The Employment Effects of the Minimum Wage Essay
The 21st century earnings inequality often characterized by the ever widening gap in income between the haves and the have-nots has been a hot topic for scholars over the past decade. Of particular importance in the entire analysis has been the effect of the statutory minimum wages on the dwindling prospects of employment growth and the subsequent poverty statistics. While an array of scholars strongly believe that statutory minimum wages serves a fundamental role of a ‘‘fair’’ distribution of income, especially to the poor families with low-wage workers, opponents argue that the poor’s input to the national income is inconsequential [most have no working members], and that using the argument in setting higher pay floors only results in massive job loses. Beneath the antagonistic claims on both sides bordering on sound political and philosophical principles are assumptions loosely hinged on individual interpretations of the time series of increasing inequalities. Indeed, there are no doubts that the magnitude of the inequality gap widened further over the past decade alone. Nonetheless, questions abound as to whether the statutory minimum wage settings do have any profound effect on the same. This short paper endeavors to highlight the controversy of the current debate and subsequently ascertain with facts the effects of the Minimum Wage on employment.
Supportive Evidence: Decent Pay and the Job Loses
The employment effect of the minimum wage is by far one of the topics in economics mostly researched and deliberated upon with an effectual outcome of scholarly arguments and counterarguments that boarder more on the authenticity of data used. A statutory minimum wage, by definition, refers to a legal binding remuneration threshold at which employers may buy labor services from prospective workers or workers may sell their labor services to prospective employers (O'Sullivan and Sheffin 130). Although such laws are effective in many jurisdictions, scholars offer varied opinions on the theoretical models that have stood the tests of time, though challenged by a myriad of data collections that continues to this day. Legally sanctioned statutory minimum wage at predetermined levels bears a strong social appeal in manipulating market labor prices to ameliorate the social income iniquity for the vulnerable members of the workforce, particularly the unskilled workers. For many, a fair distribution of the national cake can only be achieved by some political manipulation of the wage structure; a policy argument judged against the sticky poverty statistics (Eatwell, Milgate and Newman 476). Indeed, given that proliferation of industrial working environments where employers pay little attention to workers’ wellbeing, the establishment of minimum wage legislation is well in order. Entrepreneurial ventures such as the multinational corporations operating in the developing countries have long been blamed for unfair bargaining power over their workers. Clearly, the institutionalization of minimum wage laws in such countries goes a long way in ensuring that workers get at least some decent pay commensurate to the labor services they offer.
Even though the above objective is widely popular with the public as a morally justifiable political course, for economists, statutory minimum wage legislations represent a challenge of price distortion within the labor markets, yet with questionable attainment of the intent stated above. From inception, minimum wage laws have received less support from economists than from the enthusiastic public poor/lower cadre workers/unskilled workers who gullibly feel they stand to benefit over their employers. Despite decades of economic research augmented by scientific principles, the employment effect of minimum wage legislation remains a contentious policy. A classic exposition of the minimum wage's inability to substantially reduce the income inequality gap by making the unskilled workers better off pay-wise was George Stigler’s 1945 research. According to Stigler, any increase in minimum wages has more than proportionate negative effects on the size of aggregate employment (Eatwell, Milgate and Newman 477-478). Stigler further adds that restricting employers’ pay structure to a legal minimum payment level is equivalent to forbidding the sale of unskilled labor services to employers who cannot meet the legal threshold. Intuitively, the law forces such workers to find employers prepared to hire them at the legally agreed rates, technically pushing non-competitive firms/firms with smaller capital bases, whose ability to meet the new pay demands are limited, out of operation. Stigler notes that unless the fewer, better jobs in companies able to meet the restrictive pay structure are allocated to members of the needy families, which is usually not possible given the comparative skills-demand to companies knocked out of operation, the political intent of the minimum wage may well be counterproductive on the low income earners.
In a standard theoretical model of the labor market available in numerous economic publications, the introduction of a minimum wage legislation forces firms operating under perfect competition to cut their employment intake capacity. The magnitude of the aggregate job losses depends much on the wage increase requirements and the nature of the aggregate demand with respect to elasticity to the new labor prices. As illustrated in the figure below, a statutory minimum wage set above the prevailing market equilibrium actually results in unemployment in the tune of Ls-Ld.
Gwartney, Stroup, Sobel, and Macpherson (97) confirms the above scenario noting that though a few may stand to gain [a few who may not necessarily be the disadvantaged group in the society], mandating a wage floor above the market equilibrium may be actually be catastrophic in terms of precipitating massive unemployment if such policy is not well thought out. Under such restrictive circumstances given the presumptive laws of demand and supply, a greater number of workers would be fighting to fill the few vacant spaces offered at the higher wage level. Definitely, with the available manpower to choose from, companies will be going for the most qualified; the least skilled/experienced will typically face the axe. In support of the Gwartney, Stroup, Sobel, and Macpherson analysis, Mankiw (311) rightly observed that an imposition of a minimum wage restriction generally affects employment of the low skilled laborers whose wages are the usual target of such laws. Most skilled laborers are usually above the market equilibrium wages, and that a change in the minimum pay structure is and remains a problem of the unskilled workers.
