The Effects of Minimum Wages in the US

Brown, Gilroy and Cohen (1982) provide a comprehensive survey of the theoretical and empirical literature on the impact of minimum wages in the US. The

standard competitive model of the labour market predicts that minimum wages reduce employment by pricing workers out of jobs. This viewpoint seems to be borne out by the

work reviewed by Brown et al (1982). Most of the studies looked at the effect of variations in the minimum over time on teenage (16-19 years) employment rates. Some of the studies have looked at the impact on young adults (20-24 years) and a number have looked at all adults. They find that minimum wages raise the wage of covered workers up to the minimum and has some knock on effects further up the distribution of wages. They conclude that the weight of evidence points to a fairly small negative impact on

teenage employment; a 10% increase in the minimum wage reducing employment by 1-

3%. For young adults the effects are still negative but smaller in absolute terms, while for all adults the impact is uncertain, although this conclusion is based on a smaller number

of studies.

Brown et al (1982) also review the cross section studies of the impact of minimum

wages. These generally take the form of cross state studies that attempt to identify the

employment effect from the different level of minimum and average wages across states. Because most of the variation comes from differences in average wages across states there

is an issue with these studies about whether they are correctly identifying minimum wage

effects rather than average wage effects.

However, Meyer and Wise (1983a, 1983b) propose an ingenious methodology for

inferring employment effects of the minimum from data on a single cross section of wages. Using individual data they estimate a parametric distribution for wages from the

top part of the wage distribution, that is from those individuals unaffected by the minimum. They then predict how many individuals should be in the bottom part of the

distribution and compare this to the actual number present. This gives them their measured employment effect. They find that in 1978 the minimum reduced employment of 16-24 year olds by at least 7%. Although this seems an ingenious idea there are a number of serious flaws in their study. Dickens, Machin and Manning (1994) (and

Chapter 6 of this thesis) criticises their study by showing how the estimated employment effects are highly sensitive to certain key assumptions.

With the publication of Brown et al (1982) a consensus seemed to have been

reached that minimum wages in the US had small negative effects on employment at the levels they had conventionally been set at. However, beginning in the late 1980s, after a

couple of decades of neglect, there were a number of sharp increases in minimum wages at both a State and Federal level. In 1988, the Californian State minimum was raised from $3.35/hour to $4.25/hour, a 27% increase in the minimum. In April 1990 the Federal

minimum, which had been fixed at $3.35/hour since January 1981, was increased to $3.80/hour. In April 1991, it was increased further to $4.25/hour. A year later the New

Jersey minimum was increased from $4.25/hour to $5.05/hour. These relatively large

increases provided an opportunity for economists to study the employment effects in what was probably as close as one will find to a natural experiment in economics. Most of this

work was carried out by David Card, Larry Katz and Alan Krueger and is collected in the

book by Card and Krueger (1995). The results of these studies cast doubt on the conventional view that minimum wages destroy jobs and have re-opened the arguments about the economic effects of minimum wages which are still raging today.

The first of these studies Card (1992a), (See also Card and Krueger, 1995)

analysed the impact of the July 1988 increase in the Californian minimum wage. He estimates that the increase in the minimum raised the average wages of teenagers in

California by 10% and the average wage in the Retail sector by 5%. Comparing employment levels in California with the rest of the US, he finds no adverse employment

effects. Surprisingly, he finds a small positive effect on teenage employment and a similar trend in Retail employment as in comparable neighbouring States.

Card (1992b) and Card and Krueger (1995) provide a comparison of the impact of the 1990 and 1991 increases in the Federal minimum on cross State changes in wages and employment. They take advantage of the fact that wage rates vary a great deal across States and consequently the importance of a Federal minimum varies from State to State.

In low wage States the proportion of workers effected by the increase in the minimum will be far higher than in high wage States. One would expect to see more severe employment

consequences fi'om the increase in the minimum in these low wage States. Their results indicate that teenage wages rose more in States with a higher proportion of effected

workers. However, they found no evidence that teenage employment rates were lowered

more in the highly affected States. They also use data from the retail sector and again find no adverse employment effects across States. In fact, they report that retail sector

employment increased more rapidly in States where the Federal increase in the minimum raised wages the most.

