Social Europe

politics, economy and employment & labour

  • Themes
    • Strategic autonomy
    • War in Ukraine
    • European digital sphere
    • Recovery and resilience
  • Publications
    • Books
    • Dossiers
    • Occasional Papers
    • Research Essays
    • Brexit Paper Series
  • Podcast
  • Videos
  • Newsletter

Why Increasing The Minimum Wage Does Not Necessarily Reduce Employment

Alan Manning 27th January 2014

Alan Manning, minimum wage

Alan Manning

Recent months have seen President Obama make a renewed push to address inequality in the U.S., especially via one policy lever he has focused on previously- raising the minimum wage. For many, conventional economic wisdom states that raising the minimum wage costs jobs, as employers are less willing to take on staff at higher rates of pay. Alan Manning takes a close look at the economics and the evidence of these claims, finding that one of their basic assumptions, that labor markets are highly competitive, does not hold. He argues that in light of this, and of empirical evidence from academic studies of wages and employment, it is very difficult to claim that wages have a significant effect on employment in either direction.

A generation ago, the vast majority of economists would have said that a rise in the minimum wage inevitably costs jobs. It must, they would have said, if a basic principle of economics – that the demand for labor falls as wages rise – is correct. In the current debate over the federal minimum wage, many opponents of the increase have argued that any rise poses too great of a risk to the fragile economic recovery. However, recent research shows this truism to be over-simplified and not reflective to the realities of the labor market. Rather than automatically reducing employment, an increased minimum wage presents mixed outcomes.

Until the mid-1990s, almost all studies of the minimum supported the idea of an unwelcome trade-off between wage regulation and employment. But the cozy consensus was shattered by the research of two economists, David Card and Alan Krueger, then both at Princeton. They argued that the actual evidence linking the minimum wage to job losses was weak. More important, they offered new analyses concluding that the minimum wage – at the levels observed in the United States – had no effect on employment, and might even raise it! Their seminal study compared employment in fast-food restaurants in two adjacent states, New Jersey and Pennsylvania, after New Jersey raised its minimum wage.

It’s important to bear in mind – certainly Card and Krueger did – that there is still universal agreement that employment is sensitive to a wage floor when it reaches some level. But the two economists were equally convinced by their research that, in the American context, modest increases in the minimum had no effect on jobs.

To say the Card-Krueger research generated controversy is an understatement. Its publication coincided with a debate over raising the federal minimum wage, so the ensuing academic dispute was inextricably mixed with politics. Other academics testified to Congress that the Card-Krueger conclusion amounted to a rejection of the economist’s version of the theory of gravity – and that evidence of antimatter should be treated with great skepticism.

The battle lines haven’t changed much since then. For example, the White House’s 2013 fact sheet on increasing the minimum wage approvingly cited a study by Arindrajit Dube, T. William Lester and Michael Reich, economists at the University of California, Berkeley, comparing employment growth across states (essentially a souped-up version of the earlier comparison of New Jersey and Pennsylvania) and concluding that differences in the minimum wage among states had no effect. This study has since been criticized by two other economists, David Neumark of the University of California, Irvine, and William Wascher of the Federal Reserve Board, who have long been defenders of the conventional wisdom on the minimum wage. Their arguments are technical, concluding that a better analysis of the same data supports the old view that the minimum wage destroys jobs.

What is an outsider, especially one lacking the economist’s statistical weaponry, to make of all this? I think the simplest and most persuasive explanation for radical differences in researchers’ conclusions is that the differences in employment being measured aren’t large – and that it is often hard to disentangle small effects from all the other forces affecting employment.

In the circumstances, I think it is best to focus on the studies with the most accurate, fine-grained data, and increasingly those are studies with access to payroll information from individual firms. In 2011, Barry Hirsch, Bruce Kaufman and Tatyana Zelenska used data from a chain of fast-food restaurants in Georgia. They analyzed the impact of the rise in the federal minimum wage in 2007-9, exploiting the fact that this rise had a bigger impact in low-wage regions (often rural areas) within the state. They found clear effects on earnings, but no effects on employment.

