. evidence Reddy writes,

Various studies have been undertaken to measure the effects of minimum wage laws in the 50 states. In 1977, the US Congress authorised the Minimum Wage Study Commission to investigate the economic effects of the minimum wage. In 1981, the Commission released its report, which found from analysis conducted over the previous decades, during which the real minimum wage was relatively high, that a 10% increase in the minimum wage generally increased teenage unemployment by 1–3%. This strong disemployment effect was well accepted by the academic and policy-making communities (Neumark and Wascher, 2007).

Controversy over the minimum wage begin in the early 1990s when certain studies purported to show that the minimum wage may not have disemployment effects and, in some cases, may even increase employment.

The controversy began in 1992, when Card (1992a) published a paper suggesting that the April 1990 increase in the federal minimum wage from $3.35 to $3.80 had no adverse effects on teenage unemployment. This study was followed by others, namely Katz and Krueger (1992), Card (1992b) and Card and Krueger (1994), which purported to show positive employment elasticities as a result of minimum wage increases of up to 2.65, 0.35, and 0.73, respectively. Card and Krueger proceeded to publish a book, Myth and Measurement, which concluded: ‘evidence suggests that the minimum wage does not have the effect on the labor market that would be predicted from the competitive neoclassical model’ (Card and Krueger, 1995). These data from the early 1990s were widely cited as evidence that the conventional understanding of the effects of the minimum wage was poorly conceived and that minimum wages in the USA did not have adverse effects.

Unfortunately subsequent analysis of the results from the early 1990s, as well as further studies, demonstrate that the minimum wage does, indeed, displace workers and have adverse long-term effects.

First, and perhaps most importantly, David Neumark and William Wascher (2007) point out that many of the studies that have sought to measure the effect of minimum wages on employment have operated under the assumption that it would be felt rapidly, due to high turnover in the minimum-wage labour market. Concordantly, many such studies have neglected to look beyond a short-term analysis. Yet this may well be a serious error as it ignores the possibility that firms’ demand for labour may decrease in the long run as they slowly adjust non-labour inputs. Much of the difference between those studies that purport to show no disemployment effect and those that do may be reconciled by the inclusion of time lags, a particularly salient observation raised by numerous critics. In particular, Neumark and Wascher (2000) replicated Card’s methodology in the 1992 study of the federal minimum wage increase, but included the possibility of such a lag. They found that this addition produced a negative and statistically significant disemployment effect of the minimum wage. A 1999 study by Baker et al. on employment and minimum wage changes in Canada found that, while evidence is less clear over the short run, including lags generally produces statistically significant disemployment effects, and that Canadian data indicate an employment elasticity of -0.25 over the long term. The inclusion of lagged employment effects produced similar results in further US research.

Another issue is the question of the control group used in many of the studies.

Furthermore, some of the studies that found the minimum wage did not affect employment use other geographical areas as controls to measure the impact of the minimum wage. Yet such comparisons may not be appropriate, given differences in labour markets, regulatory standards and macroeconomic conditions between the studied and comparison groups.

Addition problem that have been raised include,

Specific to the studies conducted by Katz and Krueger (1992) and Card and Krueger (1994), there exist questions about the reliability of the telephone surveys used to collect data, which in the words of Neumark and Wascher (2007), ‘were not subject to the same rigorous standards as those used to develop the surveys used in government statistical programs’. Adie and Gallaway (1995) raised further concerns about Card and Krueger’s Myth and Measurement. In addition to doubts surrounding the statistical significance and methodological integrity of the studies cited in the book, the two Ohio University economists suggest that Card and Krueger’s exclusion of certain minimum wage studies from their discussion skewed the data.

More recent studies have returned to the question of teh employment effects of minimum wages in the U.S. and have, importantly, returned data indicative of disemployment effects that are particularly considerable for unskilled workers.

