C15 Lecture 1: Minimum Wages and Economic Outcomes Stephen Machin, February 2005

Issues Economic effects of minimum wages and evidence on minimum wages and employment The controversy on ‘conventional wisdom’ versus micro based ‘revisionist’ approach The introduction of the UK National Minimum Wage

Economic Effects of Minimum Wages Effect on employment/unemployment has been central issue in debate about economic effects of minimum wages. Standard textbook model of labour demand produces one of the clearest predictions in labour economics - minimum wages price workers out of jobs by forcing employers up their labour demand curve.

Standard Textbook Model

Basic model rests upon several assumptions: complete coverage; homogeneous labour; competitive labour market; short run and long run impact the same. Clear prediction: the minimum wage increase results in reduced employment - the proportional reduction in employment (lnE m - lnE 0 ) equals the proportionate wage increase (lnW m - lnW 0 ) times the elasticity of demand η. Can develop more sophisticated models, but with assumption of perfect competition produce same qualitative predictions.

Two Sector Model Basic model can be generalised in various directions. One example is to move to a two sector model - covered/non- covered, set E0 = 1, W0 = 1. Demand for workers in the covered sector depends on the minimum wage, whereas demand in the uncovered sector depends upon the market wage. Minimum wage elasticity of employment = cηεlnWm / [1 - c + εlnWm] where c = proportion in covered sector, ε = elasticity of labour supply. If c = 1, ε =   standard one sector competitive model, η Example: c = 0.7, lnWm = 0.6, ε = 0.3, η = -1  employment effect =

Implications Only pertinent question is ‘how negative is the negative effect on employment?’ Minimum wage hurts the people it sets out to help by pricing them out of work – even more the case since low skill people more likely to be low paid

Evidence Early empirical work largely supportive of basic model → ‘conventional wisdom’. Usually based on aggregate time series studies of US employment/unemployment rates and minimum wages, usually focussing on teenagers Y t = g(MW t, X 1t,......X kt ) + e t where Y t = employment / unemployment to population ratios (usually in logs), X it = aggregate demand and supply variables (teenagers in training programmes, school enrollment, time trend), MW t = minimum wage index (e.g. Kaitz index). Brown, Gilroy, Kohen (1982) Journal of Economic Literature - say “consensus” reached: minimum wages reduce teenage employment with elasticities in the -0.1 to range.

Observations on Time Series Evidence: Re-Appraisal 1). Only up to late 1970s and US minimum wage fell strongly in real terms in the 1980s

Re-Appraisal (Continued) 2). Extending the samples of teenage employment studies into the 1980s produces much smaller, often statistically insignificant, elasticities below the ‘consensus’ range (around -0.07) (Card and Krueger, 1995).

Implications of Re-Appraisal Minimum wage effects on employment seem small (centring in on zero). Alternative theoretical explanations: Monopsony based arguments: Single buyer of labour (e.g. company town) – characterised by upward sloping labour supply curve to firm

Monopsony w w m w 0 E m E 0 E Marginal product of labour Marginal cost of labour L s

Implications of Re-Appraisal ‘Dynamic’ monopsony type-notions (based on labour market frictions) can generate non-negative employment effects of minimum wages. Or – labour demand curve inelastic so that employment not very sensitive to changes in minimum wages.

Micro Work What is best conceptual way to evaluate economic effect of minimum wage? ‘Before and after’ micro work more closely approximates the theoretical approaches that talk about labour markets with and without minimum wage floors – sometimes referred to as ‘revisionist’ approach.

Methodological Issues in Newer Research Corresponds better to theoretical concepts as adopts before and after approach, with treatment and control groups. If E is employment, T and C denote treatment and controls and 1 and 2 are the before and after treatment periods then an estimate of the impact of treatment is: (E T2 – E C2 ) – (E T1 – E C1 ) or (E T2 – E T1 ) – (E C2 – E C1 )

Micro Based ‘Before and After’ Studies Most famous piece is Card and Krueger’s (1994) New Jersey / Pennsylvania comparison UK strand 1: Wages Council work UK strand 2: evaluations of introduction of UK National Minimum Wage in April 1999

New Jersey/Pennsylvania Comparison (Card and Krueger, 1994) Can be viewed as case study of fast food industry. Surveyed fast food restaurants in New Jersey and Pennsylvania in February-March and November- December In April 1992 the New Jersey minimum wage went up from the federal minimum level of $4.25 to $5.05 but the minimum in Pennsylvania remained at $4.25.

