The Minimum Wage and Employment

I hypothesized earlier this week that a minimum wage increase might be a more effective economic stimulus than tax rebates. I based this on recent research showing that after a minimum wage increase, those earners rapidly increased spending --- more than theory would predict. And the ratio of increased spending to cost to businesses (or government if the increase in wages was paid for through a cut, either temporary or permanent, in corporate taxes) was greater than the ratio of the cost of the 2001 stimulus rebates to the actual spending induced.

I was expecting some criticism, and I got it:

• wheresmymom said:

anyone who knows anything about minimum wage knows that when minimum wage increases so does unemployment.

• TJ said:

Don't try to challenge Milton Friedman. You don't have the intelligence for it.
You don't even make adjustments for unemployment or reduced work hours in your back-of-envelope calculation. Please. Don't waste our time.

• and Z said:

Clearly, a price floor (aka minimum wage) creates a surplus. Many workers will have their work hours cut or eliminated.

So I realized I needed to highlight the recent findings on the relationship between minimum wages and unemployment.

The classic reasoning, which made perfect sense, is that in a relatively free employment market, businesses were paying as much as they could (or thought sensible) to their employees. So increasing the minimum wage and increasing costs for employers would force them to cut hours and/or employees. But this thinking has come into question over the last decade.

First, <a href="http://press.princeton.edu/titles/5632.html">research</a> by Alan Krueger and David Card found some evidence of a positive effect from minimum wage increases. (Here is a summary of that line of research). A recent extensive review of findings across 100+ studies by David Neumark of UC Irvine and William Wascher of the Federal Reserve counters Card and Krueger, arguing that the majority of findings internationally show a negative effect from minimum wage hikes. But even Neumark and Wascher say that many of the studies in support of that negative effect show no statistical significance.

Here is the OECD in 2007 on the same:

There is an academic debate about whether increases in the minimum wage do more harm than good. On one side are economists who stress adverse employment effects and the poor targeting of the minimum wage. Neumark provides a good statement of this view. The other side includes 650 economists who signed a petition calling for a higher minimum wage (Economic Policy Institute, 2006). Although these economists each have their own reasons, they appear to view employment consequences as modest and outweighed by favourable distributional changes.

And two (1, 2) recently published papers again find no negative relationship between employment and higher minimum wages. So, I'm sure there's an argument to be made against my claim, but there's no strong evidence showing that minimum wage increases have a large negative effect on employment.

I think a more valid criticism came from Dekatris: "you seem to be encouraging a policy whose success is dependent upon deficit spending by consumers."

This may very well be the case. The research I cited in the earlier post was only able to look at minimum wage earners through three quarters after an increase However, the amount that earners increased their spending by was less than the total increase in lifetime income thanks to the wage hike. Are low wage earners prudent enough to not increase debt beyond that?

---