Labor Market Institutions and the Minimum Wage By Ben Bollinger

Hello all! I’m Ben (@lefteconomics) the new economic analyst at Berning Media Network and I wanted my first post to be regarding two main topics which I believe are somewhat small, but have very large implications on a macroeconomic scale, and those are: the minimum wage and in general labor market restrictions.

Now, starting with the minimum wage, it is a very controversial topic in both political and economic spheres given how radically different, people think about the topic. However, the second you step out of academic circles and start asking ordinary people what their thoughts are, it becomes clear that the minimum wage is a very popular idea:

minPoll

Source: (Edwards-Levy, 2016)

So if the majority of Americans not only support a minimum wage, but also a significant number of them support an increase in the minimum wage as well, why is nothing being done about this? Why do we often hear talk of lowering the minimum wage or even getting rid of it all together?

Well, one of the main reasons is that there are many politicians and even economists who hold that any increase in the minimum wage will have long run negative impacts for workers. Now here’s where we must also bring up again the idea of labor market restrictions in general, we can trace this notion of negative impacts on workers back to an Oxford University Press book published by Layard, Nickell and Jackman (1991) where they attempted to show a relationship between government regulation in the labor market and unemployment. In their book, Layard, et al. (1991) present graphs of long run unemployment against the duration of unemployment benefits, and imply a causal relationship from duration to unemployment. They state:

 

“It is noticeable… that all the countries where long-term unemployment has escalated have unemployment benefits of some kind that are available for a very long period, rather than running out after 6 months (as in the USA) or 14 months (as in Sweden).”

 

There are other ways to read this evidence, but the point here is that bivariate evidence (evidence which measures a relationship between two variables) has often been used to make the case for the unemployment-generating effects of labor market institutions such as the minimum wage on top of other government/union regulations.

Now, in order to empirically understand the impact labor market institutions have on employment, we must go a bit beyond bivariate evidence, and look at the bigger picture. Baker, Glyn, Howell, and Schmitt (2004) do just this in their assessment of the “empirical data” put out by institutions such as the International Monetary Fund (IMF). Baker, et al. (2004) use multivariate data to measure the impact of labor market institutions from 1998-2002 and found that the data shows:

 

“a remarkable degree of diversity, with no immediately obvious connection between the levels of individual institutions and national unemployment rates.”

1998

And finally conclude that:

“The rise in the unemployment rate in many major economies over the last three decades is probably the most striking economic phenomena of this era. Economists have struggled to find a compelling explanation for this development. There is a great temptation to blame labor market protection – economists generally believe that interferences with smooth market adjustments lead to less than optimal outcomes. Therefore, it is understandable that they would look to institutions such as employment protection legislation, unemployment benefit generosity, or unions as the villains in this story.

 

…We conclude that the evidence is far from conclusive. Expanding on an earlier review of recent literature, we find that the results of prior studies are in many cases problematic and often contradictory. Many of the results that report significant relationships between unemployment and labor market institutions appear dubious – for example finding large country specific trends in unemployment rates – which would preclude the regression results from being taken literally in other contexts. The extraordinarily wide range of estimates of the economic impact of the labor market institutions leave these estimates of relatively little use for policy purposes, even when the measured effects are found to be statistically significant. In order to intelligently assess the merits of labor market reform, policy makers need a fairly precise range of estimates of the benefits to be expected from reducing specific labor market protections (e.g. employment protections or replacement rates). These benefits can then be weighed against the cost of weakening labor market protections both in the form of reduced security for workers, and also in some cases the reduced labor-market efficiency. This literature clearly does not provide such a basis [for deregulation.]”

 

Now this study was done specifically on labor market institutions in general, and found no relationship between an increase in the power said institutions have over the economy and the employment rate, but what about the minimum wage specifically? The basic argument against minimum wages in general goes something like this:

 

“If the government forces businesses to sell above the market value of a good/service then businesses will either raise prices or lay people off thus increasing unemployment. Don’t you understand basic economics?”

 

Starting with the idea that businesses will raise prices to compensate for minimum wage losses, the fact remains that the majority of businesses would rather not raise prices so that they can compete better and have a better reputation with customers. And to take the case of Seattle’s minimum wage hike for instance, businesses there only raised prices by a few cents in order to compensate some of their losses due to the minimum wage. The reason for this is that major companies like McDonald’s, Walmart, etc. have huge equity and can afford to pay their employees more at the expense of little profit loss. And it is true smaller businesses don’t get this luxury all the time, but minimum wages can be legislated to alleviate pressure on them as I advocate and may write about in the future.