A more comprehensive literature review on the same topic in the United States and Canada conducted earlier by the Minimum Wage Study Commission in 1977 also took cue in supporting the foregoing position in theory. In a 250 page summary report, Brown, Gilroy and Kohen convincingly studied the employment effect of minimum wage increase on three groups: teenagers aged between 16-19, individuals aged between 20-24 and adults. Accordingly, the three economists found out that a 10 percent minimum wage increase reduced teen employment by an approximate percentage of between 0-1.5. The impact on young adults was also negative but slightly smaller than that of the previous teens. The effect of the same on adults was uncertain; a position strongly affirmed in the theoretical models (Brown, Gilroy and Kohen 524).
Theoretically [as demonstrated in the figure above], setting a higher wage floor not only increases the wages of the unskilled workers above the prevailing market equilibrium without guaranteed equivalent increase in output, but also causes what Gwartney and colleagues termed as the “ripple effect” (559-562). Indeed, a factor that is always relegated to the periphery, minimum wage legislation comes in a package; the rewards are not merely restricted to the least productive workers a lone but are relatively spread across employees of all levels.
Noteworthy, a firm's operation cost is a function of the price of the labor services rendered. Consequently, any out of the market pricing of labor services is bound to be disruptive in terms of hiked costs of operation. Again, it is important to note that elaborate planning cap[able of absorbing and weathering the tide of external shocks such as adverse political decisions are characteristics of big firms. An increase in the federal minimum wage, for instance, will adversely affect small businesses not capable of keeping up with the need to subsequently raise wages/salaries across all levels. Without a doubt, taking such a comprehensive wage increments is obviously an expensive undertaking that only firms with solid establishments can endure. As a restructuring measure in small enterprises, the least useful [the unskilled] find themselves in the first casualty zones, sometimes being pushed out of the labor force when hard times strike hard. Additionally, the assumption of higher labor prices crippling demand may be real, thus forcing employers to shorten on employees’ hours of work to cut on costs, which in effect may also diminish the earnings of those above the minimum wage structure. Essentially, basic economics regards labor as any other commodity whose demand declines when it becomes abundant in supply.
Criticism of the neoclassical model
Until the early 1990s, theoretical position affirmed by several studies including the Minimum Wage Study Commission’s (MWSC's) report remained the dominant view. Nonetheless, research studies based on “natural experiments” in 1990s and beyond begun to question the validity of theory on this particular topic. Such experiments have sought to measure on the ground impact of a policy change (a change in minimum wage) on workers directly affected and those not affected by the policy change. As if many were waiting for a trigger, the number of scholars who have so far used David Card and Alan Krueger's (1994) paper as their baseline argument probably is in thousands. Comparing the employment effects of the minimum wage increase in two states, New Jersey and neighboring Pennsylvania, before and after a policy change was effected in New Jersey's, the two scholars found “no evidence that the rise in New Jersey's minimum wage reduced employment at their main area of target [the fast-food restaurants] in the state (Card and Krueger 792). Card and Krueger followed their research with publication titled “Myth and Measurement: The New Economics of the Minimum Wage” upholding their earlier findings of the unlikely effects of a minimum wage policy significant enough to alter market employment levels (Card and Krueger 389-390). Though the volume of research on the state of the debate is vast, David Neumark and William Wascher's response to Card and Krueger assertions in Minimum Wages is worth mentioning. In their assessment, Neumark and Wascher concluded that there is enough evidence to support tangible reduction in employment, particularly of low-wage workers, should a state or the federal government decide to effect the minimum wage change policy (104).
At the turn of the new millennium, the employment effects of the minimum-wage debate had taken two antagonistic poles: a group of researchers that identify with the famous Card and Krueger’s 1994 “new minimum-wage research” analysis and another that are largely sticky with old theoretical model showering criticisms on Card and Krueger’s group of new minimum-wage researchers. Card and Krueger’s camp of researchers argue that the assumption that minimum wages negatively affects employment is a fallacious assumption based on a logically incoherent textbook model hardly backed by empirical evidence (White 67-73). In his submissions, Gary Fields concurs with White arguing that the standard theoretical arguments were framed on the basis of single-sector markets that excluded all other sectors. Though meant to critique the “text model”, Field’s arguments also brings to the fore a lot of omissions that on their very own group of researchers. Card and Krueger’s research, in particular, was not only a one-sector minimum-wage coverage specifically targeted at employment effect in fast-food restaurants in New Jersey and Pennsylvania, typically excluding all other sectors such as the service workers (the suppliers) and the self-employed [for instance the farm workers] who may be doing business with the restaurants, but also ruled out certain fundamental shocks that could be in play.
