The model summarized in Figure 3-19 also assumes that all workers are covered by the legislation. As noted above, only 43 percent of nonsupervisory workers in the economy were in the covered sector when the FLSA was first enacted. The size of the covered sector, however, has increased over time, so that the legislation now covers most workers.
To see how the adverse employment effects of minimum wages may be moderated by less-than-universal coverage, consider the labor markets illustrated in Figure 3-20 . 21 There are two sectors in the economy, the covered sector in Figure 3-20 a and the uncovered sec- tor in Figure 3-20 b . Prior to the imposition of a minimum wage, there exists a single equi- librium wage, w * , in both markets (determined by the intersection of the supply curve S C and the demand curve D C in the covered sector, and the intersection of S U and D U in the uncovered sector). The minimum wage is imposed only on workers employed in the indus- tries that comprise the covered sector. Workers employed in the uncovered sector are left to the mercy of the market and will receive the competitive wage.
Once the minimum wage is imposed on the covered sector, the wage rises to w and some workers lose their jobs. Covered sector employment falls to E and there are EC E displaced workers in the covered sector. Many of the displaced workers, however, can migrate to the uncovered sector and find work there. If some of these workers migrate to jobs in the uncovered sector, the supply curve in this sector shifts to S ′U (as illustrated in Figure 3-20b). As a result, the uncovered sector wage declines and the number of workers employed in the uncovered sector increases from EU to E ′U.
However, this is not the only possible type of migration. After all, some workers initially employed in the uncovered sector might decide that it is worthwhile to quit their low- paying jobs and hang around in the covered sector until a minimum-wage job opens up. If many workers in the uncovered sector take this course of action, the direction of migration would then be from the uncovered to the covered sector. The supply curve in the uncovered sector would shift to S ′′U in Figure 3-20 b , raising the uncovered sector wage.
21 Finis Welch, “Minimum Wage Legislation in the United States,” in Orley Ashenfelter and James Blum, editors, Evaluating the Labor-Market Effects of Social Programs, Princeton: Princeton University Press, 1976; and Jacob Mincer, “Unemployment Effects of Minimum Wages,” Journal of Political Economy 84 (August 1976): S87–S104.
The analysis in Figure 3-20 shows how the free entry and exit of workers in and out of labor markets can equilibrate real wages in an economy despite the intentions of policy makers. In fact, if workers could migrate from one sector to the other very easily (that is, costlessly), one would expect that migration would continue as long as workers expected one of the sectors to offer a higher wage. The migration of workers across the two sectors would stop when the expected wage was equal across sectors.
To see this, let’s calculate how much income a worker who enters the covered sector can expect to take home. Let be the probability that a worker who enters the covered sector gets a job there, so that 1 is the probability that a worker in the covered sector is unemployed. If the worker lands a minimum-wage job, he gets wage w; if he does not land a job, he has no income (ignoring any unemployment compensation). The wage that a person who enters the covered sector can actually expect to get is then given by
Expected wage in covered sector =
[ * w] + [(1 - ) * 0] = w (3-21)
or a weighted average of the minimum wage w and zero.
The worker’s alternative is to enter the uncovered sector. The wage in the uncovered sec- tor is set by competitive forces and equals w U . Because there is no unemployment in the uncovered sector, this wage is a “sure thing” for workers in that sector. Workers will move to whichever sector pays the higher expected wage. If the covered sector pays a higher expected wage than the uncovered sector, the flow of workers to minimum-wage jobs will lower the probability of getting a job, increase the length of unemployment spells, and decrease the FIGURE 3-20 The Impact of Minimum Wages on the Covered and Uncovered Sectors
If the minimum wage applies only to jobs in the covered sector, the displaced workers might move to the uncovered sector, shifting the supply curve to the right and reducing the uncovered sector’s wage. If it is easy to get a minimum- wage job, workers in the uncovered sector might quit their jobs and wait in the covered sector until a job opens up, shifting the supply curve in the uncovered sector to the left and raising the uncovered sector’s wage.
