THE MINIMUM WAGE
Until recently, most economists thought that raising the
minimum wage forces employers to tighten their belts by cutting jobs. Recent
research indicates that the truth is more complicated than this, and that
the current minimum wage can be safely raised.
The economists were essentially correct; if the minimum wage were raised
to $100 an hour, for example, jobs would not only be lost, but most businesses
would fold. But now consider the other extreme; suppose the minimum wage
were only 2 cents an hour. This wage could be safely tripled with no fear
whatsoever that jobs would be lost. So it's all a matter of degree; the
critical question is how high the minimum wage can be raised before it
starts costing jobs.
Recent research indicates that the U.S. is far below that point. A
Princeton study led by David Card and Alan Krueger compared those states
that have raised their minimum wage above the federal minimum to those
that haven't. And they found that teenage unemployment rates actually dropped
slightly after the minimum wage hike!1
However, their study has been challenged for its supposed methodological
shortcomings. We will review both sides of the debate. First, here are
the results of the Card/Krueger study:
In 1988, California significantly hiked its minimum wage, from $3.25
to $4.25, a full three years before the rest of the nation. While overall
unemployment in California closely followed the nation's, teenage unemployment
in the state actually dipped. And teenage unemployment fell in California
relative to comparable areas (Arizona, Florida, Georgia, New Mexico, and
Dallas-Fort Worth) that did not increase the minimum wage.
The same thing happened in New Jersey in 1992, when it raised the minimum
wage from $4.25 to $5.05. The unemployment rate for low wage workers fell
faster in New Jersey than it did in neighboring Pennsylvania, where there
was no boost.
The same thing happened in Texas after the federal minimum wage was
raised from $3.80 to $4.25. They found job growth was faster at restaurants
which were affected by the wage hike than those that weren't (because they
already paid more than $4.25).
These are surprising results, for which Card and Krueger attempt several
possible explanations. One is that higher pay may compel workers to take
their jobs more seriously, to identify more closely with company objectives,
to show up on time and work harder. This may not only increase productivity
and profits, but it may also reduce employee turnover. High employee turnover
is destructive to a company because it means that the company workforce
lacks experience and continuity; it means that experienced workers have
to spend much of their time training new hires; it means that managers
have to spend both time and money finding replacements. Lower turnover
also means that there are less people temporarily unemployed as they move
between jobs, which could account for the slight dip in low wage unemployment
rates. A higher minimum wage may also compel a manager to make the company's
operations more efficient and profitable. Finally, employers might be considering
hiring new workers at $5 an hour, but do not wish to offend and demoralize
those who are already working at $4.25 an hour. If the minimum wage is
then raised to $5 an hour, the employer can then hire the extra workers
without worrying about it.
The Princeton study poured a bucket of cold water over the heads of
minimum wage opponents. Naturally, they have attacked its conclusions,
alleging the study used poor methodology. The following is an excerpt from
The Economist (dated April 8, 1995):
Defenders of the faith
Now the heresy [that raising the minimum wage doesn't cost jobs]
is under attack. The New Jersey study by Messrs Card and Krueger is a case
in point. Carlos Bonilla of the Employment Policies Institute (EPI), which
is financed by retailers, restaurateurs and manufacturers, says the data
used in it are wrong. The Princeton pair got their data from a telephone
survey; the questions, he says, were vague, and errors crept into the numbers.
A study financed by the EPI and conducted by David Neumark of Michigan
State University and William Wascher of the Federal Reserve used firms'
payrolls instead. It found that New Jersey fared worse than Pennsylvania
after the minimum wage rose.
Mr. Card retorts that, although telephone data are less reliable than
payroll records, there is no reason why they should be biased. Moreover,
he points out that the EPI sample includes only 71 restaurants, compared
with 410 in the original research. And neither study suggests that minimum
wages have a significant effect on employment.
Daniel Hamermesh of the University of Texas also has his doubts. The
minimum-wage increase was passed long before it took effect. Thus, he says,
firms may have cut jobs before the study began. He also doubts that the
study isolated the effect of the minimum-wage increase from other differences
between Pennsylvania's economy and New Jersey's. Messrs Card and Krueger
disagree. The fate of the New Jersey law, they say, was uncertain until
the last minute. In any case, fast food restaurants can cut staff at short
notice. And interstate differences do not alter their finding that New
Jersey's low- and high-wage restaurants reacted differently to the rise.
The study of the federal minimum-wage increases of 1990 and 1991 has
also come under fire. Donald Deere and Finis Welch of Texas A&M University
and Kevin Murphy of the University of Chicago agree that low-wage states
did better than high-wage ones after the changes.** But they put this down
to regional variations in economic growth, not the minimum wage. Moreover,
they find evidence for the conventional theory. Because younger workers
are likelier than older ones to be poorly paid, their jobs should be more
at risk when minimum wages go up. The same is true for blacks and Hispanics
(compared with whites) and less-educated workers (compared with better-educated
ones). Sure enough, these groups all suffered when the minimum wage rose.
Some say that a higher minimum wage also has more subtle costs. In
another new study*** Messrs Neumark and Wascher argue that it makes American
16-19-year-olds more likely to leave school. And youngsters who have already
left school, whether or not they had jobs before minimum wages rose, are
more likely to become unemployed.
No doubt there is more to come from both sides. However, politicians
who support the minimum wage should be cautious. Its advocates, says Mr
Card, "overreacted to the New Jersey study." The revisionist
work suggests only that when minimum wages are low they make little difference
to employment. Few doubt that at higher levels, such as still prevail in
much of continental Europe, they destroy jobs--especially those of young
At what level do minimum wages start to cost jobs? That will vary from
industry to industry--even from firm to firm. For that reason, governments
may be right to let minimum wages wither. Yet the argument over whether
to do so will run and run-- among professors as well as politicians.
Some economists may object, but many others have concluded that the
$4.25 minimum wage is so low that raising it will have a negligible effect on
jobs. Recently, a group of 101 economists, including three Nobel prize
winners and seven past presidents of the American Economic Association,
called on Congress to support President Clinton's proposal to raise the
minimum wage to $5.15.
Return to Overview
1 David Card and Alan Krueger, Myth
and Measurement: The New Economics of the Minimum Wage (Princeton University
Press, March 1995).