Minimal evidence - impact of minimum wage increases

Reason, June, 1995 by Benjamin Zycher

As the old saying goes, economists may not be able to agree on the time of day. But for many years, almost all economists have agreed on one issue: Raising the minimum wage leads to greater unemployment among workers with low skills. Both basic theory and many empirical studies support that conclusion. Textbooks preach it, and even liberal economists who chafe at the notion teach it to their students.

Or so it was until recently. But as nature abhors a vacuum, economists prefer controversy to consensus--especially when the consensus puts their professional judgment at odds with their political instincts. Accordingly, the decades-long agreement on the employment effects of the minimum wage now has been challenged by several scholarly papers examining survey data on employment in fast-food restaurants and other low-wage sectors. Four widely publicized studies argue that raising the minimum wage has not led to greater unemployment among low-skilled workers.

Unsurprisingly, this new research has quickly become politicized. Labor leaders, who like high minimum wages because they make union pay scales more competitive, have seized on the new research to disparage the traditional view. So have Labor Secretary Robert Reich and President Clinton. "Now, I've studied the arguments and the evidence for and against a minimum wage increase," Clinton claimed in his State of the Union Address. "I believe the weight of the evidence is that a modest increase does not cost jobs, and may even lure people back into the job market."

Well, not so fast, please. While the new studies are serious works, done by serious scholars, they are not particularly believable. Indeed, they have several problems in common, as well as various individual flaws. And the (seemingly) most persuasive study turns out to be based on abysmally bad data.

To understand the studies and their problems, it is important to understand the traditional argument that raising the minimum wage reduces employment among low-skilled workers. The reason is simple. The demand for labor--the number of manhours (not workers) employers want to buy at different wage rates--is determined by the expected productivity of the given workers. So if wages rise by decree, rather than because workers can produce more per hour, employers will hire fewer hours of labor.

Moreover, not all low-skilled workers are created equal. Some have more skills than others. Some have a few or all of such advantages as good looks, physical strength, a flexible schedule, greater intelligence, more or better schooling, stronger communication skills, better health, greater perceived honesty and character, a lower perceived likelihood of resorting to the litigation system, ad infinitum. In general, they have higher expected productivity than other workers with low skills.

Other people are not so lucky. For any number of reasons they may appear "riskier" to prospective employers. They may have physical or mental handicaps, weaker references, or small children interfering with work schedules. They may be from neighborhoods or ethnic groups that lead prospective employers to expect (rightly or wrongly) a greater-than-average chance of various problems. They may have transportation problems, annoying personalities, poor personal hygiene, and so forth.

Given that employers are in business to make money--to get the biggest labor productivity bang for their wage buck--all of the anti-discrimination regulation in the world cannot overcome the simple reality that an increase in the minimum wage leads employers to hire relatively more-productive workers rather than relatively less-productive ones, who otherwise might be cheaper. The minimum wage thus makes it harder for the low-skilled--and for the lowest-skilled among them--to compete for employment. Elementary economic analysis predicts unambiguously that increases in the minimum wage, other things being equal, will reduce the employment of low-skilled workers.

Or so we all thought. The revisionist studies claim that, at least in a few instances, this story has a different ending. But a careful examination of the studies suggests that the traditional view is far from discredited.

* The Card/Krueger New Jersey-Pennsylvania Study. The most frequently cited, and seemingly most convincing, new study takes advantage of a "natural experiment" created when New Jersey raised its minimum wage from $4.25 an hour to $5.05 in April 1992. David Card and Alan Krueger of Princeton reasoned that since economic conditions ought not vary greatly between southern New Jersey and eastern Pennsylvania, which are essentially a single economy, looking at employment trends in the two states ought to reveal the effects of the minimum wage.

Card and Krueger conducted telephone surveys of about 400 fast-food restaurants in February-March 1992, and then again in November-December 1992. They asked questions about full- and part-time workers, wages, benefits, and prices. From their statistical analysis of those survey data, Card and Krueger not only "find no evidence that the rise in New Jersey's minimum wage reduced employment at fast-food restaurants in the state," but "find that the increase in the minimum wage increased employment." Indeed, the Card/Krueger statistical analysis suggests that the 18.8-percent increase in the New Jersey minimum wage yielded a 20.8-percent increase in employment relative to the Pennsylvania sample.