The new crop of minimum-wage researchers often mentions a monopsony with employers having more bargaining power than workers. Indeed, intentional collusion between employers, the cost of information search, costs of information itself among other elements of the labor market may render the case scenario in the diagram above impossible. Setting a restrictive minimum wage policy for a market with monopsonistic characteristics has the possibility of increasing both wages and employment contrary to the traditional textbook assumptions.
As shown in the figure above, monopsonist employer faces an upward sloping supply curve with relatively non-attractive terms (wages) in practice. It is not doubtable, therefore, that any increase in wages increases the marginal cost of the extra workers and so is the pay. Since the minimum wage is a restrictive pay floor, NMW effectively assumes the marginal cost of hiring labor services with better terms that actually boosts [attracts more] employment through higher rewards in wages paid out to workers.
In all of the empirical studies mentioned herein, it is clear that minimum-wage increases do increase the wages of affected workers with economically significant figures. What are still strikingly contentious are the possible channels through which employment diminishes when a minimum wage policy is effected. Empirical evidence on both sides points to statistically insignificant figures suggestive of inconsequential economic effects that have given critics of theory a voice with their “natural experiments.” A recent research study by Allegretto, Dube and Reich concludes that:
“Our analysis finds that heterogeneity in employment patterns and selectivity among states constitute significant concerns for conventional minimum wage studies. Although adding division and state trend controls does not constitute a panacea, they provide important controls that mitigate the bias from unobserved heterogeneities that may be correlated with minimum wage changes. […] Put simply, our findings indicate that minimum wage increases—in the range that have been implemented in the United States—do not reduce employment among teens” (238).
The statement by the three scholars is an admission that apart from the introduction of the minimum wage policy, quite a number of responses are often released to counter the adverse effects of the change. Indeed, the knowledgeable would not sit back and wait for the changes to sweep them through. Plausible explanations to the findings that pervade the current literature point to a multifaceted strategy employed by both employers and workers to remain relevant in a fixative situation born outside the market. Quite frankly, individual establishments will follow complex paths that best suit the circumstances; circumstances that the limited set of data captured in the studies cannot fully explain.
In a recent review of the status of the debate, Schmitt notes that the most expedient route for employers is passing on the increased costs to consumers through product pricing (22). Others do a quick cut on the hours of work; fringe unnecessary benefits; cut the wages of the highly paid; while others may creatively reorganize work processes to cut on escalating costs. Workers on their part may put in impressive efforts enough to compensate the cost increases on employers. Any of the channels mentioned bear sufficient possibilities in eliminating the supposed employment cuts to levels where researchers can reliably measure true outcomes devoid of distortions. A combination of the adjustment paths at the same time makes it even harder to obtain accurate results. Given the modest historical increases in the minimum wage and the associated costs thereof, the traditional position on employment remains unchanged; other than raising the wage levels of the entire workforce, a higher wage floor cuts down the aggregate employment level.
Allegretto, Sylvia, Arindrajit, Dube and Michael, Reich. “Do Minimum Wages Really Reduce Teen Employment? Accounting for Heterogeneity and Selectivity in State Panel Data.” Industrial Relations 50.2 (2011): 205-240. Print.
Brown, Charles, Curtis Gilroy, and Andrew Kohen. “The Effect of the Minimum Wage on Employment and Unemployment.” Journal of Economic Literature 20.2 (1982): 487-528. Print.
Card, David and Alan Krueger. “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania.” American Economic Review 48.4 (1994): 772-793. Print.
Card, David and Alan B. Krueger, Myth and Measurement: The New Economics of the Minimum Wage. Princeton University Press, 1995. Print.
Eatwell, John, Milgate, Murray and Peter, Newman. The New Palgrave: A Dictionary of Economics. London: The Macmillan Press Limited, 1987. Print.
Fields, Gary. “The Unemployment Effects of Minimum Wages.” International Journal of Manpower 15.2 (1994): 74–81. Print.
Graham White. “The Poverty of Conventional Economic Wisdom and the Search for Alternative Economic and Social Policies.” The Drawing Board: An Australian Review of Public Affairs 2.2 (2001): 67–87. Print.
Gwartney, James D., Stroup, Sobel, Russell S. and Macpherson, David A. Economics: Private and Public Choice. 10th ed. Cincinnati, Ohio: Thomson/South-Western, 2003. Print.
Mankiw, Gregory N. Principles of Macroeconomics. 6th ed. Cincinnati, Ohio: South-Western Pub, 2011. Print.
Neumark, David and William Wascher. Minimum Wages. Cambridge, MA: The MIT Press, 2008. Print.
O'Sullivan, Arthur and Steven Sheffin. Economics: Principles in Action. Upper Saddle River, New Jersey: Prentice Hall, 2007. Print.
Schmitt, John. Why Does the Minimum Wage Have No Discernible Effect on Employment? Washington, D.C.: Center for Economic and Policy Research, 2013. Print.
White, Graham. “The Poverty of Conventional Economic Wisdom and the Search for Alternative Economic and Social Policies.” The Drawing Board: An Australian Review of Public Affairs 2.2 (2001): 67–87. Print.