Tuesday, June 10, 2008

Did Minimum Wage Increase Cause The Increase In Unemployment?

In the recent U.S. employment report, the U.S. unemployment rate rose from 5.0% to 5.5%. As that number tends to be somewhat erratic on a month to month basis, I didn't pay much attention to it. However, if you look beyond monthly fluctuations and look at the trend over several months, then the increase in unemployment from a cyclical low of 4.4% certainly is significant and confirms the reality of a recession. And other commentators did pay great attention to it, with some Democrats jumping on this number for political purposes. Some Republican commentators have responded by attributing the rise to the increase in minimum wages implemented last year.

According to economic theory, higher minimum wages should all other things being equal increase unemployment as it prices out workers with low productivity. There are however two cases where it won't result in higher unemployment. One case is the so-called monopsony scenario where the employment of new workers would compel employers to raise wages for existing workers, causing the marginal cost of labor to exceed wages. A minimum wage above existing wage levels but below the marginal cost of labor would imply that even as existing workers get more paid, employing new ones would be cheaper. The other case is when minimum wages are so low that no workers get affected by it. For example, if there was a minimum wage of 10 cents per hour and it was raised to 15 cents, the number or workers losing their jobs from this increase will be approximately zero.

The first scenario of monopsony doesn't seem very applicable to the real world. It is relatively rare that new employees get better paid than previous employees had before, and even in the cases when they do, the employer can usually get away with it. The other scenario however seems to be closer to the truth. The new minimum wage of $5.85 is so low that very few workers are affected by it in either a positive (higher pay check) or negative (losing their jobs) way. Even assuming government inflation statistics does not underestimate inflation, the real value of the minimum wage is more than 30% lower than in 1980, and is roughly 50% lower than in for example the U.K., France and Australia. And that is the $5.85 minimum wage we're talking about, the $5.15 minimum wage is of course even lower. While the increase may have destroyed a few jobs, we are talking about very few, at most a tenth of a percent or so.

This is confirmed if we look at the pattern of job losses. Most jobs have been lost in manufacturing and construction, two sectors where pay is so high that virtually no jobs are affected by the minimum wage. By contrast, leisure and hospitality, the sector where pay is lowest and so the sector most likely affected by the minimum wage, the number of employed workers is actually up roughly 2% compared to last year. Even if that number is somewhat inflated by the flawed birth death model, it seems clear that the sector is one of the best performing. All of this suggests that the minimum wage increase have been only a negligible factor behind the jump in the unemployment rate.

This should of course not be seen as a defense of the minimum wage increase. The reason the increase has resulted in so few job losses is because it affects so few workers, which of course also means that only very few workers have experienced higher take home pay. But these results do indicate that the increase in unemployment is cyclical, which in turn suggests that the blame for the higher unemployment rate should be placed on the people responsible for the current downturn, which is to say first and foremost Greenspan and to a lesser extent also Bernanke.


Anonymous ninja said...

Could you give me the examples of the empirical academic studies about the minimum wage in Sweden ? i think the economic theories are always suppose to be studied and confirmed empirically, and in according to my knowledge , the minimum wage is very controvercial field , and , we can see the fact that the mimum wage has given the good impact on the labour market , like , the studies of David Card or Allan Krueger , who are the one of the most brilliant economist in the us.

2:52 AM  
Blogger stefankarlsson said...

I don't have any study for Sweden, which would be difficult anyway since there is no general minimum wage, instead it is unions who set minimum wages, but I found a lot of studies linked to in a comment at the Angry Bear blog.

7:46 PM  
Blogger Richard Jennings said...

stefan - unemployment is up but have you ever noticed all the high paying jobs online (& yes low paying) I just cant help but think many people dont realize the number of employers hiring and the salaries they are offering...not minimum wage either:


Does anyone HAVE to be unemployed?? I dont get it

3:52 AM  
Blogger Dermot said...

If you look at Ireland the minimum wage is €9.00 an hour.This has created a slowdown on job creation.
Along with the weighted employee labour laws.

2:25 PM  
Anonymous Anonymous said...

Well its now official the recession started right after the min wage went up. So it doesnt matter what your theories say. A Recession was created right after the min wage increase. Its clear to me that the min wage increase caused the recession and later the high gas prices made it worse. With another planned increase in 09 it will get worse.

6:41 PM  
Blogger Pedro Garcia said...

Minimum wage laws absolutely create unemployment because they establish a price minimum for a product, which in this case is labor. If you establish a minimum price for cars, you will end up with a lot of cars unsold because people won't pay the minimum price set for those that are worth less than that. Here is a good and funny video explaining how this works: http://www.truthinexile.com/2011/07/19/how-the-minimum-wage-creates-unemployment/

4:05 AM  

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