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A short history of minimum wage research
Minimum wages have been a political piñata for as long as I can remember. In general, conservative politicians and free marketeers argue that a minimum wage is like a tax and reduces employment for low-income workers while increasing costs for businesses. Meanwhile, progressive and social-democratic politicians argue that a minimum wage prevents businesses from exploiting low-income workers and reduces income inequality.
Meanwhile, economists have struggled for decades to identify the true impact of minimum wage increases and our understanding of the impact of minimum wages on employment and wages is still evolving.
The conservative view of minimum wages as a job killer goes back to a 1981 paper by Robert Meyer and David Wise that claimed that the wage distribution essentially gets cut off at the lower end of the distribution due to three effects. First, there are workers who get a raise from the increase in the minimum wage. Second, there are workers who lose their jobs because their employers cannot afford to pay them. Third, there are workers who continue to work but (illegally) at a wage below the minimum wage. In their model, Meyer and Wise make one crucial assumption: They assume that the overall wage distribution stays constant. Thus, whatever some workers gain from higher minimum wages, others lose from becoming unemployed or having to work for below minimum wages. Once you make that assumption, it isn’t too surprising to get an outcome that essentially says that higher minimum wages are a job killer (professional labour economists may forgive me for oversimplifying here).
Because the paper of Meyer and Wise came right at the beginning of the Reagan revolution, it became influential both in the US and the UK throughout the 1980s and has been conservative gospel ever since.
12 years later David Card and Alan Krueger re-examined the claims of Meyer and Wise using case studies in New Jersey and Pennsylvania and found much smaller employment effects than previously claimed. This set of an entire series of research efforts all showed that in real life the effect of rising minimum wages on employment is either very small or even positive (i.e. higher minimum wages create a net gain of employment). A recent influential paper by Doruk Cengiz and others showed that the employment effect is effectively zero in the United States. Similar results have been found for the UK and for Europe. This research of the last 25 years or so is why most economists today think that minimum wages are not bad for the economy and don’t necessarily lead to higher unemployment.
Yet, a closer look by Yujiang Chen from Cambridge University and Coen Teulings from Utrecht University indicates that there is probably some truth in both interpretations. They build a complex statistical model to examine both the effect of minimum wages on the distribution of wages and on employment. According to their study, two things are going on at the lower end of the income distribution when the minimum wage is increased.
First, the wages paid to the lowest income workers rise. This does create job losses for the lowest qualified workers along the lines of the original study by Meyer and Wise. But something else happens as well. Workers who had wages a little bit above the minimum wage see their wages increase as well as companies adjust not only the wages they pay to minimum wage workers but also to workers with similar but slightly higher wages and similar skills. Furthermore, in reaction to a higher minimum wage, companies start to compete for workers with qualifications that are somewhat higher than the lowest levels of qualifications provided by minimum wage workers. These minimally qualified workers can be used more flexibly, are a little bit more productive, and justify the higher wage they get paid.
The overall effect is that in response to a minimum wage increase a small number of extremely low and unskilled workers lose their job while workers with only a little bit higher qualifications see their employment and their wages rise. Note that I am not talking about unskilled workers being replaced by technicians with a four-year university degree. The new research estimates that an increase of the minimum wage by 9% creates the best trade off. For that kind of minimum wage increase, wages for the lowest 16% of workers by income increase, while employment for the lowest 7% of workers by income declines. The net effect is not only an increase of the minimum wage by 9% but also an increase in overall employment by 2.2%.
Of course, that net increase in employment is of little comfort to those in the bottom 7% of the income distribution with no qualifications, because they still face a higher probability of unemployment. But it also shows that just a little bit of job training to create some employment skills for these people can go a long way to help them find a job and earn substantially more money.