In spite of this accumulating weight of empirical evidence, it is still very common to find economists falling back on the argument that a minimum wage must cost jobs because demand curves for labor inevitably slope downward. Faced with a conflict between the evidence and 20th century economic models, they reject the evidence rather than the theory – not an ideal template for scientific endeavor. But there are, in fact, uncomplicated theoretical reasons why the minimum wage set at the levels seen in the United States has little or no effect on employment. Hence the problem may be with the economics all too often taught as dogma.

The Minimum Wage – What’s wrong with economics 101?

Bare-bones models of market behavior may assume away important elements of reality. First, the increase in total labor costs associated with a given increase in the legal minimum wage is often considerably smaller than the numbers suggest. As the minimum wage rises and work becomes more attractive, labor turnover rates and absenteeism tend to decline. Moreover, the sacrifice associated with the consequences of losing a job rises; so, arguably, workers are inclined to work a bit harder and need less monitoring. Absenteeism and shirking are not trivial problems in many low-wage labor markets, so one can reasonably expect to see a material reduction in the associated costs as the minimum wage rises.

Of course, an employer could voluntarily choose to pay $9 an hour if net labor costs actually fell as wages rose and one would expect some to adopt higher wages without government prodding if it were, in fact, a win-win. So a reasonable guess here is that these offsetting economies reduce, but do not eliminate, the impact of a rise in wage rates.

Then there’s the gap between employer perception and reality. Individual employers often view a rise in wages (or other costs) with horror, assuming it will drive them out of business. But they’re all too often implicitly assuming that they alone will suffer the cost inflation – that changes in the minimum wage will leave them at a disadvantage with respect to competitors.

In reality, businesses generally try to pass a rise in the minimum wage (or sales taxes or anything else that raises the cost of doing business for all) on to their customers. So with fast food, one would expect firms to raise prices. In that circumstance, the effect on employment is only through the effect of a fall in sales of the product, which may well be minimal. Ask yourself: do you eat fewer Whoppers if the price goes up a little at the same time as the price of Big Macs (and Taco Bell Burrito Supremes) goes up a little? Do you even keep track of the price changes?

Theory and reality reconciled

Actually, there is a more fundamental reason why one cannot find the job losses predicted by standard-issue economic theory. The key assumption, that labor markets are highly competitive, is often wrong. The view of the labor market that underlies Economics 101 is not one that many people would recognize. For in this hypothetical world, losing a job is no big deal because finding an identical job is no harder than discovering that the local 7-Eleven is out of Coke and driving around the block to a Circle K for a six-pack. But that is not most people’s experience of labor markets. The reality is that competition for workers is not as strong as many economists would have you believe. An employer who cuts wages will find that most employees are unhappy, but that few will just walk out the door. It thus follows that it may make economic sense for employers to pay workers less than the marginal worker adds to revenues. This completely alters one’s expectations about how a change in the minimum wage will affect the labor market. In this world, a change will not necessarily price the marginal worker out of his job.

Consider, too, that the higher minimum will increase the supply of labor, so the firm may actually find it easier to recruit workers. The bottom line: if one drops the assumption that the labor market is fully competitive, an increase in the minimum wage can lead to a decrease or an increase in total employment. The direction can only be discovered through observation. And as we’ve seen, the empirical evidence does not suggest much effect on employment at the levels of the minimum wage seen in the United States.

Although many people find the stylized account of how labor markets function that’s presented here to be credible for skilled workers, they still doubt it is relevant for minimum-wage workers – the archetypal teen mom flipping burgers or bussing tables. Surely, the argument goes, there are so many potential employers for this sort of labor that one should be able to switch jobs easily. But the reality that some low-skill openings go begging actually tells us that the constraint on employment may be as much labor supply as labor demand.