Neumark and Wascher (2007), in a lengthy and comprehensive review of recent minimum wage literature published between 1992 and 2007, conclude: ‘the preponderance of evidence points to disemployment effects’. Of the 33 studies examined in depth, 28 indicated disemployment effects. Neumark and Wascher examine the methodological processes and results of the studies at considerable length, and some of these studies are particularly telling. In 1992, for example, Neumark and Wascher published their own study of teenage unemployment and minimum wage statistics throughout the 50 states over the 1970s and 1980s, and found unemployment elasticities of between -0.1 and -0.2 for teenagers (Neumark and Wascher, 1992). In various other studies that focused on the effects of the minimum wage on both teenage employment and school enrolment, the two economists concluded that ‘these results are consistent with a higher minimum wage causing employers to substitute away from lower-skilled teenagers (who are less likely to be in school) toward higher-skilled teenagers (who are more likely to be in school), with the resulting increase in the relative wages of higher-skilled teenagers inducing some of them to leave school for employment’ (Neumark and Wascher, 2007). Considering enrolment, they estimated the employment elasticity to be -0.22. Keil et al. (2001) found an employment elasticity of -0.11 for total employment and -0.37 for youth unemployment in the short term, while the long-run elasticities were even starker at -0.19 and -0.69, respectively. The significance of these long-run elasticities prompted the authors to conclude: ‘the cost of the minimum wage legislation, far from being negligible as claimed by its apologists, may be higher still than even the minimum wage hawks have argued’ (Keil et al., 2001). Burkhauser et al. (2000) estimated elasticities of -0.27 for the 1996 increase in the federal minimum wage, and -0.17 for the subsequent rise in 1997. Orazem and Mattila (2002) studied data from minimum wage increases in Iowa in the 1990s and found employment elasticities of between -0.31 and -0.85. A comprehensive study of the states of Oregon and Washington between 1994 and 2001 by Singell and Terborg (2007) found negative employment effects of the three minimum wage increases in each state throughout that period. The results of these studies are complemented by a number of others reviewed by Neumark and Wascher (2007). More recently, in 2010, Danziger found that employment in small firms is particularly affected in a negative manner by minimum wage increases.

Reddy then turns to the U.K. data and finds that the data from the U.K. generally supports the US evidence. Next Reddy looks at measurement issues to do with the study of the minimum wage.

There do exist significant problems that complicate the measurement of the effects of the minimum wage. Minimum wage increases that have been studied in the USA remain quite small as a proportion of the wage in total, rendering it difficult to find clear and discernible effects of the minimum wage, and the proportion of workers earning the minimum wage is very small. As Keil et al. (2001) note: ‘An intrinsic problem with event studies in this context is that the sought effect is acknowledged to be small compared to ambient fluctuations in employment rates.’ Moreover, there may be substantial endogeneity bias present that skews the data in a way that masks the negative effects of the minimum wage. Minimum wage increases do not happen randomly, and are instead controlled by political and economic conditions. As such, wage hikes may only take place in jurisdictions in which economic and employment conditions are good or improving, and may be resisted by governments in jurisdictions where such conditions are poor or worsening. This bias would indicate that studies of minimum wage increases may not fully recognise the full disemployment effect of the increase. Indeed, the effects may not be felt until many years later when the economy moves into recession and individuals find it more difficult to find employment after they have lost their jobs: the minimum wage could then be particularly problematic as workers are then seeking possible ‘second-best’ employment opportunities whilst their skills deteriorate. Thirdly, there is the significant difficulty of finding an adequate comparison group to serve as a control by which to measure the effects of minimum wage increases. These difficulties have undoubtedly contributed to the perception of uncertainty surrounding the effects of minimum wages.

When looking at studies on the minimum wage its worth keeping in mind that the effects of the minimum wage is likely to be masked in periods when the minimum wage is low compared to the average wage and/or when labour demand is strong.

Overall it seems most likely that increases in the minimum wage will not have positive effects for the working poor, increasing the minimum wage is likely to have a negative effect on employment, mainly for the low skilled groups in the economy.