Dollars
Employment –E EC
DC SC –w
w*
Dollars
(If Workers Migrate to Covered Sector)
(If Workers Migrate to Uncovered Sector)
(b) Uncovered Sector (a) Covered Sector
Employment EU
SU
E''U
S''U
E 'U
S'U
DU w*
expected wage. In contrast, if the wage is higher in the uncovered sector, the migration of workers to that sector shifts the supply curve outward and lowers the competitive wage w U . As a result, the free migration of workers across sectors should eventually lead to
w = wU (3-22)
so that the expected wage in the covered sector equals the for-sure wage in the uncovered sector.
The discussion suggests that factors that influence the probability of landing a minimum- wage job help determine the direction of the migration flow between the two sectors. Suppose that workers who get a minimum-wage job keep it for a long time. It is then difficult for a person who has just entered the covered sector to obtain a job. An unemployed worker, there- fore, quickly recognizes that she is better off working in the uncovered sector where wages are lower, but jobs are available. If the persons who hold minimum-wage jobs are footloose (so that there is a lot of turnover in these jobs), there is a high chance of getting a minimum- wage job, encouraging many workers to queue up for job openings in the covered sector.
Evidence
The simplest economic model of the minimum wage predicts that as long as the demand curve for labor is downward sloping, an increase in the minimum wage should decrease employment of the affected groups. A large empirical literature attempts to determine if this is, in fact, the case. Many of the empirical studies focus on the impact of minimum wages on teenagers, a group that is clearly affected by the legislation. 22 In 2003, about 10 percent of workers between the ages of 16 and 19 earned the minimum wage or less, as compared to only 1.7 percent of workers over the age of 25. 23
A comprehensive survey of these studies concludes that the elasticity of teenage employment with respect to the minimum wage is probably between 0.1 and 0.3. 24 In other words, a 10 percent increase in the minimum wage lowers teenage employment by between 1 and 3 percent. Although this elasticity might seem small, it can have numerically
22 See Finis Welch and James Cunningham, “Effects of Minimum Wages on the Level and Age Com- position of Youth Employment,” Review of Economics and Statistics 60 (February 1978): 140–145;
Robert Meyer and David Wise, “The Effects of the Minimum Wage on the Employment and Earnings of Youth,” Journal of Labor Economics 1 (January 1983): 66–100; Alison Wellington, “Effects of the Minimum Wage on the Employment Status of Youths: An Update,” Journal of Human Resources 26 (Winter 1991): 27–47; and Richard V. Burkhauser, Kenneth A. Couch, and David C. Wittenburg,
“A Reassessment of the New Economics of the Minimum Wage Literature with Monthly Data from the Current Population Survey,” Journal of Labor Economics 18 (October 2000): 653–680.
23 U.S. Bureau of the Census, Statistical Abstract of the United States, 2002, Washington, DC:
Government Printing Office, 2002, Table 627.
24 Charles Brown, “Minimum Wages, Employment, and the Distribution of Income,” in Orley C.
Ashenfelter and David Card, editors, Handbook of Labor Economics, vol. 3B, Amsterdam: Elsevier, 1999, pp. 2101–2163. Many studies also examine the impact of the minimum wage in other coun- tries. Recent examples include Linda Bell, “The Impact of Minimum Wages in Mexico and Colombia,”
Journal of Labor Economics 15 (July 1997): S102–S135; Richard Dickens, Stephen Machin, and Alan Manning, “The Effects of Minimum Wages on Employment: Theory and Evidence from Britain,”
Journal of Labor Economics 17 (January 1999): 1–22; and Zadia M. Feliciano, “Does the Minimum Wage Affect Employment in Mexico?” Eastern Economic Journal 24 (Spring 1998): 165–180.
important effects. For example, between 1990 and 1991, the minimum wage rose from
$3.35 to $4.25, or a 27 percent increase. If the elasticity of teenage employment with respect to the minimum wage is 0.15, the minimum wage increase reduced teenage employment by about 4 percent, or roughly 240,000 teenagers. 25 A quarter million dis- placed workers may not necessarily be a “numerically trivial” impact.
