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Revisiting the minimum wage disemployment effects

Last Thursday the Vancouver Sun ran an opinion piece by yours truly entitled “BC’s minimum wage should not be a poverty wage.” I drew attention to the fact that between March 31 and May 1 this year, all other nine provinces increased their minimum wages and, as a result, BC now has one of the lowest minimum wages in the country. We are ahead of PEI and New Brunswick where the minimum wage is $7.75, and on par with Newfoundland at $8. I also called for an increase in BC’s embarrassingly low minimum wage to a level that lifts a single individual without dependents out of poverty and for indexing the minimum wage to inflation to preserve its value over time.

Today’s Vancouver Sun features the Fraser Institute’s response, “Minimum wage increase may cut jobs,” in which Keith Godin calls my argument “well-intentioned, but ultimately misguided and contradicted by the evidence.” What evidence, you ask? It’s the literature review authored by “two of the world’s most renowned minimum-wage experts, University of California Professor David Neumark and U.S. Federal Reserve Board economist Dr. William Wascher.” Sounds impressive until you realize that these two are the most vocal proponents of the adverse disemployment effect and that their opinion is in fact in the minority among the rest of (more renowned) economists who have studied the minimum wage (see Liana Fox for more information here).

The supposed negative employment effect of a minimum wage increase that Mr. Godin worries about is not as clearly established as he would like you to believe. Andrew Jackson has made this point on the blog before (see The Economics of the Minimum Wage) but it may be time to revisit the topic.

While the research findings are certainly not unanimous and individual studies can be endlessly cited on one side of the debate or the other, mainstream economists’ opinion has shifted towards the conclusion that “modest increases” in minimum wages do not kill jobs. This is best illustrated by the joint statement issued in October 2006 by over 650 US economists, including 5 Nobel laureates, asserting that “a modest increase in the minimum wage would improve the well-being of low-wage workers and would not have the adverse effects that critics have claimed.”

The key here is the size of the increase. When studies showing negative employment effects are reviewed carefully, one notes that modest employment declines are found in response to fairly large increases in minimum wages. But sharp one-time hikes are only necessary if the government leaves minimum wages unchanged for long periods. They can be easily avoided by indexing minimum wages to inflation. Employers would benefit from the increased certainty: with scheduled annual adjustments they would know what to expect and could plan for the upcoming increases in their wage bill.

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Comment from Rod Smelser
Time: August 8, 2008, 1:58 pm

Neumark and Wascher are indeed anti-minimum wage as far as I can tell. Still, their criticisms aren’t all knee-jerk and one wouldn’t want to steer ahead without taking their’s and similar contributions into account.

Several years ago I did a review of this topic and found many economists trying hard to draw up new types of monopsony models that would allow for rising wages and employment.

Of all the critiques of minimum wage increases, the most alarming to me was one study (and I would have to look it up, I don’t recall off hand) that linked risising minimums to declining high school completions. IOWs, a higer minimum attracts marginal HS students out of school and into work too early. It’s a point that would have to be addressed.

Comment from Iglika Ivanova
Time: August 8, 2008, 2:24 pm

I agree that all research contributions should be evaluated and taken into account. At the same time, it’s important to emphasize that the causal link between increasing the minimum wage and increasing unemployment for traditionally low-wage groups (e.g. teenagers) has been questioned over the past 15 or so years, both empirically and theoretically.

I have heard the argument that higher minimum wages can be linked to increased school drop-out rates. It’s interesting that you should bring it up because it flies in the face of the adverse employment effects of higher minimum wages (which would ensure that fewer not more teenagers were employed). What seems more threatening to high school completion in Canada at this point is not a $10 minimum wage but rather the carrot of considerably higher-paying resource sector jobs that do not require a high school diploma (see also Alberta).

That being said, if the goal is to keep teenagers in school longer, it would be much easier for policy-makers to do it by legislating a higher legal drop-out age (say, 18) than by keeping wages low. There is much empirical literature on the effects of higher drop-out ages on school completion both internationally and in Canada.

Comment from Rod Smelser
Time: August 10, 2008, 12:28 am

“It’s interesting that you should bring it up because it flies in the face of the adverse employment effects of higher minimum wages (which would ensure that fewer not more teenagers were employed). What seems more threatening to high school completion in Canada at this point is not a $10 minimum wage but rather the carrot of considerably higher-paying resource sector jobs that do not require a high school diploma (see also Alberta).”

I suppose it all depends on what labour market condition the marginal teen student responds to, the wage, or the employment rate or the unemployment rate. Insofar as the wage represents the return to getting a job, and the employment or unemployment rate relates to the probability of getting a job, there’s different decision making processes that the teen on the margin of leaving school might consider.

A higher minimum wage would have an effect similar to good pay in resource or manufacturing or construction industries during a boom, though of much smaller magnitude. If the minimum wage goes up, the return to getting a fast food job is now a bit better, so maybe leaving school is a better package than it was prior to the hike.

If the increase has been modest enough that the disemployment impacts are insignificant, then there is no change in the probability of getting a job.

So with the return on getting a job increased, and the probability of finding one has remained the same, there could be an attraction to leave school.

Comment from Iglika Ivanova
Time: August 13, 2008, 5:34 pm

Yes, when the return of getting a job increases (because the minimum wage has increased), teens on the margin would have an increased incentive to leave school but we also need to consider the magnitude of this effect in practice (I’d have to look at empirical studies, but my guess is that it would be pretty small). Furthermore, the exact same response can be triggered by an increase in the wages of unskilled labour because of a tightening of the labour market completely independent of a legislated minimum wage, so I don’t see this as a particularly convincing argument against raising the minimum wage.

Basically, if we want to keep teenagers in school against their wishes (perhaps because we think they are not sufficiently forward-looking), there are more effective ways of doing it than freezing the minimum wage.

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