Friday, October 20, 2006

Changing the Minimum Wage: Some Evidence

One of the first things that a Democratically-controlled Congress can be expected to do is to pass an increase in the minimum wage. Some people warn that such a move would cost many people their jobs (see today’s op-ed piece by Diana Furchtogott-Roth as an example), the logic being that firms would do better to lay off those workers that they currently pay $5.50 or $6.00 per hour, rather than increase their pay to $7.25. Yet there must also be some reason that over 650 economists signed a letter last week calling for a rise in the minimum wage.

In a couple of posts over the next week, I want to try to present the specific evidence on both sides of this debate. But let me start by letting you know my opinion right up front.

When I started my graduate studies in economics, I was perfectly accepting of the classical economic analysis that illustrates why a minimum wage should cause low-income people to lose jobs. But by the time that I had finished grad school, I had learned that there are economic theories that lead to different conclusions, and I felt that I had seen enough evidence to call into question the classical prediction of the effects of raising the minimum wage. Since then, the additional evidence that I’ve seen has tended to generally confirm that minimum wage laws only have a very small negative impact (or very possibly no impact at all) on employment.

This is a subject on which I have tried to let the empirical evidence guide my opinion. And personally, I'm persuaded that the benefits of a higher minimum wage for low-income individuals (and the distribution of income more generally) outweigh any possible negative employment effects.

As a cursory preview to the kinds of evidence that I’m talking about, let me share with you a quick analysis I did last night on the northeastern states of the US. Most – but not all – states in the northeast have minimum wages that are above the federal level of $5.15/hr. And most of those states have raised their minimum wages at some point in the past several years. This provides a type of natural experiment, where we can compare what happens to employment and wages in neighboring states (and thus states that are hopefully quite similar, and subject to similar economic forces) when some of them raise the minimum wage, and others don’t.

The first table shows the minimum wages across the northeastern states between 2000 and 2005. The states are ranked by the level of their minimum wage in 2005.

As you can see, there's quite a range, from Connecticut, which raised its minimum wage all the way up to $7.10, to New Hampshire, New Jersey, and Pennsylvania, which have kept their minimum wages at the federal level of $5.15.

Now take a look at how employment and wages have changed across those states. The following picture shows private sector employment and average weekly wages for each state. The states are ranked from left to right in order of how much they raised their minimum wage over the period 2001-05. Maine tops the list, having raised their minimum wage by $1.20 over the period; in the middle come states like Massachussets and New York, who raised their minimum wages by $0.75 and $0.85 respectively; and rounding out the group (at the right of the graph) are the three states in the Northeast that have adhered to the federal minimum wage.

Sources: State employment levels comes from the Current Employment Statistics; data on wages by state comes from the Quarterly Census on Earnings and Wages.

If you see a systematic relationship in this chart between raising the minimum wage and employment or wages, then you have better eyes than I do. (Note: their formal statistical correlations are almost exactly 0.0 in both cases.)

One last thing we can do is look at specific episodes of increases in the minimum wage. In the following table I’ve selected all of the instances where one of the Northeastern states increased its minimum wage, but where a similar neighboring state did not. The table shows what happened to overall employment in the private sector and to the average weekly wage in the private sector each case.

In one of these six cases (Massachussets) private-sector employment grew a tiny bit more slowly than in its neighbor; in two of these cases private-sector employment grew by roughly the same as in a neighboring state that didn’t raise the minimum wage; and in three of these cases the state raising its minimum wage actually enjoyed faster employment growth than a neighboring state.

This is not definitive proof, of course. But what this data does suggest is that any effect of raising the minimum wage on employment levels is almost certainly tiny, and generally swamped by other factors in the economy that influence employment much more strongly. The burden of proof is on those who think that higher minimum wages do indeed cause employment to fall, and as hinted at by the charts and tables presented here, it’s surprisingly tough to come by such evidence.


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