The long-standing consensus that the minimum wage has adverse employment impacts on the most susceptible workers has come under attack in recent years. The “consensus”
elasticity estimates of 0.1 and 0.3 were typically obtained by looking at the time-series relation between the employment of teenagers and the minimum wage. In effect, these studies correlate teenage employment in a particular year with some measure of the real minimum wage, after adjusting for other variables that could potentially affect teenage employment in that year. The estimated elasticities, however, are extremely sensitive to the time period over which the correlation is estimated. During some time periods, the elastic- ity estimate is quite small (nearly zero), while if one estimates the same correlation over other time periods, one obtains a much more negative elasticity. 26
A number of studies in the 1990s introduced a different methodology for estimating the employment effects of minimum wages by carrying out case studies that trace out the employment effects of specific minimum-wage increases on specific industries or sectors.
These studies often conclude that many of the recent increases in the minimum wage have not had any adverse employment effects. One of these studies surveyed a large number of fast-food restaurants in Texas prior to (December 1990) and after (July 1991) the imposi- tion of the $4.25 minimum wage. 27 Fast-food restaurants are a major employer of youths in the United States, and the minimum wage presumably should have a particularly strong effect on youth employment in that industry. It turns out, however, that there was little change in employment in these establishments, and, if anything, many of the restaurants actually increased their employment.
The “revisionist” evidence also seems to suggest that teenage employment is not affected when states enact a minimum wage that is higher than the federal level. In July 1988, two years prior to the increase in the federal minimum wage, California raised its minimum from $3.35 to $4.25 an hour. Prior to the increase, about 50 percent of California’s teen- agers earned less than $4.25 an hour, so that many teenagers were obviously affected by the
25 There also exists a subminimum wage. Employers can pay teenage workers 85 percent of the minimum wage in the first three months of the job, as long as the worker is engaged in on-the-job training activities. This provision of the legislation reduces the price of younger unskilled workers relative to the price of older unskilled workers. Employers might then reevaluate their existing mix of labor inputs in order to take advantage of the now-cheaper youth workforce. However, only about 1 percent of employers use the subminimum wage; see David Card, Lawrence F. Katz, and Alan B.
Krueger, “Employment Effects of Minimum and Subminimum Wages: Panel Data on State Minimum Wage Laws,” Industrial and Labor Relations Review 47 (April 1994): 487–497.
26 John F. Kennan, “The Elusive Effect of Minimum Wages,” Journal of Economic Literature 33 (December 1993): 1950–65.
27 Lawrence F. Katz and Alan B. Krueger, “The Effect of the Minimum Wage on the Fast-Food Industry,”
Industrial and Labor Relations Review 46 (October 1992): 6–21; see also David Card and Alan B.
Krueger, Myth and Measurement: The New Economics of the Minimum Wage, Princeton, NJ: Princeton University Press, 1995.
state-mandated raise. Nevertheless, it seems as if California teenagers did not suffer any employment loss when the higher state minimum wage went into effect. 28
The best-known case study analyzes the impact of the minimum wage in New Jersey and Pennsylvania. 29 On April 1, 1992, New Jersey increased its minimum wage to $5.05 per hour, the highest minimum wage in the United States, but the neighboring state of Pennsylvania did not follow suit and kept the minimum wage at $4.25, the federally man- dated minimum. The New Jersey–Pennsylvania comparison provides a “natural experi- ment” that can be used to assess the employment impacts of minimum wage legislation.
Suppose, for example, that one contacts a large number of fast-food establishments (such as Wendy’s, Burger King, KFC, and Roy Rogers) on both sides of the New Jersey–
Pennsylvania state line prior to and after the New Jersey minimum went into effect. The restaurants on the western side of the state line (that is, in Pennsylvania) were unaffected by the New Jersey minimum wage, so employment in these restaurants should have changed only because of changes in economic conditions such as seasonal shifts in con- sumer demand for fried chicken and hamburgers. Employment in restaurants on the east- ern side of the state line (that is, in New Jersey) were affected both by the increase in the legislated minimum as well as by changes in economic conditions. By comparing the employment change in the restaurants on both sides of the border, one can then “net out”
the effect of changes in economic conditions and isolate the impact of the minimum wage on employment. In effect, one can use the difference-in-differences technique to measure the employment effect of minimum wages.
