The Effects of the Minimum Wage: A Short Survey for the Diligent Voter

| Zach Swaziek | May 9, 2019 |

The minimum wage has been the focus of many public policy discussions recently. Tony Evers, the newly elected Governor of Wisconsin, announced in February that his budget includes a state minimum wage hike in 2020 and 2021 to $8.25 and $9 per hour, respectively. After two $0.75 increases the following two years, Wisconsin’s minimum wage would be increased each year in accordance with inflation. Across the border, the mayor of St. Paul signed an ordinance in November to raise the city’s minimum wage to $15 per hour and the Minnesota Court of Appeals upheld Minneapolis’ $15 minimum wage ordinance with a 5-4 vote.

The minimum wage has also been in the news at a national level. Democratic Representative Alexandria Ocasio-Cortez from New York is a strong proponent for increasing the federal minimum wage to $15 per hour, more than doubling the current rate of $7.25 per hour.

As a voter, it is important to understand research on the effects of this public policy measure, which have been hotly debated in the field of economics. Proponents argue that increases in the minimum wage will increase the compensation of those most in need without much effect on employment or other factors. Opponents of the minimum wage have argued that increases will cause inflation, make businesses fail, and lead to reductions in employment or hours. This article focuses primarily on the latter: how the minimum wage affects employment but also touches on recent research on several other effects.


Research Suggesting Negative Employment Effects

Classical economic theory, taught primarily in introductory economic courses, suggests that increases in the minimum wage will result in decreases in employment in a perfectly competitive market. Even though the real world generally consists of imperfect markets, the majority of minimum wage research shows the same basic result – that increases in the minimum wage lead to small decreases in employment. A comprehensive report by David Neumark of the IZA Institute of Labor Economics notes that of the “most credible” studies from the minimum wage literature that his team reviewed, only 15% showed positive or zero employment effects. Out of all of the studies reviewed, approximately 66% showed reduced employment from increasing the minimum wage.

In addition, Neumark’s report explains that there are negative distributional effects from increasing the minimum wage. Neumark argues that because most poor families do not have any workers in the household, low hours, not low wages, are keeping them in poverty. He also notes that because teenagers are a large percentage of minimum wage earners, of whom many do not live in poor households, minimum wage increases likely result in “far more of the increase in income [going] to families in the top half of the income distribution than to families below the poverty line.” If the benefits of minimum wage increases are realized mostly by non-low-wage persons, are they worth the potential consequences of job losses?

Another concern of many politicians and policymakers is that increases in the minimum wage may lead to the automation of jobs. This concern is supported by a paper published in the June 2018 edition of Labour Economics, co-authored by Neumark. This paper shows that firms tended to shift from low-skilled workers to technology following minimum wage increases over the period of 1980 to 2015. Looking at a more recent time period, the magnitude of this effect increases. As technology becomes more advanced and cheaper to produce, minimum wage increases may disproportionately hurt the people they are supposed to help. It is possible, however, that the automation of these jobs is inevitable – increases in the minimum wage just speeds up this effect – and that the immediate increase in welfare from the wage increase is larger than the potential costs of automation.

If the minimum wage doesn’t work as intended, what other policies should be used? David Neumark closes his report with his suggestions for improvement. One of his suggestions is for more cities to have a minimum wage of their own, often referred to as a “living wage.” This policy allows for specific geographic areas to adjust the minimum wage according to the cost of living. An example of this is Seattle’s 2015 minimum wage increase to $15 an hour. Additionally, Neumark notes that federal subsidies that create incentives to join the labor force, like the Earned Income Tax Credit, paired with increases in the minimum wage can be more beneficial than just increasing the minimum wage alone.


Research Suggesting Zero or Positive Employment Effects

While Neumark’s meta-analysis of the minimum wage research suggests that increases in the minimum wage usually results in small negative employment effects, it is possible that these studies made errors in measuring these effects. A 2010 paper by Arindrajit Dube, T. William Lester, and Michael Reich suggests that the usual econometric approach for analyzing minimum wage increases are biased towards showing negative employment effects. These authors argue that the usual analysis does not account for differences in regional employment conditions and trends, leading to the downward bias. When these conditions and trends are accounted for, in this case, by considering trends and conditions in counties across state borders, “no adverse employment effects” in low-wage industries are found. This paper demonstrates an important idea in economic research – different research designs and econometric approaches may find different results. Just because a certain result is found does not mean that it was found using the most robust methodology or that it is the “true” result.