 

Now, let’s deal with the minimum wage’s specific effects on the employment rate. As stated previously, one of the most common arguments given against a minimum wage is that it will increase the unemployment rate and have a long run negative impact on working people. To understand this point, I will be using the recent example of Seattle and their raising of the minimum wage from $9.47 to $11 per hour in 2015 and to $13 per hour in 2016. [1]

 

Just a few weeks ago, Jardim, et al. (2017) published a working paper for the National Bureau of Economic Research (NBER) which analyzed the data from Seattle’s test with minimum wage hikes. Their conclusion was that:

 

“…the second wage increase to $13 reduced hours worked in low-wage jobs by around 9 percent, while hourly wages in such jobs increased by around 3 percent. Consequently, total payroll fell for such jobs, implying that the minimum wage ordinance lowered low-wage employees’ earnings by an average of $125 per month in 2016.”

 

Now this is a pretty bold claim, and if it holds true, can potentially pose a major threat to advocates of a minimum wage. However, several days after the NBER published that study, a response article was written by Zipperer and Schmitt (2017) where they point out some key methodological flaws in in Jardim, et al.’s study as well as present some important data the original study left out.

 

Firstly, the original study’s estimates of job loss are far outside the range of earlier estimates, including those made by consistent critics of the minimum wage (such as Neumark and Wascher, 2008). Interestingly, Jardim, et al. argued in their paper that the significant implications of their research indicate that their results should be seen as an important new contribution to the large body of existing research on the minimum wage. However there are serious doubts to be raised on this assertion.

 

For instance, the results put forth by Jardim, et al. suggest that a 1% increase in the minimum wage leads directly to a 3% reduction in employment. From this, therefore, they conclude that any benefits the minimum wage may potentially give to workers will easily be offset by the simple fact that businesses can’t afford to pay employees more money. So, what’s the problem with this analysis? Well, first let’s look at the author’s justification for these results. They argue that they “analyze[d] the impact of raising the minimum wage to a significantly higher level than what has been analyzed in most prior work.” To support this, Jardim et al. explain how they compared the $13 minimum wage to the historical, nationally inflation-adjusted values of the federal minimum wage. But, this comparison is invalid: the relevant comparison is how Seattle’s new minimum wages compare to the city’s underlying wage distribution.

 

Because of this irrelevant standard of measuring minimum wage impacts, the author’s data is nothing but an outlier in the existing research that exists surrounding the minimum wage especially pertaining to their outlandish findings on labor elasticity demand and restaurant jobs. For example Card (1992), when studying the impacts of the 1990s minimum wage increases, found very small positive and negative labor demand elasticities for teenagers, ranging from -0.06 to 0.19. A more recent study by by Dube, Lester, and Reich (2016) examined nearby counties with different minimum wages over the 2000–2011 time period and found labor demand elasticities of -0.27 for teenagers and -0.11 for restaurants. Lastly on this point an even more recent study by Reich, Allegretto, and Godoey (2017) came to a conclusion measuring minimum wage impacts on employment in the restaurant sector (the sectors impacted by the minimum wage increase) that are in line with earlier research and concludes that to date the minimum wage increases have had no negative impact on employment.

Finally, the last important flaw in the Jardim, et al. study I will bring up in this article is that they excluded employees at businesses in Washington that operate establishments at multiple locations in the state and report employment, hours, and earnings information jointly for those locations from their assessment of Seattle’s minimum wage experience. The problem with doing this is the authors cannot determine whether individual workers are at an establishment in Seattle, and therefore covered by the higher minimum wage, or are elsewhere in the state and, therefore, not covered by the new law. According to the authors’ calculations, this restriction excludes just under 40 percent (37.9 percent) of the overall workforce (likely many employees at chain stores and restaurant chains).

 

Unfortunately for people who cite this study as evidence of all the harm minimum wages cause, this paints an incomplete picture of employment trends in the state as a whole. We can demonstrate this by understanding a few things research has shown the minimum wage does to businesses. For example, Luca and Luca (2017) found in their analysis of minimum wage impacts that after an increase in the minimum wage, restaurants with lower customer ratings are more likely to go out of business. Further research by Aaronson, French, Sorkin, and To (2016) found that restaurant chains are both more likely to close restaurants and more likely open new establishments after a minimum wage increase. From this, we therefore see that Jardim, et al.’s failure to count jobs created in the large sector comprised of multi location businesses biases the study toward finding employment losses, even if the shift in employment to multi-location businesses more than made up for the drop in single-location businesses.

