C15 Lecture 1: Minimum Wages and Economic Outcomes

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C15 Lecture 1Minimum Wages and Economic
Outcomes

• Stephen Machin,
• February 2005

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Issues

• Economic effects of minimum wages and evidence on
  minimum wages and employment
• The controversy on conventional wisdom versus
  micro based revisionist approach
• The introduction of the UK National Minimum Wage

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Economic Effects of Minimum Wages

• Effect on employment/unemployment has been
  central issue in debate about economic effects of
  minimum wages.
• Standard textbook model of labour demand produces
  one of the clearest predictions in labour
  economics - minimum wages price workers out of
  jobs by forcing employers up their labour demand
  curve.

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Standard Textbook Model
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Standard Textbook Model

• Basic model rests upon several assumptions
  complete coverage homogeneous labour
  competitive labour market short run and long run
  impact the same.
• Clear prediction the minimum wage increase
  results in reduced employment - the proportional
  reduction in employment (lnEm - lnE0) equals the
  proportionate wage increase (lnWm - lnW0) times
  the elasticity of demand ?.
• Can develop more sophisticated models, but with
  assumption of perfect competition produce same
  qualitative predictions.

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Two Sector Model

• Basic model can be generalised in various
  directions. One example is to move to a two
  sector model - covered/non-covered, set E0 1,
  W0 1.
• Demand for workers in the covered sector depends
  on the minimum wage, whereas demand in the
  uncovered sector depends upon the market wage.
• Minimum wage elasticity of employment
• c?elnWm / 1 - c elnWm
• where c proportion in covered sector, e
  elasticity of labour supply.
• If c 1, e ? ? standard one sector competitive
  model, ?
• Example c 0.7, lnWm 0.6, e 0.3, ? -1 ?
  employment effect -0.26.

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Implications

• Only pertinent question is how negative is the
  negative effect on employment?
• Minimum wage hurts the people it sets out to help
  by pricing them out of work even more the case
  since low skill people more likely to be low paid

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Evidence

• Early empirical work largely supportive of basic
  model ? conventional wisdom.
• Usually based on aggregate time series studies of
  US employment/unemployment rates and minimum
  wages, usually focussing on teenagers
• Yt g(MWt, X1t,......Xkt) et
• where Yt employment / unemployment to
  population ratios (usually in logs), Xit
  aggregate demand and supply variables (teenagers
  in training programmes, school enrollment, time
  trend), MWt minimum wage index (e.g. Kaitz
  index).
• Brown, Gilroy, Kohen (1982) Journal of Economic
  Literature - say consensus reached minimum
  wages reduce teenage employment with elasticities
  in the -0.1 to -0.3 range.

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Observations on Time Series Evidence Re-Appraisal

• 1). Only up to late 1970s and US minimum wage
  fell strongly in real terms in the 1980s

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Re-Appraisal (Continued)

• 2). Extending the samples of teenage employment
  studies into the 1980s produces much smaller,
  often statistically insignificant, elasticities
  below the consensus range (around -0.07) (Card
  and Krueger, 1995).

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Implications of Re-Appraisal

• Minimum wage effects on employment seem small
  (centring in on zero).
• Alternative theoretical explanations
• Monopsony based arguments
• Single buyer of labour (e.g. company town)
  characterised by upward sloping labour supply
  curve to firm

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Monopsony
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Implications of Re-Appraisal

• Dynamic monopsony type-notions (based on labour
  market frictions) can generate non-negative
  employment effects of minimum wages.
• Or labour demand curve inelastic so that
  employment not very sensitive to changes in
  minimum wages.

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Micro Work

• What is best conceptual way to evaluate economic
  effect of minimum wage?
• Before and after micro work more closely
  approximates the theoretical approaches that talk
  about labour markets with and without minimum
  wage floors sometimes referred to as
  revisionist approach.

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Methodological Issues in Newer Research

• Corresponds better to theoretical concepts as
  adopts before and after approach, with treatment
  and control groups.
• If E is employment, T and C denote treatment and
  controls and 1 and 2 are the before and after
  treatment periods then an estimate of the impact
  of treatment is
• (ET2 EC2) (ET1 EC1)
• or
• (ET2 ET1) (EC2 EC1)

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Micro Based Before and After Studies

• Most famous piece is Card and Kruegers (1994)
  New Jersey / Pennsylvania comparison
• UK strand 1 Wages Council work
• UK strand 2 evaluations of introduction of UK
  National Minimum Wage in April 1999

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New Jersey/Pennsylvania Comparison(Card and
Krueger, 1994)

• Can be viewed as case study of fast food
  industry.
• Surveyed fast food restaurants in New Jersey and
  Pennsylvania in February-March and
  November-December 1992.
• In April 1992 the New Jersey minimum wage went up
  from the federal minimum level of 4.25 to 5.05
  but the minimum in Pennsylvania remained at 4.25.

