December 2006

The Minimum Wage and Employment: A Review of Evidence from the "New Minimum Wage Research"

The Democratic leadership has announced plans to pass an increase in the federal minimum wage soon after their party takes over Congress in January. The current rate of $5.15 per hour has not been raised since 1997. Some argue that an increase in the minimum wage is long overdue to help America’s poorest workers. However, others argue that raising the minimum wage does more harm than good, resulting in less hiring and scaled-back hours for low-wage workers.

What effect does the minimum wage have on employment? To answer this question, David Neumark of the University of California at Irvine presented his comprehensive review of the "new minimum wage research" from the past fifteen years. on December 4, 2006. Jared Bernstein from the Economic Policy Institute and Harry Holzer of the Georgetown Public Policy Institute discussed Dr. Neumark’s review.

David Neumark
University of California, Irvine

In the late 1980s, there was a proliferation of state minimum wage increases as the federal minimum wage stagnated. This motivated many researchers to study the subject as they could compare the effects of changes in minimum wage more easily. Some concluded that there are no employment effects of raising the minimum wage, in stark contrast to the traditional view that raising the minimum wage increases unemployment. Very few papers suggested strong employment effects. Current research reviews a wide range of this literature.

Among the ninety researchers that we studied, the most credible twenty suggest that there is some negative effect. Most studies that find zero or positive employment effects tend to focus on either the short run (up to two years) or focus on a particular industry. On the other hand, research that looks at the long run finds a consistently negative employment effect of raising the minimum wage. This is understandable because firms will take time to react to changes in wages. There is even stronger evidence of unemployment in studies that pull out the least-skilled workers.

It is wrong to conclude that the research fails to provide a consensus view because the preponderance of evidence points to an unemployment effect of raising the minimum wage.

Jared Bernstein
Economic Policy Institute

The conclusions that raising the minimum wage increases unemployment and that minimum wage increases have no effect on employment are both overly bold assertions. Moderate growth in the minimum wage, especially in periods of strong demand, may not show measurable numbers of jobs and hours lost even for the narrow categories like low-skilled workers. The increased compensation comes from a redistribution from profits to wages, which is not necessarily harmful. The redistribution can even come from price increases and productivity gains. The benefits will often overshadow the costs. More workers will end up with higher incomes than will lose jobs and hours; some may even end up working fewer hours without losing income.

In 1996-97 the federal minimum wage increased from $4.25 per hour to $5.15 per hour. Combined with a higher Earned Income Tax Credit, welfare reform, and high immigration, this created a strong supply effect in the labor market. However, labor demand for low-wage workers grew faster and real wages grew at the rate of productivity growth for the first time in thirty years. Poverty rates of the most disadvantaged workers fell faster than ever. One has to take into account that demand for labor does not stay constant.

The Democrats are supporting a minimum wage hike to $7.25 by 2009, but the current tenth percentile wage is $7.50. A statement by the Economic Policy Institute supporting an increase in the minimum wage received support from over 600 economists, including five Nobel laureates. The view on the minimum wage has obviously changed since such support would not have existed if the traditional view had continued to hold sway.

Harry Holzer
Georgetown Public Policy Institute

Moderate increases in the minimum wage are not very harmful, but there is too much uncertainty about the issue. People earning at a level marginally above the minimum wage are also affected by the minimum wage, since many employers consciously try to stay above minimum wage level. There may also be efficiency gains due to a higher minimum wage as employers find it easier to fill vacancies.

Consumption behavior does not solely depend on price. Thus, if employers react to a minimum wage increase by raising prices, there may be no substantial effect on employment levels. Modest increases in wages cannot have a large effect on substituting labor with capital.

One reason that researchers found a higher negative employment effect in the 1970s could be due to demographics: there was a large population of baby boomers. Furthermore, per-unit increases in the minimum wage will have increasingly greater effects, since workers further up in the distribution are affected. The federal minimum wage is currently very low by historical standards. Even an increase to $7.25 per hour will still keep it at a low level.

If the increase is modest compared to the rest of the labor market, there will be hardly any unemployment effect, especially because so many states already have minimum wages higher than the federal level. Research on the minimum wage needs to focus on the benefits of such policies rather than solely considering employment effects.

AEI intern Waseem Alim prepared this summary.