Wednesday 11 September 2013

The minimum wage and employment dynamics

In the U.S. the recent proposal by President Obama to raise the federal minimum wage has brought the minimum wage debate back to life. Not that it really left the limelight in the U.S., or anywhere else around the world. A new column at presents new research suggesting minimum-wage policies may not cause an immediate shock to employment, as is often feared, but do cause a reduction in the rate of net job growth. The long-run prospects for individuals are damaged, as they are delayed the opportunity to develop skills and work experience – that crucial first rung on the career ladder. Thus who suffer most from the effects of the minimum wage are those who can afford to suffer least.

Most papers in the long literature on the minimum wage have focused on the number of people employed but there are several reasons, grounded both in theory and data, to expect the effects to be reflected in the rate of net job growth. The transition from one employment level to the next may be slow due to adjustment costs or even an aversion to firing existing employees, so it is more likely that minimum wage increases result in a change in the rate at which employment grows.
This phenomenon becomes more clear when one considers the composition of the minimum-wage work force. Using the Current Population Survey’s Merged Outgoing Rotation Groups from 1979 to 2011, we found that, although only about 3.3% of all employees are paid the minimum wage, nearly 12% of those who enter the workforce are paid that amount. Indeed, nearly a third of minimum-wage workers are recent workforce entrants. Minimum-wage workers are also likely to transition to higher pay quickly: of those who remain employed after one year, about 60% are paid in excess of the minimum wage the following year. As such, it seems likely that any effects of the minimum wage are more likely to be reflected among new workers and in new job openings than on the existing stock of employment.
So dynamics of the labour market are important for the effects of changes to the minimum wage. Despite this importance little of the previous literature has focused on dynamics. In their column Jonathan Meer and Jeremy West set out to correct this lack of interest.

In Meer and West's view this lack of focus on dynamics is particularly worrisome because, unlike many of the other policies that economists study, the minimum wage is characterised by frequent, relatively small increases.
This means that slow adjustments in response to these increases are difficult to detect. Moreover, in Meer and West (2013), we use a simulation to show that a common practice in regression analysis in this literature – including state-specific time trends – leads to incorrect estimation of the effect of the minimum wage on the level of employment when the true effect is on the rate of employment growth. Essentially, the deck is often stacked against finding any effect.

The data for our study are drawn from the Business Dynamics Statistics, which covers the population of non-agricultural private employer businesses between 1977 and 2011. The underlying data are sourced from mandatory employer tax filings and aggregated by state in each year. The Business Dynamics Statistics includes not only the number of jobs in each state for every year, but the number of jobs created by expanding establishments and the number of jobs destroyed by contracting establishments. These numbers are used to calculate the rate of net job growth.

We combine the Business Dynamics Statistics with data on state minimum wages and other state attributes, like the state economic environment, to estimate how the minimum wage affects the rate of net job growth. We also account for annual shocks to the outcome variables occurring at the regional level, to account for any conditions that lead a state to see both a change in the minimum wage and job growth. This would be a concern if, for instance, a state legislature responded to lower job growth with a minimum-wage increase. We also conduct a number of robustness checks to ensure that our results are not driven by spurious correlation. For instance, we show that future increases in the minimum wage do not predict current job growth outcomes. If they did, we would be concerned that other factors are driving the correlation.
What of the results of the Meer and West study.
[Their] findings are unequivocal: higher minimum wages lead to lower rates of job growth. Indeed, a ten percent increase in the minimum wage causes roughly half a percentage point reduction in the rate of job growth, a very large effect. The effect of this hypothetical increase is not permanent, though, since it is eroded by inflation and increases in the state’s comparison group. Our calculations show that this ten percent increase in a state’s real minimum wage, relative to its regional neighbours, causes a 1.2% reduction in total employment relative to what it would have been. We further find that this appears to be driven primarily by reductions in job creation by expanding establishments, not by increases in job destruction by contracting establishments. Essentially, then, the intuition is that employers respond to the minimum wage by growing more slowly.

Judging whether the effect we find is large or small is not necessarily simple. Some might point to a 1.2% reduction in the level of employment after five years and argue that is relatively small – it represents about 23,000 fewer jobs for the average state – and that those who earn the minimum wage and remain in the labour force would earn more. But that argument seems coldly indifferent to those who remain outside of the labour market, unable to take advantage of the relatively rapid transitions out of minimum-wage jobs. At a broader level, it is important to note that, in contrast to much of the previous literature and the dismissiveness of some advocates, we document that the minimum wage does, in fact, affect employment.
The conclusion of the column is that the type of effect we should see, and the type found in their study, is a reduction of job creation, not a loss of existing jobs. Minimum-wage policies may not cause an immediate loss in the number of jobs, but rather a reduction in the rate of net job growth. This effect is all the more insidious for being difficult to detect. Employment growth is slowed, but more importantly, the long-run prospects for individuals are damaged, as they are delayed in the opportunity to develop skills and work experience – to grasp that crucial first rung on the career ladder.

  • Meer, J and West, J (2013), “Effects of the minimum wage on employment dynamics”, Working Paper.

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