Economists often have a blind spot on this point. Indeed, I am baffled by their degree of resistance. For example, last year Christina Romer, a former chairwoman of President Obama’s Council of Economic Advisors (and an analyst with impeccable credentials as a champion of the poor), wrote critically of the proposal to raise the minimum wage, arguing that competition between employers was sufficiently robust to push wages close to the marginal product of labor. She seemed trapped in the view that the only exceptions were cases in which large employers dominated a local market – say, a coal mine in a remote corner of Appalachia. I believe that, in most circumstances, the market power of employers derives from the fact that it’s hard for workers to change jobs even when there are alternative employers in abundance.

Consider an irony. The financial crisis has rightly shaken the beliefs of many economists that financial markets can do no wrong because they are disciplined by competition. But faith in the competitive nature of labor markets seems unshakable in the teeth of evidence to the contrary. Markets (labor markets as well as financial markets) need to be regulated to work well, and the minimum wage is a legitimate weapon in the regulatory arsenal. Next time you read that minimum wages hikes inevitably destroy jobs – that you don’t need an econometrician to tell which way the labor market blows – remember that economic theory is no better than the veracity of the assumptions on which it rests.

This article is based on a paper from the Milken Institute Review and was first published by USAPP@LSE.

Alan Manning

Alan Manning is Professor of Economics at the London School of Economics and Political Science (LSE) and Director of the Communities Programme in the Centre for Economic Performance at LSE.

You are here: Home / Economy / Why Increasing The Minimum Wage Does Not Necessarily Reduce Employment

Most Popular Posts

Visentini,ITUC,Qatar,Fight Impunity,50,000 Visentini, ‘Fight Impunity’, the ITUC and QatarFrank Hoffer
Russian soldiers' mothers,war,Ukraine The Ukraine war and Russian soldiers’ mothersJennifer Mathers and Natasha Danilova
IGU,documents,International Gas Union,lobby,lobbying,sustainable finance taxonomy,green gas,EU,COP ‘Gaslighting’ Europe on fossil fuelsFaye Holder
Schengen,Fortress Europe,Romania,Bulgaria Romania and Bulgaria stuck in EU’s second tierMagdalena Ulceluse
income inequality,inequality,Gini,1 per cent,elephant chart,elephant Global income inequality: time to revise the elephantBranko Milanovic

Most Recent Posts

Pakistan,flooding,floods Flooded Pakistan, symbol of climate injusticeZareen Zahid Qureshi
reality check,EU foreign policy,Russia Russia’s invasion of Ukraine: a reality check for the EUHeidi Mauer, Richard Whitman and Nicholas Wright
permanent EU investment fund,Recovery and Resilience Facility,public investment,RRF Towards a permanent EU investment fundPhilipp Heimberger and Andreas Lichtenberger
sustainability,SDGs,Finland Embedding sustainability in a government programmeJohanna Juselius
social dialogue,social partners Social dialogue must be at the heart of Europe’s futureClaes-Mikael Ståhl

Other Social Europe Publications

front cover scaled Towards a social-democratic century?
Cover e1655225066994 National recovery and resilience plans
Untitled design The transatlantic relationship
Women Corona e1631700896969 500 Women and the coronavirus crisis
sere12 1 RE No. 12: Why No Economic Democracy in Sweden?

ETUI advertisement

The EU recovery strategy: a blueprint for a more Social Europe or a house of cards?

This new ETUI paper explores the European Union recovery strategy, with a focus on its potentially transformative aspects vis-à-vis European integration and its implications for the social dimension of the EU’s socio-economic governance. In particular, it reflects on whether the agreed measures provide sufficient safeguards against the spectre of austerity and whether these constitute steps away from treating social and labour policies as mere ‘variables’ of economic growth.


