What will a 10% ... 50% ... 100% increase in the minimum wage do?

Professors Kreuger and Card have reviewed their New Jersey wage study, and the paper can be found at Working Papers no 393. We would be interested in publishing reviews of this work.

Economists, like Gilbert and Sullivan's Englishmen, are divided into two basic groups. On one side are those who believe that responses to price incentives are usually large -- Big Responders (BR). On the other side are those who believe that responses to price incentives are generally small -- Small Responders (SR).

Present a BR with an exogenous change in price or wage -- for instance a mandated increase in the minimum -- and his prior is that there will be a large response in quantities. Br's feel comfortable with perfect competition, Hecksher-Ohlin trade models; factor price equalisation; large responses in effort and hours to marginal taxes; welfare traps; arbitrage of financial opportunities across national lines; large employment losses to administered wages. Forced to choose between a first-approximation economic model with an infinite elasticity of response and one with zero elasticity, the BR economist opts for infinity: "in the long run, there are many substitutes, new competitors, suppliers, etc."

Present an SR with a change in price or wage, and his prior is that quantities will not change much. SR's feel comfortable with input-output analysis, imperfect competition, factor content analyses of the effects of trade on employment, the correlation of investment and savings across countries, backward-bending supply curves, and the persistence of economic rents. Forced to choose between a first-approximation model with infinite elasticity of response and one with zero elasticity, the SR economist opts for zero: "in real world, costs of adjustment are large, uncertainty slows responses, habits change gradually, etc."

What does the BR-SR divide have to do with the Card and Krueger volume? A lot. Along with its other valuable contributions, the book provides the most important evidence in recent years on the SR side of this recurrent debate. It does this through an exemplary empirical analysis of the effects of minimum wages, on which most economists tend to be Br's by inclination.

It is important to recognise at the outset that there is little in economic analysis to help us decide whether quantity responses to price incentives are likely to be large or small. Many economists expect larger responses in the long run; or when budget constraints are important. Logic tells us that massive changes in prices (say, tripling our wages) that turn balance sheets from the black to the red will have large effects on quantities (the Deans might close down our departments). But whether the BR or SR perspective applies to minimum wages in the range observed in the U.S. is a purely empirical question. It does not have to do with acceptance or rejection of neo-classical economic theory. There is no theoretic or a priori reason for assuming that minimum wages that average 40-50% of hourly earnings in manufacturing have large or small effects on employment, or even that minimum wages that average 70 or 80% of average earnings will necessarily do so. Indeed, economic theory is so "rich" that it offers us monopsony models that predict increases in employment in response to minimum wages. Only careful empirical analysis can determine the magnitude of employment responses to the minimum.

The BR-SR divide is an empirical one. This book offers the most careful and wide-ranging analysis of the empirical evidence on minimum wages in the U.S. that any social scientist could ask for. On many issues, the evidentiary base is sufficiently diffuse to allow economists with different priors to reach different conclusions -- to make a lawyers' case, as it were, for their preferred BR or SR world. (Labor economists think this is true of virtually all macro-economic studies, where conclusions seemingly hinge on assumptions -- called structural models -- that determine what one sees in limited time series data, because the evidence does not "speak for itself"). This is not the case for assessing the short or medium run effects of the minimum wage on employment. Minimum wages change in discrete exogenous jumps over time and across areas that creates "natural experiments".

Card and Krueger exploit this variation admirably. Indeed, they do so in such a way as to provide an exemplary example of how to do empirical economics. The authors examine not one, not two, but many such experiments to judge the minimum wage's employment effects. They (and colleagues) gathered new data or analysed available CPS files, before/after recent changes in minimum wages, with control groups, where feasible. They looked at evidence on the effects of the minimum on the distribution of earnings and, using event studies, of the effect of announced increases on the value of firms and on prices. Forget for the moment the results or possible data problems in particular parts of the work. If you want to find out what the world says about an issue, rather than to force the world into your prior structural model, this is the way to do it. Richard Lester, to whom the book is dedicated, has been greatly honoured by such a depthful analysis.

The only thing missing, which I would have liked to see, are some detailed case investigations of low wage employers' response to the minimum, or better yet, some ethnographic experience, to enrich the book. Such analysis would please Lester, also, if I am not mistaken. A few Ronald Reagan style anecdotes would go a long way to diffusing some of the criticisms the book has received from employer groups.