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New Jersey/Pennsylvania Comparison (Continued)

• Two treatment versus control experiments
• a) T New Jersey restaurants, C Pennsylvania
  restaurants
• b) T low wage New Jersey restaurants, C
  high wage New Jersey restaurants

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Survey Descriptive Statistics
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New Jersey/Pennsylvania Comparison (Continued)

• Results
• i) Substantial impact on wage structure
  February 1992 33 percent of NJ and 34 percent
  of Penn restaurants had starting wage 4.25
  November 1992 90 percent of NJ restaurants had
  starting wage 5.05 and 30 percent of Penn
  restaurants had starting wage 4.25.
• ii) But no negative effect on employment (if
  anything positive)

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Wage Structure Impact
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Identification of Employment Effects

• ?Ei a bXi cNJi ei
• ?Ei a bXi cGAPi ei
• Where GAP 0 for P stores and NJ stores with
  W1i 5.05 and (5.05 - W1i) / W1i for other NJ
  stores/

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New Jersey/Pennsylvania Comparison (Continued)
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Employment Models
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UK Wages Councils

• System of minimum wages that used to operate in
  UK was a partial coverage industry based system.
• Wages councils introduced in 1909 (by Churchill)
  covered workers in low wage industries (the
  sweated trades). Abolished in 1993.
• At time of abolition covered around 12 percent of
  workers in the labour market. Were concentrated
  in low wage service sector industries. Largest
  was retail trade.

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UK Wages Councils (Continued)

• Dickens, Machin, Manning (1999) look at
  employment and minimum wages in Wages Council
  industries from 1975-92.
• Reduced wage inequality, but no evidence of
  disemployment effects.

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Wages Councils Wage Structure Impacts
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Changes in Employment and Toughness
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Employment Models
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The Introduction of a National Minimum Wage in
the UK

• Introduced in April 1999 at 3-60 for over 21s,
  3-00 for 18-21s, none for 16-17 year olds.
• Raised (by fairly small amounts) on an irregular
  basis. Now (after last change of October 2004)
  stands at 4.85 for the adult rate and 4.10 for
  the development rate. And, since October 2004,
  there is a rate for 16-17 year olds, of 3.00 per
  hour.

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Introduction of NMW(Continued)
Adult rate Development rate
April 1999 3.60 3.00
June 2000 3.60 3.20
October 2000 3.70 3.20
October 2001 4.10 3.50
October 2002 4.20 3.60
October 2003 4.50 3.80
October 2004 4.85 4.10
Notes denotes rate for employees aged 18 to 21
and those aged 22 and over receiving accredited
training and in the first six months of
employment
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Introduction of NMW(Continued)

• Issues
• Who affected and wage benefits.
• Evaluating the economic effects.
• Initially focus on wage impact, coverage and
  employment.

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Introduction of NMW- Low Pay Commission

• Ex-ante Low Pay Commission (LPC) set up and
  reported on evidence and how expect labour market
  to be affected by NMW
• Predicted 2 million workers to benefit (9
  percent of workforce), most of whom were women.
• Estimated wage boost of 30 percent for those
  affected

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Introduction of NMW Low Pay Commission
(Continued)

• Ex-post
• Fewer than 2 million workers benefited, more
  like 4 or 5 percent (due to measurement error in
  earnings data).
• The Office for National Statistics now put the
  number of people beneath the minimum before
  introduction at 1.52 million, whilst the most
  recent Low Pay Commission report goes even lower
  at 1.3 million.
• Average wage gain for beneficiaries smaller,
  more like 6-10 percent

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Beneficiaries of Minimum Wage Introduction
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Introduction of NMW Employment Effects

• Key economic question concerns impact on
  employment.
• LPC stated that their view was that NMW was set
  at level that would not harm jobs (logic is idea
  that can have monopsony power up to a certain
  level of wages so get inverse U-shape in
  employment effects).

