An Empirical Study on the Effect of Minimum Wages on Employment

An empirical study on the effect of minimum wages on employment.

Introduction

In June of 2014 Seattle proudly proclaimed to implement the highest minimum wage of the US (NOS 2014). Yet economic theory would predict that the minimum wage is either to low and won’t have any effect, or it will cause an increase in unemployment (Dolado et al., 1996). So further study in the importance of minimum wage could improve the effectiveness of national policy and refine the economic theory concerning labour and employment.

It isn’t possible to conclusively say if minimum wages have a negative effect on employment. While France had a negative correlation between minimum wages and employment, it is not possible to say if changes in employment where due to a raise in minimum wages or decreasing economic activity at the time (Dolado et al., (1996). As a contrast the institutions concerned with minimum wages in Great Britain seemed to have a positive effect on employment (Machin & Manning, 1994). When Spain raised it minimum wage for age under 17 the employment for these ages decreased, while the overall employment increased (Machin and Manning, 1994).

Results from the United States are just as interesting. A study focussed on New Jersey found that the increase in minimum wage resulted in slight increase in employment (Card & Krueger, 1993). What complicates the results is that fast-food chains in New Jersey didn’t slow their expansion and raised their prices (Card & Krueger, 1993). Another study focussed on California found that an increase in the minimum wage resulted in an increase in employment for teenagers (Card, 1992). The interesting part about this study is that it also found a decrease in school enrolment by teenagers and a relatively low wage for teenagers prior to increase in the minimum wage (Card, 1992).

As of April 2015 the first part of the minimum wage ordinance went in effect in Seattle. Raising the minimum wage from 9.32 to 11.00 dollars an hour and creating the office of labor standards. The ordinance covers every person employed within the city of Seattle, leaving the suburbs unaffected. These clear distinctions in time and reach, makes Seattle a great natural experiment.

Literature

In Seattle’s minimum wage ordinance, the need to alleviate poverty was mentioned as one of the main reason of increasing the minimum wage. This coincidently follows the original debates concerning minimum wage. As the employment effect was taken for granted, the main concern was the effect on the total welfare and if there were better alternatives. The Economics of Minimum Wage Legislation (Stigler, 1946) is a good example of this debate. The paper argues that an increase in the minimum wage would require employees to increase their productivity to stay competitive. This could be achieved by the employee increasing his effort or the employer investing in capital to make the labour more efficient. However a high minimum wage makes it unlikely that an employee can raise its productivity enough and a competitive economy makes further efficiency gains by companies unlikely. As such the paper argues that a minimum wage only increases welfare for those that still have a job after the wage increase, as a result a cash transfer for poor households would have better results.

A good contrast to the paper of Stigler Would be The Effect of the Minimum Wage on the Fast-Food Industry (Katz & Krueger, 1992). This paper studies the effect of the federal minimum wage increase of 1991 on the fast-food industry in Texas. After surveying individual stores before and after the minimum wage increase, the effect on the unemployment was estimated using OLS. Although the paper found a positive effect on the employment, it could be argued that Katz and Krueger only measured a general upward trend in employmentthat occurred independent of the minimum wage increase.Therefore Card and Krueger provide a more reliable study, in their 1993 paper they also survey the fast-food industry. With the difference that they analysed New Jersey and compared it to Pennsylvania using the diff-in-diff method. This paper also found a positive employment effect and it has the advantage that it controls for national or state level shocks in employment (Card & Krueger, 1993).

As a contrast to these paperstake the case of retailers in California during its 1988 minimum wage increase. A paper by Cardfound that as a result of the minimum wage increase the fraction of employed teenagers also increased (Card, 1992).However a paper from 1995 suspected that the wage increase found by D. Card was the result of a larger development in California that occurred despite of the minimum wage. As there was a strong growth in the Californian retail industry during the period of 1988-1989, it could be argued that the growth in employment was because of the performance of the retail industry not the minimum wage. To test this the paper compared the growth in employed of the Californian retail industry to that of the U.S.’s. Here they found that there was actually a decline in the growth of employment in California as a result of the minimum wage (Kim & Taylor, 1995).

Taking our focus away from the US for a moment to look at some other interesting studies. There is some discussion on which variable should be used to capture the impact of minimum wage. We will be using the unemployment rate, which isn’t very complex thus guarantees that sufficient data is available. The drawback of the unemployment rate is, that this variable not only the employment but also the replacement effect of the minimum wage captures. To exclude the replacement effect from the data generally studies look at the employees who had a wage equal or lower to the minimum wage, or the Kaitz index. A good example of the Kaitz index in action is a study of the minimum wage in Europe by Dolado et. Al. (1996) where they found a negative employment effect in France. More interesting might be the study by Dolton et. Al. (2011), while looking at the effects of minimum wage on the middle long term they found some evidence that minimum wage had a positive effect on the employment. What makes there study really interesting is that the Kaitz index and two different variables for employees where used to estimate the effects. It showed that the different variables had different estimates and different likelihoods of finding a significant effect.