Katz and Krueger (1992) analyse the effect of the April 1991 Federal minimum

wage increase on the fast food industry in Texas. They carried out a telephone survey of Burger King, Wendy’s and Kentucky Fried Chicken restaurants in both December 1990

and July-August 1991 collecting information on starting wages and employment by

establishment. They found that those firms that had to raise wages the most to comply

with the new minimum were more likely to increase employment. Defining a variable called the wage gap as the proportional increase in the starting wage required to comply

with the minimum they find this is positively correlated with changes in employment. A finding that is at odds with the predictions from the standard competitive model of the labour market.

Perhaps the most important and controversial piece of new work on the effects of minimum wages is that by Card and Krueger (1994, 1995) looking at the impact of the State increase in the New Jersey minimum in April 1992. They carried out a telephone survey of fast food restaurants in New Jersey in February-March 1992 and then 10 months later in November-December 1992. They also surveyed restaurants in Pennsylvania,

where the minimum was unchanged, to act as a control group. Their results show that employment actually increased in New Jersey as compared to Pennsylvania between the

two surveys. In addition, employment in those New Jersey establishments that had to raise their wages the most to comply with the new law rose relative to those unaffected

by the minimum. This result is similar to that found in the Texas study and is contrary to the conventional thinking about the economic effects of minimum wages.

Card and Krueger (1995) also carry out a re-evaluation of the time series studies

of the impact of the minimum wage on teenage employment. Most of the time series studies were carried out on data up to the late 1970s. They supplement the earlier data

and re-estimate the relationship for the years 1954 to 1993. Their results for this period suggest an insignificant negative effect of the minimum wage on teenage employment.

This could be partially explained by the fact that they are now including a time period when the value of the minimum wage was falling and had perhaps become less important

in determining employment.

There is one piece of recent work that does find the conventional negative employment effect. Neumark and Wascher (1992) use data on employment and minimum

wages from a panel of States from 1973-1989. They find results similar to those from the time series studies reviewed in Brown et al (1982), that a 10% increase in the minimum reduces teenage (16-19 years) employment by 1-2% and reduces the employment of

young adults (16-24 years) by 1.5-2%. They also find that States that utilise the youth subminimum wage have higher levels of employment. However, this study has been

criticised by Card, Katz and Krueger (1994) who point out that there are problems with the treatment of teenagers enrolled in school, the construction of the minimum wage

variable and the level of utilisation of the youth subminimum. When the equation is re­ specified they find that Neumark and Wascher’s data show no significant effect of

minimum wages on employment. However, Neumark and Wascher (1994) have defended their work and claim that it stands up to the criticisms of Card, Katz and Krueger.

This collection of recent studies that find zero or positive effects of minimum

wages on employment has cast some doubt on the conventional view that minimum wages destroy jobs. Card and Krueger’s book has provoked a strong reaction from many

economists and commentators who find the results difficult to reconcile with their

theoretical priors. The following quote from the Wall Street Journal perhaps provides a flavour of these criticisms:

“No self respecting economist would claim that increases in the minimum wage increase employment. Such a claim, if seriously advanced, becomes equivalent to a denial that there is even minimum scientific content in economics and that, in consequence, economists can do nothing but write as advocates for ideological interests. Fortunately, only a handful of economists are willing to throw over the teaching of two centuries; we have not yet become a bevy of camp-following whores”

- James Buchanan, The Wall Street Journal

A number of leading labour economists have also criticised the work in a review symposium edited by Ehrenberg (1995). Arguments against the book have ranged from

questions about the ability of the impact studies to pick up long run effects of the

minimum wage increase (Hamermesh, 1995) to those questioning the survey methodology (Welch, 1995).

Perhaps the most robust criticism came from Neumark and Wascher (1995a) who used payroll data on restaurants in New Jersey and Pennsylvania supplied by the

Employment Policies Institute, an employers' organisation representing the retail and restaurant trade. They argued that this data is more reliable than the survey data collected by Card and Krueger. An analysis of this data found negative effects of the minimum wage hike on employment, but these were not quite significant at conventional statistical

levels. Further analysis by Neumark and Wascher (1995b, 1995c, 1996), using their own sample of restaurants in New Jersey and Pennsylvania found a zero impact on

employment. See Schmitt (1996) for a review of these studies. He questions the validity

of the Employment Policies Institute data and also their impartiality, which even Neumark and Wascher question. This is where the debate in the US has reached at this stage, with

the bulk of the recent evidence suggesting no employment effects of the recent minimum wage increases. However, the arguments are set to continue as the US Senate increase the Federal minimum to $4.75/hour on 1st October 1996 and has legislated for a further

increase to $5.15/hour on 1st September 1997.