DOWNLOAD HERE

Eurofound advertisement

Eurofound webinar: Making telework work for everyone

Since 2020 more European workers and managers have enjoyed greater flexibility and autonomy in work and are reporting their preference for hybrid working. Also driven by technological developments and structural changes in employment, organisations are now integrating telework more permanently into their workplace.

To reflect on these shifts, on 6 December Eurofound researchers Oscar Vargas and John Hurley explored the challenges and opportunities of the surge in telework, as well as the overall growth of telework and teleworkable jobs in the EU and what this means for workers, managers, companies and policymakers.


WATCH THE WEBINAR HERE

Foundation for European Progressive Studies Advertisement

The winter issue of the Progressive Post magazine from FEPS is out!

The sequence of recent catastrophes has thrust new words into our vocabulary—'polycrisis', for example, even 'permacrisis'. These challenges have multiple origins, reinforce each other and cannot be tackled individually. But could they also be opportunities for the EU?

This issue offers compelling analyses on the European health union, multilateralism and international co-operation, the state of the union, political alternatives to the narrative imposed by the right and much more!


DOWNLOAD HERE

Hans Böckler Stiftung Advertisement

The macroeconomic effects of re-applying the EU fiscal rules

Against the background of the European Commission's reform plans for the Stability and Growth Pact (SGP), this policy brief uses the macroeconometric multi-country model NiGEM to simulate the macroeconomic implications of the most relevant reform options from 2024 onwards. Next to a return to the existing and unreformed rules, the most prominent options include an expenditure rule linked to a debt anchor.

Our results for the euro area and its four biggest economies—France, Italy, Germany and Spain—indicate that returning to the rules of the SGP would lead to severe cuts in public spending, particularly if the SGP rules were interpreted as in the past. A more flexible interpretation would only somewhat ease the fiscal-adjustment burden. An expenditure rule along the lines of the European Fiscal Board would, however, not necessarily alleviate that burden in and of itself.

Our simulations show great care must be taken to specify the expenditure rule, such that fiscal consolidation is achieved in a growth-friendly way. Raising the debt ceiling to 90 per cent of gross domestic product and applying less demanding fiscal adjustments, as proposed by the IMK, would go a long way.


DOWNLOAD HERE

ILO advertisement

Global Wage Report 2022-23: The impact of inflation and COVID-19 on wages and purchasing power

The International Labour Organization's Global Wage Report is a key reference on wages and wage inequality for the academic community and policy-makers around the world.

This eighth edition of the report, The Impact of inflation and COVID-19 on wages and purchasing power, examines the evolution of real wages, giving a unique picture of wage trends globally and by region. The report includes evidence on how wages have evolved through the COVID-19 crisis as well as how the current inflationary context is biting into real wage growth in most regions of the world. The report shows that for the first time in the 21st century real wage growth has fallen to negative values while, at the same time, the gap between real productivity growth and real wage growth continues to widen.

The report analysis the evolution of the real total wage bill from 2019 to 2022 to show how its different components—employment, nominal wages and inflation—have changed during the COVID-19 crisis and, more recently, during the cost-of-living crisis. The decomposition of the total wage bill, and its evolution, is shown for all wage employees and distinguishes between women and men. The report also looks at changes in wage inequality and the gender pay gap to reveal how COVID-19 may have contributed to increasing income inequality in different regions of the world. Together, the empirical evidence in the report becomes the backbone of a policy discussion that could play a key role in a human-centred recovery from the different ongoing crises.


DOWNLOAD HERE

About Social Europe

Our Mission

Article Submission

Membership

Advertisements

Legal Disclosure

Privacy Policy

Copyright

Social Europe ISSN 2628-7641

Social Europe Archives

Search Social Europe

Themes Archive

Politics Archive

Economy Archive

Society Archive

Ecology Archive

Follow us

RSS Feed

Follow us on Facebook

Follow us on Twitter

Follow us on LinkedIn

Follow us on YouTube