Minimum wage

The third of July 2014 mayor Edward Murray signed ordinance 124490 which added a new chapter to the human rights section of the Seattle Municipal Code. Chapter nineteen gives a description of the affected persons, the schedules at which the minimum wage is implemented, and means of enforcing the ordinance.

The ordinance covers all persons employed within the boundaries of Seattle, independent of residence or immigration status. The hourly wage follows a schedule for yearly raises until 2017,this wage is not affected by any form of tips or health benefits. After the schedule has ended the minimum wage is increased following the inflation. To accommodate small enterprises a second schedule has been created. Type 1 businesses, which have more than 500 employees, are expected to pay 15 dollars an hour by the first of January 2017. Type 2 businesses, which have 400 or fewer employees, are expected to have reached 15 dollars an hour in January 2019. Both types of enterprises can follow an extended schedule when they provide certain health benefits. At the end of the schedules all enterprises are expected to pay the same minimum wage as type one businesses. To enforce the ordinance a special agency called the Office of Labor Standards has been created.

Seattle itself is located in the state of Washington and next to the Puget Sound. Ithas a population of around 600.000, a labour force of around 400.000, and a median household income of around 95.000 dollars. Two of its largest employers are Boeing and the port of Seattle. Ordinance 124490 makes it clear that major considerations for implementing a minimum wage was to combat poverty and keep the city affordable for lower incomes.

When it comes to analysinglabour markets there are generally two models used. The first model is perfect competition, where the potential demand and supply of labour is large enough that no one agent has any market power. The second model is a monopsony, where there is one buyer of labour. Although some interesting arguments have been made that employers have a tendency to act as a monopsony when confronted with a minimum wage (Card, 1992). For this paper we will assume that the Seattle labour market behaves as a case of perfect competition, as there is no evidence that any monopsony like behaviour actually occurs.

With the assumption that the labour market follows the model of perfect competition, then there two possible effects of a minimum wage. The minimum wage is equal or lower than the market wage. In which case the minimum wage has no effect as the market wage is preferred. Alternatively the minimum wage is higher than the market wage, this causes more supply and less demand for labour and thus creates unemployment.

Analysis

As the minimum wage ordinance follows clear boundaries in the form of geography and time, while at the same time only affecting a part of a larger economic area. Thus the ordinance creates a natural experiment. The choice for the counterfactual of Seattle was based on two criteria, Geographic distance and size. As a relatively close city is more likely to endure the same shocks as Seattle, while a size of at least 25.000 citizens was required fordata to be available at a monthly basis. Other variables were ignored as inherit differences can be ignored for a difference in difference analysis.

The cities chosen as counterfactual are, Kent, Bellevue, and Kirkland. These towns are significantly smaller than Seattle with a labour force between 75 and 50 thousand each. In these towns Commuters tend to travel by car, people are generally employed in the service industry. And most importantly changes in the unemployment rate tend to follow those of Seattle without any occurrences that might disrupt this around the month of April.

Data was retrieved from the LAUS database of the U.S. Bureau of Labor Statistics. The advantage of the LAUS database is that the unemployment rate for cities is given on a monthly basis. Allowing for a more detailed analysis of the period around the introduction of minimum wage.

Natural experiments lend them self to the use of a difference in difference analysis(Dolado et al., (1996). A time series analysis would unwieldy as there are a number of variables that differ between Seattle and the surrounding cities. While a regression with only Seattle would be unreliable as there seems to be some inherit instability in the unemployment rate.At the same time a Regression discontinuity design, although preferable, was impossible to implement as there aren’t enough observations for comparison.

As Shown in Figure 1, the cities of Seattle, Bellevue, Kirkland, and Kent tend to have similar changes in the unemployment rate. They also seem to be affected by the same shocks over time. Additionally Local papers didn’t show any major, or minor, events that could directly or indirectly influence the employment rate in Seattle and its Neighbours other than the minimum wage implemented on April 1st. These factors create a safe condition to use the difference in difference analysis on Seattle as any differences that are stable over time do not influence the outcome.

Although the financial crisis of 2007 had no effect on the parallel trends assumption of Diff-in-Diff, it did break the linearity assumption of OLS. To compensate for this lack of linearity the data used for the analysis was limited to three years prior to the intervention. This results in 36 observations prior to the intervention and should not have a significant adverse effect on the reliability of the analysis.

Results

Following the prediction of economic theory, the minimum wage has increased the unemployment in Seattle. The effect, significant at the 5% confidence interval, is estimated at 0,19 percentpoint represented with the variable Effect wage. Effect April distinct the dates in post and pre intervention.Effect Cityrepresents the inherit difference between the treated and the nontreated.

