C15 Lectures, 2004 Lecture 1: Minimum Wages and Economic Outcomes Stephen Machin

Issues Economic effects of minimum wages and evidence on minimum wages and employment The 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.

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 E 0 = 1, W 0 = 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 = cηεlnW m / [1 - c + εlnW m ] 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, lnW m = 0.6, ε = 0.3, η = -1  employment effect =

Implications Only 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 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 Yt = 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

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 The micro based ‘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 )

Methodological Issues in Newer Research (Continued) Some issues that arise: i) assignment to treatment and control ii) different idiosyncratic shocks that hit T and C groups differentially iii) E T1 must not be affected by the treatment – anticipation effects iv) how long does the time gap between period 1 and 2 need to be? (short term versus long term effects and trade off between length of time between 1 and 2 and error due to non-comparability of control group)

Micro Based 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

New Jersey/Pennsylvania Comparison (Continued) Empirical approach: ∆E i = a + b X i + cNJ i + e i or ∆E i = a’ + b’ X i + c’GAP i + e’ i where NJ i = 1 for New Jersey restaurants (0 for Pennsylvania) GAP i = 0 for control groups and = (5.05 – W 1i ) / W 1i for treatment group.

New Jersey/Pennsylvania Comparison (Continued) Results: i) Substantial impact on wage structure (Figure 1 from Card-Krueger article) ii) But no negative effect on employment (if anything positive)

New Jersey/Pennsylvania Comparison (Continued) New JerseyPennsylvania Before min wage increase Average FTE employment Average starting wage ($per hour) After min wage increase Average FTE employment Average starting wage ($ per hour)

New Jersey/Pennsylvania Comparison (Continued) Difference-in-difference results NJ-Penn Comparison DifferenceRestaurants in New Jersey with starting wage Difference PennNJNJ-Penn=$4.25$4.26 to $4.99 $5.00+Low – High Mid – High Change in mean FTE employment (1.36) (1.48) 2.91 (1.41)

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 (Table 2), but no evidence of disemployment effects (Fig 4, Table 3).

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 2003) stands at £4.50 for the adult rate and £3.80 for the development rate.

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 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.

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

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 wage 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 (2003a) 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) Let e 0it = employment status of individual i in time period t in the absence of a minimum wage and e 1it be their employment status in the presence of a minimum wage. The problem is only one of these is observed in the data. Let t* denote the time of minimum wage introduction so one sees e 0it in the data before t* and e 1it after t*. If there are g groups of workers then one sees E[e 0it |g,t] for t < t* and E[e 1it |g,t] for t ≥ t*.

Introduction of NMW- Employment Effects (Continued) The counterfactual that a researcher wants to estimate is E[e 1it |g,t, t ≥ t*], what the employment rate of group g would be had the minimum not been introduced. So, if there is a suitable control group g = 2 and a treatment group g = 1 the minimum wage effect on employment is the ‘difference-in-difference’ {E[e it |g = 1,t = t 2 ] - E[e it |g = 2,t = t 2 ]} - {E[e it |g = 1,t = t 1 ] - E[e it |g = 2,t = t 1 ]} Control group definition: taken to be people slightly above the minimum wage defined by c in the equation w it ≥MIN i (1+c).

Introduction of NMW- Employment Effects (Continued) Stewart (2003a) presents difference-in- difference estimates for four groups: adult men, young men (<22), adult women, young women (<22). Also cross-area paper (Stewart, 2003b) where uses geographical variation in the proportion affected (across 140 areas) to identify any minimum wage effect.

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 useful? 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 because it 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 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 home-level equations of form  lnW it =  1 +  1 MIN i,t-1 +  1 X i,t-1 +  it Also benchmark versus earlier time period.

Introduction of NMW- Employment Effects (Continued) Both reveal a sizable wage impact: Approach 1 % paid less than minimum % paid exactly NMW %paid exactly adult NMW Approach 2 Table 3 of paper – confirms sizable positive impact on average wages.

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 (Table 6), but moderate given scale of wage gains. Even in this most vulnerable sector hard to find employment losses due to minimum wage introduction.