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Introduction of NMW - Employment Effects
(Continued)

• 1). Macroeconomic picture
• No obvious unemployment effect from NMW
  introduction.
• Aggregate employment rates () 1998 73.5, 1999
  73.9, 2000 74.4, 2001 74.4 Unemployment
  rates () 1998 6.3, 1999 6.0, 2000 5.4,
  2001 5.1.
• (Source Labour Market Trends, March 2003)

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Introduction of NMW- Employment Effects
(Continued)

• 2). Micro studies with treatment-control design.
• Stewart (2004) looks at individual-level data
  sources to appraise the impact of NMW
  introduction on individual employment
  probabilities.
• Explicitly looks before and after minimum wage
  introduction using longitudinal data on people
  (from Labour Force Survey, British Household
  Panel Survey and New Earnings Survey).

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Introduction of NMW- Employment Effects
(Continued)

• Stewart (2004) presents difference-in-difference
  estimates for four groups adult men, young men
  (lt22), adult women, young women (lt22).
• Also cross-area paper (Stewart, 2002) where uses
  geographical variation in the proportion affected
  (across 140 areas) to identify any minimum wage
  effect.

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Introduction of NMW- Employment Effects
(Continued)

• Stewart (2004) approach is to compare those
  workers affected by the minimum wage with workers
  above the minimum wage floor.
• Looks at differences-in-differences across these
  groups (again treatment-control type
  comparison).

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Introduction of NMW- Employment Effects
(Continued)

• Step 1 looks at wage effects.

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Introduction of NMW- Employment Effects
(Continued)

• Step 2 looks at differences in employment
  probabilities.

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Introduction of NMW- Employment Effects
(Continued)

• In both papers fails to find negative effects on
  employment from NMW introduction.
• Across all workers no evidence of an adverse
  effect on employment resulting from NMW
  introduction.

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Introduction of NMW- Employment Effects
(Continued)

• 3). Employment Effects in a Vulnerable Sector
  Care Homes
• Machin, Manning and Rahman (2003) look for
  minimum wage effects in one of the sectors most
  vulnerable to employment losses induced by
  minimum wage introduction, the labour market for
  care assistants.
• Carried out own survey to collect data on workers
  and homes before and after minimum wage
  introduction.

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Introduction of NMW- Employment Effects
(Continued)

• Why is this a useful research exercise?
• 1). The sector contains many low-wage workers, so
  the minimum wage has real potential to have a
  noticeable important impact on outcomes.
• 2). The sector is not unionised.
• 3). It consists of large numbers of small firms
  (average employment being somewhere in the range
  of 15-20 workers) doing a very homogeneous
  activity in geographically concentrated markets.
• 4). The product market side of this sector is
  interesting. An important fraction of the
  residents of these homes have their care paid for
  by the Department for Social Security (DSS).

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Introduction of NMW- Employment Effects
(Continued)

• Therefore provides good testing ground for trying
  to identify minimum wage effects on employment.
• Carried out survey of all UK residential care
  homes before and after introduction. Asked for
  information on all workers in each home.
• Then considered wage and employment effects using
  methodology that relates changes in wages and
  employment before and after the minimum wage
  introduction to the fraction of low paid workers
  in the pre-minimum wage period.

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Introduction of NMW- Employment Effects
(Continued)

• Impact on Wages
• Approach 1 look at percent below minimum before
  introduction and for spike at minimum after
• Approach 2 estimate statistical models, relating
  the change in the average wage before and after
  minimum wage introduction to the proportion of
  workers paid less than the minimum wage in the
  period before introduction.

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Introduction of NMW- Employment Effects
(Continued)

• Impact on Wages, Approach 1

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Introduction of NMW- Employment Effects
(Continued)

• Impact on Wages, Approach 1

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Introduction of NMW- Employment Effects
(Continued)

• Impact on Wages, Approach 2
• Estimate home-level wage change models

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Introduction of NMW- Employment Effects
(Continued)

• Impact on Employment
• Study whether homes where wages went up by more
  experienced employment falls.
• Slight evidence of job losses, but moderate given
  scale of wage gains.
• Even in this most vulnerable sector hard to find
  employment losses due to minimum wage
  introduction.

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Introduction of NMW- Employment Effects
(Continued)
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Distributional Impact

• If employment effects moderate then one may be
  interested in distributional consequences of
  minimum wage floors
• Wage inequality
• Family income distribution

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Wage Inequality

• Dickens-Manning impact limited further up
  distribution (small spillovers).

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Income Distribution

• Need to be careful what group to study. If
  households with someone in work

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Current Research

• Moving on from employment effects.
• Particular focus on firm outcomes (like prices,
  profitability).
• Also work on training, crime impacts.

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Summary

• Economics of minimum wages is interesting area
  to illustrate
• How basic first order principles of economics can
  be evaluated.
• How economics can link closely to issues of
  public policy.
• How evidence based policy formation can be useful.