To control for the possibility of wider trend that could explain the change in employment indipendent of the minimumwage. The same test was performed on a number of different cities in the Seattle Metropolitan Area. If the unemployment rate in these cities behave in similar way as Seattle it would be a strong indication of a larger trend toward a higher unemployment. Making the estimate of figure 2 unreliable.

The cities Everett, Lynwood, Auburn and Marysville where tested because these showed a similar development in unemployment as Seattle, Kirkland, Bellevue and Kent. Al four cities had their unemployment rate dropped by 0,1-0,7 percent point at the time of the minimum wage increase, giving evidence that effect in Seattle wasn’t due to a general downturn.

The drop in the unemployment rate indicates that some form of spilover effect may have occurred towards the surrouding cities. The theorie of a spilover effect is supported by the fact that the city of Lynwood lies relativly close to Seattle compared with the other cities.

Implemented minimum wage / Not affected by minimum wage (robustness)
Seattle / Everett / Lynwood / Auburn / Marysville
Effect City / -0,36***
(0,02) / 0,93***
(0,05) / 1,10***
(0,05) / 0,93***
(0,05) / -0,04
(0,03)
Effect April / -1,76***
(0,12) / -1,76***
(0,12) / -1,76***
(0,12) / -1,76***
(0,12) / -1,76***
(0,12)
Effect Wage / 0,19***
(0,02) / -0,19***
(0,05) / -0,67***
(0,05) / -0,19***
(0,05) / -0,13***
(0,03)
Observations / 37 / 37 / 37 / 37 / 37

Note:Standard deviations are presented within parentheses. Significance is denoted as follows: * p < 0.10, ** p < 0.05, *** p < 0.01.
Conclusion:
As discussed in the results. The minimum wage has caused an estimated extra unemployment of about 0.19 Percent Points or 770 persons, and supports the prediction given by the economic theory. The estimate is also statistically significant, the question is however if this effect is economically significant.

Ordinance 124490 names two economic effects it expects to have on the Seattle economy. It is expected that the minimum wage negatively affects profitability of enterprises and positively affect employee productivity. Although any effects on employment go unmentioned, the council is concerned with combating poverty. As such it is up to the citizens of Seattle to determine if the cost in employment is worth the gains.

As the wage increase of April was the first in series of raises leading up to 2017 for some companies. A similar test in 2016 and 2017 could further check de robustness of these findings. Furthermore as not all companies follow the same schedule, there might be changes in the type of companies people are employed in.

As major strike for dockworkers ended in May, it was impossible to reliably compare the effects on port facilities. However there are a couple of ports that could act as a counterfactual to the port of Seattle. And differences in employees or containers handled might indicate an effect of the minimum wage.

Further investigation would be possible in the direction of enterprises at the edge of Seattle. As a significant part of the border is zoned for businesses. Through a regression discontinuity design the effect of operating on either side of border could be estimated. These businesses tend to publish their performance on a yearly basis which coincides with increases in minimum wage. There are however a number of city taxes, subsidies, and other programs that influence the performance of these businesses.

References

NOS. (2014). “Seattle krijgt hoogste minimumloon”,NOS, June 3, (downloaded 26th June 2014)

Dolado, J. Kramarz, F. Machin, S. Manning, A. Margolis, D. Teulings, C. Saint-Paul, G. Keen, M. (1996). The Economic Impact of Minimum Wages in Europe, Economic Policy, Vol. 11, pp. 317-372

Machin, S. Manning, A. (1994). The Effects of Minimum Wages on Wage Dispersion and Employment: Evidence from the U.K. Wages Councils, Industrial and Labor Relations Review, Vol. 47, pp. 319-329

Card, D. Kreuger, A. B. (1993). Minimum Wages and Employment: A Case Study of the Fast Food Industry in New Jersey and Pennsylvania, American Economic Review, Vol. 84, pp. 772-793

Card, D. (1992). Do Minimum Wages Reduce Employment? A Case Study of California, 1987-89, Industrial and Labor Relations Review, Vol. 4, pp. 38-54

Stigler, G. J. (1946). The Economics of Minimum Wage Legislation, The American Economic Review, Vol. 36, pp. 358-365

Katz, L. F., & Krueger, A. B. (1992). The effect of the minimum wage on the fast-food industry. Industrial & Labor Relations Review, 46(1), 6-21.

Kim, T. and Taylor, L. J. (1995).The Employment Effect in Retail Trade of California's 1988 Minimum Wage Increase, Journal of Business & Economic Statistics, Vol. 13, pp. 175-182

Dolton, P. Bondibene,C. R. Wadsworth, J. (2011).Employment, Inequality and the UK National Minimum Wage over the Medium-Term, Oxford Bulletin of Economics and Statistics, Volume 74, pp. 78-106