While many undergraduates may learn about how the minimum wage affects employment in a perfectly competitive labor market – where firms and workers have equal bargaining power in determining wages – this situation does not always occur in the real world. In theory, when a firm has more bargaining power than workers, the firm will pay wages below what the workers are worth to the company – or in economist-speak, the firm sets the wage below a worker’s marginal revenue product. This firm not only pays its workers lower than what they are worth but also doesn’t hire as many workers or produce as much as in a competitive market. A firm that has the ability to influence the price it pays labor is called a monopsony.

In a labor market with a monopsony, economic theory suggests the introduction of a minimum wage set at an efficient level will lead to increases in both employment and production. Although the monopsony firm loses out on profit from the price floor, as long as the minimum wage isn’t set above the equilibrium wage in a competitive market, the firm will still employ the profit-maximizing amount of labor, thus leading to employment increases.

Monopsony power can be explained with a thought experiment that many people who live in or grew up in rural areas are likely familiar with. Suppose that in a small, isolated, rural town, there is only one employer. Also suppose that the residents of the town cannot relocate easily or travel to different areas for work, essentially limiting their employment options to this employer. Because of the lack of competition from other employers and because it knows that employees have no other options, this firm will pay low wages relative to what employees produce.

Many studies have been done the on potential monopsony markets in the U.S. For example, a 2010 paper investigated how increases in registered nurse’s (RN’s) wages at VA hospitals affected the wages of RNs employed at nearby private hospitals. In this case, the RN wages at the VA hospitals could be viewed as the minimum wage, as it is set by the government and likely viewed as somewhat of a base-level pay for RNs. After an increase in RN wages at the VA hospitals, private hospitals increased RN wages and employment on average. This result was largest for those private hospitals closest to VA hospitals. This empirical result is in line with the theoretical results from increases in the minimum wage in a monopsonistic market. Additionally, one of the author’s calculations suggested that “the [marginal revenue product] of RNs was about 50% above their wages.” The RNs at private hospitals were being significantly underpaid, likely because of monopsony power.

A more recent paper from researchers at the National Bureau of Economic Research (NBER) called Labor Market Concentration suggests that antitrust regulators need to be more concerned with widespread monopsony power. The paper shows that labor market concentration, using a measure from antitrust regulators at the Department of Justice and Federal Trade Commission, is very high in the U.S. This measure of concentration is normally used to determine whether or not the merging of companies would create too much power in setting prices in a specific product market. Instead, these researchers use it to see how much power firms have in setting wages. The authors also identify that higher labor market concentration leads to lower wages on average, further evidence of widespread monopsony power. Although antitrust regulators focus primarily on monopolies, this paper suggests that they should also be cognizant of market power in hiring – monoposonies.

The findings of Labor Market Concentration also support the thought experiment of monopsony power in a small rural town mentioned earlier. The paper explains that areas “around large cities tend to have lower levels of labor market concentration than smaller cities or rural areas.” This result makes intuitive sense: as residents of cities have more opportunities for work because of a larger number of employers, there is greater competition for workers, which means that individual firms have less labor market power. The opposite is true in rural areas. This leads to higher wages in cities and lower wages in rural areas, on average. In a state like Wisconsin, where nearly 30% of the population lives in rural areas according to the 2010 Census, the negative effects of monopsony power are likely to be significant in large numbers of people.

As the percentage of Americans that live in urban areas increases, the effects of monopsony are likely to be reduced, as discussed above. However, as the urban-rural divide continues to increase, rural Americans will continue to disproportionately be affected by monopsony power and the reduced employment and wages that are the consequence of it.


Research on Other Effects – Inflation, Wage Growth, and Inequality

As mentioned at the beginning of this article, the employment effects of the minimum wage are just one of many that must be analyzed. Recent research highlights the effects of the minimum wage on important economic variables like inflation, wage growth, and inequality.

