Serious economic debate over the wisdom of minimum wages has been going on for at lease 70 years, and the debate has been revived by President Obama’s proposal to raise the US’ federal minimum wage to $9 per hour. The two main issues debated are the effects of a higher minimum on employment of the low skilled, and its effects on the degree of poverty. both theory and evidence indicate that higher minimums reduce employment for teenagers and other workers with low productivity, and that it does little to alleviate poverty. Neither conclusion, however, is without controversy, especially the employment effect.
Federal minimums in the United States have never been higher than to affect a rather small fraction of the working population, such as teenagers, unskilled immigrants, and some others. The expectation from economic theory is that when the minimum wage is raised above the wages that these low skilled workers are receiving, some of them would become unemployed because they would be priced out of the labor market. The challenges to this conclusion have both theoretical and empirical aspects.
One old theoretical argument is that employment may not fall if firms hiring low skilled workers have monopoly power in the labor market. Yet the great majority of low skilled workers are employed in fast food establishments and other retail and manufacturing sectors that face much competition even in local labor markets. Another claim is that higher minimums mainly reduce the profitability of the firms employing low skilled workers without have much effect on employment. Perhaps that claim would apply to highly profitable companies, but profit margins are generally thin in the typical firms employing the workers affected by higher minimums. Since there is not much room for these margins to go much lower without the firms going out of business, the firms affected try to preserve their thin margins by cutting costs, including reducing employment of low skilled workers.
Also argued is that higher wages shock firms into more efficient behavior that offsets the effects on costs of the higher wages. That claim too is not persuasive in the highly competitive sectors with much entry and exit of firms that employ the great majority of low skilled workers. The Economist in a recent article on minimum wages (issue of Feb. 6-23) refers to the claim that higher minimum wages are good for employers because they reduce worker turnover, which is costly to employers. But employers could raise wages on their own if they believed that this reduced turnover enough to raise their profits. In fact, the reduction in turnover is smaller, not larger, when higher minimums force competitor firms also to raise their wages. For then the gain to workers from staying with their jobs is lower, aside from the effects of higher minimums in reducing employment options.
The great majority of the literature during past couple of decades on the effects of higher minimum wages is empirical with little theoretical discussion. Two eminent economists, David Card and Allen Krueger, launched the first modern attack on the traditional conclusion that higher minimums significantly reduce the employment of the low skilled. They studied employment changes in fast food restaurants in adjacent states before and after one of the states raises its minimum wage. They found essentially no effect on employment, or sometimes even a slight positive effect. I wrote a Business Week article at the time (1995, reprinted in The Economics of Life) that was harshly critical of their study. In retrospect I believe my criticisms were too harsh, for their study was pioneering, and stimulated a large amount of serious empirical work using both time series changes in federal minimums, and state differences in minimum wages.
Some of the more recent studies have supported the Card-Krueger finding of little if any effects of “moderately” higher minimum wages on employment, although the “majority” has tended to confirm the older conclusion that a 10% increase in the minimum wage reduces teenage employment by about 1to 3 per cent. A very recent study by Neumark, Salas, and Wascher (January 2013] goes over a few recent studies challenging this conclusion. They conclude, as Neumark and Wascher did in their 2008 book, Minimum Wages, regarding earlier evidence, that the recent evidence does not overturn the conclusion that higher minimum wages do significantly reduce employment of vulnerable groups, like teenagers.
France has one of the highest minimum wages relative to average wages in the developed world, so its record is particularly interesting to analyze. Several studies by the French economists Guy Laroque and Bernard Salanie support the view that higher minimum wages significantly reduce employment of married women and young persons. Consistent with their analysis, France has the highest minimum in Europe, and also has unusually high unemployment rates of younger persons, especially Moslem males.
Some proponents of higher minimum wages indicate that while they believe that small to “moderate’ increases in minimum wages have negligible effects on unemployment and employment, they admit that sizable increases in the minimum wage would significantly reduce employment. Obviously small changes usually have small effects, but this view appears to be claiming that the employment effect per each one per cent increase in the minimum wage gets bigger as the overall increase in the minimum wage gets larger. This is not at all obvious, and depends on complex substitution and complementarity relations with skilled labor and other inputs.
Even if one accepts the conclusion, as I do, that higher minimum wages lowers employment significantly of vulnerable groups like teenagers, this conclusion does not imply that minimum wages are an ineffective way to fight poverty. Higher minimum wages might still increase the overall earnings of the poor because the higher earnings of those who manage to keep their jobs dominates the negative effects on the earnings of workers who lose their jobs.
That conclusion too is not justified because minimum wages are ill suited to raise the incomes of the poor, partly because it targets individual earnings rather than family incomes. Posner gives several reasons why low earnings of individuals and low family incomes are only loosely connected.
There is an additional reason why higher minimums may not help poor families. By raising the costs of employers, higher minimums induce competitive firms to raise their prices. I pointed out earlier that the principal employers of low skilled workers are fast food establishments and other producers of cheaper goods. Poorer families are also the main consumers of fast foods and other low-end goods and services that employ low skilled workers. As a result, low-income families are hit by two bullets: some of their members find it harder to get jobs, and they face a higher cost of the goods they consume.