Table 3-3 summarizes the key results of this influential study. It turns out that the fast-food restaurants on the New Jersey side of the border did not experience a decline in employment relative to the restaurants on the Pennsylvania side of the border. In fact, employment in New Jersey actually increased relative to employment in Pennsylvania. The typical fast-food res- taurant in New Jersey hired 0.6 more worker after the minimum wage increase than it did before the increase. At the same time, however, the macroeconomic trends in the fast-food
28 David Card, “Do Minimum Wages Reduce Employment? A Case Study of California, 1987–89,”
Industrial and Labor Relations Review 46 (October 1992): 38–54. Card’s findings have been challenged by David Neumark and William Wascher, “State-Level Estimates of Minimum Wage Effects: New Evidence and Interpretations from Disequilibrium Methods,” Journal of Human Resources 37 (Winter 2002): 35–62.
29 David Card and Alan B. Krueger, “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania,” American Economic Review 84 (September 1994): 772–793.
TABLE 3-3 The Employment Effect of Minimum Wages in New Jersey and Pennsylvania
Source: David Card and Alan B. Krueger, “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania,” American Economic Review 84 (September 1994), Table 3.
Employment in Typical Fast-Food Restaurant (in full-time equivalents)
New Jersey Pennsylvania
Before New Jersey increased the minimum wage 20.4 23.3
After New Jersey increased the minimum wage 21.0 21.2
Difference 0.6 2.1
Difference-in-differences 2.7
industry led to a decline in employment of about 2.1 workers in Pennsylvania—a state that was unaffected by the minimum wage increase. The difference-in-differences estimate of the impact of the minimum wage on employment, therefore, was an increase of about 2.7 workers in the typical fast-food restaurant. Needless to say, if correct, this line of research raises important questions about how labor economists think about the economic impact of minimum wages.
We are beginning to understand why the recent evidence based on specific case studies differs so sharply from the time-series evidence that dominated the earlier literature, and why the implications of our simple—and sensible—supply-and-demand framework seem to be so soundly rejected by the case-study data. 30
One plausible reason is that the adverse effect of the minimum wage on employment is relatively small. It might then be hard to detect this effect in a rapidly changing economic environment. In other words, the “true” impact of the minimum wage on employment is negative, but small. As a result, sampling errors lead researchers to find either small posi- tive or small negative effects.
It also has been convincingly shown that the survey data used in the New Jersey–Pennsylvania study contained a lot of measurement error and that this noise in the data generated cor- respondingly noisy estimates of the labor demand elasticity. In fact, if one replicates the study using the administrative employment data actually reported by the establishments, as opposed to the survey data collected by researchers, the employment effect of the mini- mum wage in the New Jersey–Pennsylvania experiment turns negative, and the estimated elasticity is within the consensus range of 0.1 to 0.3. 31
An equally serious conceptual problem with the New Jersey–Pennsylvania case study is that the focus on employment trends in fast-food restaurants could easily provide a myo- pic and misleading picture of the employment effects of minimum wages. After all, these establishments might use a production technology where the number of workers is rela- tively fixed (one worker per grill, one worker per cash register, and so on). As a result, the minimum wage might not reduce employment in existing restaurants, but might dis- courage the national chain from opening additional restaurants (as well as accelerate the closing of marginally profitable restaurants). Moreover, economies of scale might also
“shelter” fast-food restaurants from the minimum wage. The minimum wage would then accelerate the decline of the smaller and less competitive “mom-and-pop” restaurants and fast-food restaurants might even “thrive” as a result of the minimum wage.
The before-and-after comparisons of employment in affected firms also are affected by the timing of these comparisons. Employers may not change their employment exactly on the date that the law goes into effect, but may instead adjust their employment slowly as they take into account the mandated increase in their labor costs. In fact, a careful study of the impact of minimum wages in the Canadian labor market shows that the employment effects of the minimum wage are smallest when one compares employment just before and
30 An excellent and comprehensive survey of the recent literature is given by David Neumark and William Wascher, “Minimum Wages and Employment,” Foundations and Trends in Microeconomics 3 (2007): 1–182. A potential explanation that is commonly offered in the literature is that fast-food restaurants have some degree of market power when hiring workers, so that the labor market is not competitive. This explanation will be discussed in more detail in Chapter 4
31 David Neumark and William Wascher, “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania, Comment,” American Economic Review 90 (December 2000): 1362–1396.