The chapter that I found weakest was on foreign experiences, which also is largely the case of limited information. Here, recent British work on the abolition of wages councils yields SR results consistent with those in this book: no adverse change in employment (Machin and Manning). And analysis of the employment consequences of comparable worth in Australia found little or no job losses for women from large mandated increases in their pay (Gregory and Duncan).

There is more support for the SR view in empirical analysis than most economists have recognised.

Methodology aside, Card and Krueger reach strong and in some cases, surprising conclusions, or, rather and more properly, they report empirical results that yield these conclusions: negligible employment effects in most cases, and positive employment effects in some well-designed natural experiments. Their summary table (table 12.1) shows 6 positive employment effects, of which 2 are significant, and one 0 effect.

Are the results believable? They are generated by well-designed analyses, but even the best natural experiment does not have the power of a controlled laboratory experiment, so we (and the authors) must apply some prior judgement. It could be, for instance, that the minimum wage is not truly exogenous (as they suggest in some cases), or that BR level employment effects simply take longer to take effect.

To economists with an SR orientation, the results will fit with priors and thus surely pass any believability test. To those who work with data, the quality of the analysis makes the results believable, largely because the design of most of the studies is such that "ceteris paribus" is much more than a theorists fable. I read table 12.1 as rejecting negative effects rather than showing that minimum wages raise employment and would be surprised if further work found much additional evidence that minimum wage increases were associated with employment gains. But empirical analysis is full of surprises.

Economists with a BR orientation who give more weight to priors than to evidence will find the results troubling. But they cannot simply denounce the findings. One virtue of Card and Krueger's book is that it has shifted the burden of proof about the employment effects of the minimum wage. Even a cursory look at data from the last decade provides support for their position as opposed to a BR view of the U.S. minimum. During the 1980s, the Reagan Administration cut the real minimum wage. Employment of the group most affected, teenagers, fell relative to that of adults. Unemployment rates improved at most a whisker relative to those of adults. At the end of the decade/early 1990s, the federal minimum was increased and several states raised their minimum. If you thought these changes would have noticeable adverse effects on employment, Card and Krueger show otherwise. To answer a slightly paraphrased version of Charlie Brown's 1988 question, "yes, Virginia, the employment effects of the minimum wage were overrated".

Maybe there is a case for BR employment changes to the minimum over some long time horizon. This book does not reject the possibility that ten years after, say, New Jersey raised its minimum (and maintains the level of the minimum relative to other wages), employment in low wage sectors might be lower than it would otherwise be. To test this possible BR claim will, however, be exceedingly difficult, because economies change so much over a decade (Card and Krueger mention inflation; I would stress structural changes) that even the most creative economist will find it hard to make ceteris paribus all that believable. For this reason, I would bet the family house that no one will find large employment effects of the minimum wage over longer periods (if they can find such) with the authority that Card and Krueger have rejected employment responses in the time periods they explore. Empirical analysis of quantitative responses to price incentives is most convincing over periods when the structure of the economy, technology, etc can safely be viewed as fixed.

In an era with rising inequality, it is natural to look anew at the minimum wage as a possible way to improve the earnings of low paid workers, and thus at the policy implications of a major volume on the minimum. The authors suggest that their results should lead to "a reorientation of policy discussions away from the efficiency aspects of the minimum wage and toward distributional issues" (p 393). I hope this is the case. In recent years the BR view has dominated much public discussion -- supply side economics typically posit large responses to prices, taxes, regulations etc. Discussions of regulations and administered wages or other mandatory labor costs are often said to explain European unemployment problems. Textbook discussion of minimum wages has the same flavor: stressing job losses not wage gains. Increases in the minimum thus seem exceedingly dangerous, and its supporters are often viewed as populists with little knowledge of economics. This book goes a long way to redressing this imbalance. Perhaps it will be part of an overall resurgence of SR economics. At the least, it should make it respectable to discuss the minimum wage as a policy option, with benefits and costs, in an era of rising inequality.

What factors ought we to consider as part of a "reorientation" of public discussion?

There are, in my view, five issues in assessing the policy of using the minimum wage to help low paid workers.

1. Does the minimum redistribute income to low wage workers? It will do so if the estimated elasticity is below one. The book shows that modest increases in the minimum are likely to have no effect on employment. While there are researchers, notably Neumark and Wascher, who argue the opposite, the debate is over whether there is "no" effect, modest positive employment effects, or small negative effects, to the minimum. It is not about whether or not there are large negative effects.

2. Does the minimum divide the work force into insiders, employed permanently at the minimum, and outsiders, longterm jobless because of the minimum?