New Jersey/Pennsylvania Comparison (Continued) Two treatment versus control ‘experiments’: a) T = New Jersey restaurants, C = Pennsylvania restaurants b) T = low wage New Jersey restaurants, C = high wage New Jersey restaurants

Survey Descriptive Statistics

New Jersey/Pennsylvania Comparison (Continued) Results: i) Substantial impact on wage structure: February 1992 – 33 percent of NJ and 34 percent of Penn restaurants had starting wage $4.25; November 1992 – 90 percent of NJ restaurants had starting wage $5.05 and 30 percent of Penn restaurants had starting wage $4.25. ii) But no negative effect on employment (if anything positive)

Wage Structure Impact

Identification of Employment Effects ΔE i = a + bX i + cNJ i + e i ΔE i = a’ + b’X i + c’GAP i + e’ i Where GAP = 0 for P stores and NJ stores with W 1i ≥ $5.05 and = ( W 1i ) / W 1i for other NJ stores/

New Jersey/Pennsylvania Comparison (Continued)

Employment Models

UK Wages Councils System of minimum wages that used to operate in UK was a partial coverage industry based system. Wages councils introduced in 1909 (by Churchill) covered workers in low wage industries (the sweated trades). Abolished in At time of abolition covered around 12 percent of workers in the labour market. Were concentrated in low wage service sector industries. Largest was retail trade.

UK Wages Councils (Continued) Dickens, Machin, Manning (1999) look at employment and minimum wages in Wages Council industries from Reduced wage inequality, but no evidence of disemployment effects.

Wages Councils: Wage Structure Impacts

Changes in Employment and Toughness

Employment Models

The Introduction of a National Minimum Wage in the UK Introduced in April 1999 at £3-60 for over 21s, £3-00 for 18-21s, none for year olds. Raised (by fairly small amounts) on an irregular basis. Now (after last change of October 2004) stands at £4.85 for the adult rate and £4.10 for the development rate. And, since October 2004, there is a rate for year olds, of £3.00 per hour.

Introduction of NMW(Continued) Adult rateDevelopment rate* April 1999£3.60£3.00 June 2000£3.60£3.20 October 2000£3.70£3.20 October 2001£4.10£3.50 October 2002£4.20£3.60 October 2003£4.50£3.80 October 2004£4.85£4.10 Notes: *denotes rate for employees aged 18 to 21 and those aged 22 and over receiving accredited training and in the first six months of employment

Introduction of NMW(Continued) Issues: Who affected and wage benefits. Evaluating the economic effects. Initially focus on wage impact, coverage and employment.

Introduction of NMW- Low Pay Commission Ex-ante – Low Pay Commission (LPC) set up and reported on evidence and how expect labour market to be affected by NMW Predicted 2 million workers to benefit (9 percent of workforce), most of whom were women. Estimated wage boost of 30 percent for those affected

Introduction of NMW – Low Pay Commission (Continued) Ex-post – Fewer than 2 million workers benefited, more like 4 or 5 percent (due to measurement error in earnings data). The Office for National Statistics now put the number of people beneath the minimum before introduction at 1.52 million, whilst the most recent Low Pay Commission report goes even lower at 1.3 million. Average wage gain for beneficiaries smaller, more like 6-10 percent

Beneficiaries of Minimum Wage Introduction

Introduction of NMW – Employment Effects Key economic question concerns impact on employment. LPC stated that their view was that NMW was set at level that would not harm jobs (logic is idea that can have monopsony power up to a certain level of wages so get inverse U-shape in employment effects).

