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Free exchange - The argument in the floor
Nov 24th 2012 | from the print edition
MINIMUM-WAGE laws have a long history and enduring political appeal. New
Zealand pioneered the first national pay floor in 1894. America s federal
minimum wage dates from 1938. Most countries now have a statutory pay floor and
the ranks are still swelling. Even Germany, one of the few big countries
without, may at last introduce a national one. And in an era of budget
austerity and widening inequality, the political temptation to prop up wages at
the bottom by fiat may well grow.
Economists have tended to oppose minimum wages on the grounds that they reduce
employment, hurting many of those they are supposed to help. Milton Friedman
called them a form of discrimination against low-skilled workers. In standard
models of competitive markets, anything that artificially raises the price of
labour will curb demand for it, and the first to lose their jobs will be the
least-skilled workers.
Yet economic theory allows for the possibility that wage floors can boost both
employment and pay. If employers have monopsony power as buyers of labour and
are able to set wages, for instance, they can keep pay below its competitive
rate. Academic supporters of wage floors, mainly economists on the left,
appealed to this logic. But most of their colleagues disagreed; and until about
1990, most empirical studies found that higher minimum wages cost jobs,
particularly among young workers.
Then a pioneering case study by two noted labour economists, David Card and
Alan Krueger, examined the response of fast-food restaurants to a rise in New
Jersey s state minimum wage. It found that this had actually increased
employment. The paper spawned a flood of similar case-study research, a
flurry of revisionist thinking and a heated academic debate. The most prominent
critics of the new research were David Neumark of the University of California
at Irvine and William Wascher of the Federal Reserve. They disputed Messrs Card
and Krueger s findings for New Jersey and argued that a comparison of different
states over time showed that higher minimum wages hurt jobs.
Almost two decades later, the minimum-wage debate has matured, not least
because policy changes have brought heaps of new evidence to analyse. Britain
introduced a national minimum wage in 1999. America s states saw numerous
adjustments in their minimum wages, and the federal floor was raised by 40%
between 2007 and 2009.
America s academics still do not agree on the employment effects. But both
sides have honed their methods and, in some ways, the gap between them has
shrunk. Messrs Card and Krueger moved on to other work, but Arindrajit Dube at
the University of Massachusetts-Amherst and Michael Reich of the University of
California at Berkeley have generalised the case-study approach, comparing
restaurant employment across all contiguous counties with different
minimum-wage levels between 1990 and 2006. They found no adverse effects on
employment from a higher minimum wage. They also argue that if research showed
such effects, these mostly reflected other differences between American states
and had nothing to do with the minimum wage.
Messrs Neumark and Wascher still demur. They have published stacks of studies
(and a book) purporting to show that minimum wages hit jobs. In a forthcoming
paper they defend their methods and argue that the evidence still favours their
view. But even they are no longer blanket opponents. In a 2011 paper they
pointed out that a higher minimum wage along with the Earned Income Tax Credit
(which tops up income for poor workers in America) boosted both employment and
earnings for single women with children (though it cost less-skilled, minority
men jobs).
Britain s experience offers another set of insights. The country s national
minimum wage was introduced at 46% of the median wage, slightly higher than
America s. A lower floor applied to young people. Both are adjusted annually on
the advice of the Low Pay Commission. Before the law took effect, worries about
potential damage to employment were widespread. Yet today the consensus is that
Britain s minimum wage has done little or no harm.
The most striking impact of Britain s minimum wage has been on the spread of
wages. Not only has it pushed up pay for the bottom 5% of workers, but it also
seems to have boosted earnings further up the income scale and thus reduced
wage inequality. Wage gaps in the bottom half of Britain s pay scale have
shrunk sharply since the late 1990s. A new study by a trio of British
labour-market economists (including one at the Low Pay Commission) attributes
much of that contraction to the minimum wage. Wage inequality fell more for
women (a higher proportion of whom are on the minimum wage) than for men and
the effect was most pronounced in low-wage parts of Britain.
The British way versus the American way
This new evidence leaves economists with lots of unanswered questions. What
exactly is going on in labour markets if minimum wages do not hurt employment
but reduce wage gaps? Are firms cutting costs by squeezing wages elsewhere? Are
they improving the productivity of the lowest-wage workers? Some of the newest
studies suggest firms employ a variety of strategies to deal with a higher
minimum wage, from modestly raising prices to saving money from lower turnover.
Policymakers face practical issues. Bastions of orthodoxy, such as the OECD, a
rich-country think-tank, and the International Monetary Fund, now assert that a
moderate minimum wage probably does not do much harm and may do some good.
Their definition of moderate is 30-40% of the median wage. Britain s experience
suggests it might even be a bit higher. The success of the Low Pay Commission
points to the importance of technocrats rather than politicians setting wage
floors. Britain s small, regular changes may be easier for firms to absorb than
America s infrequent but hefty minimum-wage increases. Whatever their flaws,
minimum wages are here to stay.
Sources
"Minimum wage channels of adjustment", by Barry T. Hirsch, Bruce E. Kaufman and
Tetyana Zelenska, IZA Discussion Paper No 6132, November 2011
"Minimum wages and wage inequality: Some theory and an application to the UK",
by Tim Butcher, Richard Dickens and Alan Manning, October 2012
"Why has the British national minimum wage had little or no impact on
employment?", by David Metcalf, CEP Discussion Paper No 781, April 2007
"Minimum wage effects across state borders: estimates using contiguous
counties", by Arindrajit Dube, T. William Lester and Michael Reich, The Review
of Economics and Statistics, November 2010
"Minimum wage: Maximum impact", by Alan Manning, Resolution Foundation, April
2012
"Revising the minimum wage-employment debate: Throwing out the baby with the
bathwater?", by David Neumark, J.M. Ian Salas and William Wascher, forthcoming
"Do minimum wages really reduce teen employment? Accounting for heterogeneity
and selectivity in state panel data", by Sylvia A. Allegretto, Arindrajit Dube
and Michael Reich, Industrial Relations, April 2011
http://www.Economist.com/blogs/freeexchange
from the print edition | Finance and economics