 

There were many other methodological flaws in Jardim, et al.’s study that you can read about in sections 3-5 of Zipperer and Schmitt’s review of it, but I believe I have made my point clear on the fact that increases in the minimum wage do not necessarily correlate with increases in the unemployment rate in the long run, and can actually lead to higher rates of employment as some of my cited studies suggest. This view can be further emphasized from the work of Doucouliagos and Stanley (2009) where, ontop of demonstrating clear anti-minimum wage biases in much of the minimum wage research that gets published in academic journals, also comprised this graph for us:

min1

 

Which clearly shows that the minimum wage can be estimated to have little to almost no impact on the employment rate of a given area. This point can be further emphasized by using data from the Bureau of Labor Statistics to measure the minimum wage and employment rate side by side, and when this is done:

minimum-wage-vs-ratio-of-unemployment-rates-1950-jan-2013

We once again find almost no correlation between the two. Now I want to use this graph to lead me into my next point about the minimum wage and the role of government institutions and policies in the labor market. You may notice that the minimum wage (held constant on January 2013 prices) was much higher in the past, despite there being very little unemployment. In fact, the post-war period up until the 70s and 80s are often referred to as “the golden age” of capitalism where the American Dream was more than just propaganda, it was something that was actually possible.

 

The reason for this is mostly because of the fact that the post-war period was during something known as “The Keynesian Revolution” where interventionist economic policies were the dominant way of thinking for mainstream economists. Because of this, the government was able to maintain full employment policies which kept the majority of people employed, inequality down, and economic growth high and as Sorkin (1997) notes, what little recessions occurred were easily combated by highly interventionist policy.

 

This is something we need to go back to. Everyone talking about “making America great again” should remember that when America was its greatest economically speaking, was when the government played a large role in the economy. My point in explaining all of this is that even if we accept the notion that minimum wages do in fact cause mass unemployment, which we don’t even have to as explained above, it still remains that any unemployment caused by minimum wages can easily be offset by government fiscal policy to maintain full employment. I will save the later implications of this for a future post, but for further theoretical and empirical research done on this subject, see Mitchell and Muysken (2008). I hope you all enjoyed reading, and if I got anything wrong or you think my arguments are bad, feel free to reply to this article or leave a comment!

 

Notes:

[1] Note that the majority of this section of the article is either directly taken or paraphrased from Zipperer and Schmitt (2017).

References:

Aaronson, D., French, E., Sorkin, I., To, T. (2016) Industry Dynamics And The Minimum Wage: A Putty-clay Approach

http://bit.ly/2uogZ69

 

Baker, D., Glyn, A., Howell, D., Schmitt J. (2004) Unemployment and Labor Market Institutions: The Failure of the Empirical Case for Deregulation

http://cepr.net/documents/publications/unemployment_dereg_2004_09.pdf

 

Card, D. (1992) Using Regional Variation in Wages to Measure the Effects of the Federal Minimum Wage

http://journals.sagepub.com/doi/10.1177/001979399204600103

 

Doucouliagos, H., Stanley, T. (2009) Publication Selection Bias in Minimum-Wage Research? A Meta-Regression Analysis

http://onlinelibrary.wiley.com/doi/10.1111/j.1467-8543.2009.00723.x/full

 

Dube, A., Lester, W., Reich, M. (2016) Minimum Wage Shocks, Employment Flows, and Labor Market Frictions

http://www.journals.uchicago.edu/doi/10.1086/685449

 

Edwards-Levy, A. (2016) Raising The Minimum Wage Is A Really, Really Popular Idea

http://www.huffingtonpost.com/entry/minimum-wage-poll_us_570ead92e4b08a2d32b8e671

 

Jardim, E., Long, M., Plotnick, R., van Inwegen, E., Vigdor, J., Wething, H. (2017) Minimum Wage Increases, Wages, and Low-Wage Employment: Evidence From Seattle

https://evans.uw.edu/sites/default/files/NBER%20Working%20Paper.pdf

 

Layard, R., Nickell, S. Jackman R. (1991) Unemployment

https://global.oup.com/academic/product/unemployment-9780199279173?cc=us&lang=en&

 

Luca, D., Luca, M. (2017) Survival of the Fittest: The Impact of the Minimum Wage on Firm Exit

http://www.hbs.edu/faculty/Publication%20Files/MW_Exit_7a89f82f-b2fa-42f2-9a0e-f8a61e95b679.pdf

 

Mitchell, W., Muysken, J. (2008) Full Employment Abandoned: Shifting Sands and Policy Failures

http://gen.lib.rus.ec/book/index.php?md5=87351AC7BD96A9769CABF63CECBD0937

 

Neumark, D., Wascher, W. (2008) Minimum Wages

https://mitpress.mit.edu/books/minimum-wages

 

Reich, M., Allegretto, S., Godoey, A. (2017) Seattle’s Minimum Wage Experience 2015-16

http://irle.berkeley.edu/files/2017/Seattles-Minimum-Wage-Experiences-2015-16.pdf

 

Sorkin, A. L. (1997) “Recessions after World War II,” in D. Glasner and T. F. Cooley (eds), Business Cycles and Depressions: An Encyclopedia

http://gen.lib.rus.ec/book/index.php?md5=06A8DD15CBBDF013646AC43738CB8F7D

 

Zipperer, B., Schmitt, J. (2017) The “high road” Seattle labor market and the effects of the minimum wage increase

http://www.epi.org/files/pdf/130743.pdf

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