Many politicians say that increases in the minimum wage will defeat its purpose by increasing price levels. They suggest that the purchasing power of those intended to be helped by the minimum wage will not increase – people that receive the minimum wage will not be able to buy any more necessities than they previously could. In contrast to this idea, a recent paper from researchers at the University of Washington found no significant effects on supermarket prices in Seattle over a two-year period following the hike to $15 per hour. This research suggests that minimum wage increases will, in fact, increase the real purchasing power of those that earn the wage. While it is important to keep in mind that this research is limited to a single urban area over a short time period, it is still a significant finding especially as the United State’s urban populations continue to grow.

Ironically, the effects of inflation, albeit that not caused by the minimum wage, is also why many think the wage should be increased. Simply put, inflation has outpaced minimum wage increases over the past 40 years, decreasing the real purchasing power of minimum wage earners. In 1980, the federal minimum wage was $3.10 per hour. Adjusting this wage for inflation using the Consumer Price Index (CPI) and the Personal Consumption Expenditures Price Index (PCE), two different ways to measure increases in consumer price levels, results in wages at approximately $10.25 and $9.00 in today’s dollars, respectively. As the federal minimum wage is currently at $7.25 per hour, this means that minimum wage earners in 1980 were compensated $1.75 to $3.00 more per hour in today’s dollars than earners today depending on whether you use the CPI or PCE. For a full-time minimum wage earner, this translates to approximately $3,500 to $6,000 more in annual disposable income, measured in today’s dollars. Indexing the minimum wage to inflation, like in Governor Ever’s budget, means that minimum wage earners would keep their real purchasing power constant – enabling them to purchase the same amount of goods for the same amount of work each year.

Increases in the minimum wage can also have benefits other than increasing hourly pay. A 2018 working paper authored by Kevin Rinz and John Voorheis of the U.S. Census Bureau finds that “increasing the minimum wage increases earnings growth at the bottom of the [income] distribution, and those effects persist and… grow in magnitude over several years.” Specifically, this effect was robust up to five years after the minimum wage increase and was relatively contained at or below the 30th percentile. Compared to previous economic expansions, wage growth has been stagnant, and this paper suggests that increases in the federal minimum wage would contribute to increased wage growth over several years.

The minimum wage also acts to counteract wage inequality. During a time when inequality has reached record levels, this is an important characteristic. David Autor, Alan Manning, and Christopher Lee, economists at MIT, the London School of Economics, and the Board of Governors, respectively, suggest that the falling real value of the minimum wage, resulting from not adjusting the minimum wage for inflation, has increased wage inequality materially in the United States. Their paper “The contribution of the Minimum Wage to US Wage Inequality over Three Decades: A Reassessment” in the American Economic Journal: Applied Economics uses econometric methodologies to show that the falling value of the minimum wage between 1979 and 2012 “made a meaningful contribution to female inequality, a modest contribution to pooled gender inequality, and a negligible contribution to male lower tail inequality.” Not only does a lack of minimum wage increases increase inequality, but it does also so unequally – disproportionately affecting women. This finding suggests that minimum wage increases, even just in line with inflation, would have reduced income inequality. Instead, the lack thereof contributed to it.

What does all of this research mean for Governor Evers’ proposal to increase the minimum wage in Wisconsin? Most research thus far suggests that increases in the state minimum wage will have some small, negative effect on employment. In some areas, especially small, rural towns, however, minimum wage increases may weaken monopsony power and have minimal or even positive effects on employment. Additionally, the minimum wage combats income inequality, boosts income growth of low wage earners, and may only have negligible effects on inflation. It also must be acknowledged that new research designs and approaches are constantly being analyzed. While some of these research findings may seem robust, future methodologies may discount them. The minimum wage increases in Minneapolis and St. Paul, as well as the potential increases in Wisconsin,  give economists more valuable opportunities to research the effects of such hikes.

As a voter, it is your decision to support this policy or not. This article is not meant to cover all research or theories in the literature; rather, to give some general insight. The minimum wage literature is vast, but it is important to understand the common themes and findings so that your voting decisions are rooted in evidence and not blind faith. As economist and Nobel Prize winner Milton Friedman said, “One of the great mistakes is to judge policies and programs by their intentions rather than their results.”

Zach Swaziek is a senior double majoring in Economics and Finance, Investment, & Banking. Zach grew up in Muscoda, WI and his research interests include macroeconomics, labor economics, and public policy.