In the U.S. labor market with high turnover, particularly in low wage jobs, it is hard to make the case for such a division; even analysts who believe in segmented labor markets do not draw the European insiders (employed) - outsiders (unemployed) division. The studies by Topel and Juhn, Murphy, and Topel of employment at the lower end of the wage structure make it clear that low and falling wages, not excessively high minimum or other administered wages, have reduced employment at the bottom tier of the wage distribution.

3. Are low wage workers low income workers? No one who advocates the minimum wage wants to raise the pay of teenaged kids in upper income families at the expense of lower income consumers. If the result of an effective minimum is that Harvey Poor pays more for his hamburger so Melissa or Roderick Well-to-Do can earn more pocket money, the minimum will be redistributive, but in a regressive direction. In chapter 9 of the book, Card and Krueger show that currently many workers paid around the minimum are, in fact, from low income families: one-third of workers whose wages were affected by the 1990 and 1991 increases in the minimum came from the bottom 10 percent of the earnings distribution. The widening dispersion of wages has meant that more low skill young adults earn "teenage" wages. Card and Krueger do not explore the distribution of consumer products that use minimum wage type labor. I would expect lower income families to purchase more such products, but I would also expect the differences in consumer spending patterns to be modest.

4. How does the minimum fit with other economic policies? We all know that, despite the valiant efforts of the Invisible Hand, at best we live in a second best world. The effects of the minimum wage or of any other policy must be judged in the context of numerous other policies and institutions. Many on both sides of the aisle in the Congress favor Earned Income Tax Credits as a way to improve the economic well-being of low wage workers. EITCs subsidize low wage employers. Minimum wages "tax" those employers. The two policies would seem to complement one another. While no one has analysed the quantitative interactions between these (and other) policies, my guess is that the minimum looks better in the second best world in which we live than it does in most textbooks.

The bottom line question is:

5. What is a reasonable level of the minimum to redistribute income without risking sizeable job loss?

Myth and Measurement -- the new economics of the minimum wage makes a convincing case that we have overestimated the dangers of job losses and that level of the minimum that does more good than harm is probably much higher than many economists have previously thought. The book shows as best as empirical economics can that 10%-20% increases in the current U.S. federal minimum will not harm employment (much if at all). It is properly cautious in extrapolating analysis of minimum in the range found in the U.S. to potentially much higher minima. At some point, every SR economist becomes a BR economist. A 100% increase in the minimum? A 200% increase? I know (sadly) that if you raise my pay to rock star levels, my employers will disemploy me, tenure and my singing talents notwithstanding. Still, if within plausible ranges, the minimum has little effect on employment, per Card and Krueger; if low wages reduce employment through supply responses, per Juhn, Murphy, and Topel; and if earnings inequality has become a major national problem, as we all recognise, policy debate should concentrate on the question of "what level of the minimum can redistribute income to low paid workers without serious job loss?" We do not have too many weapons in the policy arsenal to raise the pay of low wage workers. The book has raised my assessment of what level of minimum wage could redistribute income without causing job losses. I predict it will do the same to yours.

References

Brown, Charles 1989 "Minimum Wage Laws: Are They Overrated?" Journal of Economic Perspectives, 20: 487-528

Gregory, Robert and R.C. Duncan "Segmented Market Theories and the Australian Experience of Equal Pay for Women" Journal of Post-Keynesian Economics, Spring 1991

Juhn, Chinhui, Murphy, Kevin M. and Topel, Robert "Why Has the Natural Rate of Unemployment Increased Over Time?" Brookings Papers on Economic Activity 1991 (2), 75-142.

Machin, Steve and Alan Manning. 1994 "The Effects of Minimum Wages on Wage Dispersion and Employment: Evidence from the U.K. Wage Councils" Industrial and Labor Relations Review 47: 319-329

Neumark, David and W. Wascher "Employment Effects of Minimum and Subminimum Wages: Panel Data on State Minimum Wage Laws" Industrial and Labor Relations Review vol 46 no 1, 1992, pp 55-81.

Neumark, David and W. Wascher "Employment Effects of Minimum and Subminimum Wages: Panel Data on State Minimum Wage Laws" Industrial and Labor Relations Review vol 46 no 1, 1992, pp 55-81.

Topel, Robert "What Have We Learned from Empirical Studies of Unemployment and Turnover?" American Economic Association, Papers and Proceedings, May 1993, pp 110-115

Wellington, A. "Effects of the Minimum Wage on the Employment Status of Youth: An Update" Journal of Human Resources, vol 26, no 1, 1991, pp 27-46