Introduction of NMW - Employment Effects (Continued) 1). Macroeconomic picture No obvious unemployment effect from NMW introduction. Aggregate employment rates (%): 1998 – 73.5, 1999 – 73.9, 2000 – 74.4, 2001 – 74.4; Unemployment rates (%): 1998 – 6.3, 1999 – 6.0, 2000 – 5.4, 2001 – 5.1. (Source: Labour Market Trends, March 2003)

Introduction of NMW- Employment Effects (Continued) 2). Micro studies with treatment-control design. Stewart (2004) looks at individual-level data sources to appraise the impact of NMW introduction on individual employment probabilities. Explicitly looks before and after minimum wage introduction using longitudinal data on people (from Labour Force Survey, British Household Panel Survey and New Earnings Survey).

Introduction of NMW- Employment Effects (Continued) Stewart (2004) presents difference-in- difference estimates for four groups: adult men, young men (<22), adult women, young women (<22). Also cross-area paper (Stewart, 2002) where uses geographical variation in the proportion affected (across 140 areas) to identify any minimum wage effect.

Introduction of NMW- Employment Effects (Continued) Stewart (2004) approach is to compare those workers affected by the minimum wage with workers above the minimum wage floor. Looks at differences-in-differences across these groups (again ‘treatment’-’control’ type comparison).

Introduction of NMW- Employment Effects (Continued) Step 1 looks at wage effects.

Introduction of NMW- Employment Effects (Continued) Step 2 looks at differences in employment probabilities.

Introduction of NMW- Employment Effects (Continued) In both papers fails to find negative effects on employment from NMW introduction. Across all workers no evidence of an adverse effect on employment resulting from NMW introduction.

Introduction of NMW- Employment Effects (Continued) 3). Employment Effects in a Vulnerable Sector – Care Homes Machin, Manning and Rahman (2003) look for minimum wage effects in one of the sectors most vulnerable to employment losses induced by minimum wage introduction, the labour market for care assistants. Carried out own survey to collect data on workers and homes before and after minimum wage introduction.

Introduction of NMW- Employment Effects (Continued) Why is this a useful research exercise? 1). The sector contains many low-wage workers, so the minimum wage has real potential to have a noticeable important impact on outcomes. 2). The sector is not unionised. 3). It consists of large numbers of small firms (average employment being somewhere in the range of workers) doing a very homogeneous activity in geographically concentrated markets. 4). The product market side of this sector is interesting. An important fraction of the residents of these homes have their care paid for by the Department for Social Security (DSS).

Introduction of NMW- Employment Effects (Continued) Therefore provides good testing ground for trying to identify minimum wage effects on employment. Carried out survey of all UK residential care homes before and after introduction. Asked for information on all workers in each home. Then considered wage and employment effects using methodology that relates changes in wages and employment before and after the minimum wage introduction to the fraction of low paid workers in the pre-minimum wage period.

Introduction of NMW- Employment Effects (Continued) Impact on Wages Approach 1: look at percent below minimum before introduction and for spike at minimum after Approach 2: estimate statistical models, relating the change in the average wage before and after minimum wage introduction to the proportion of workers paid less than the minimum wage in the period before introduction.

Introduction of NMW- Employment Effects (Continued) Impact on Wages, Approach 1:

Introduction of NMW- Employment Effects (Continued) Impact on Wages, Approach 1:

Introduction of NMW- Employment Effects (Continued) Impact on Wages, Approach 2: Estimate home-level wage change models

Introduction of NMW- Employment Effects (Continued) Impact on Employment: Study whether homes where wages went up by more experienced employment falls. Slight evidence of job losses, but moderate given scale of wage gains. Even in this most vulnerable sector hard to find employment losses due to minimum wage introduction.

Introduction of NMW- Employment Effects (Continued)

Distributional Impact If employment effects moderate then one may be interested in distributional consequences of minimum wage floors: 1)Wage inequality 2)Family income distribution

Wage Inequality Dickens-Manning – impact limited further up distribution (small spillovers).

Income Distribution Need to be careful what group to study. If households with someone in work:

Current Research Moving on from employment effects. Particular focus on firm outcomes (like prices, profitability). Also work on training, crime impacts.

Summary Economics of minimum wages is interesting area to illustrate: i)How basic first order principles of economics can be evaluated. ii)How economics can link closely to issues of public policy. iii)How evidence based policy formation can be useful.