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Myth and Measurement
The New Economics of the Minimum Wage
By David Card, Alan B. Krueger PRINCETON UNIVERSITY PRESS
Copyright © 1995 Princeton University Press
All rights reserved.
ISBN: 978-1-4008-8087-4
CHAPTER 1
Introduction and Overview
There are two excesses to avoid in regard to hypotheses: the one of valuing them too much, the other of forbidding them entirely.
— The Encyclopédie of Diderot and D'Alembert
Nearly 50 years ago, George Stigler implored economists to be "outspoken, and singularly agreed" that increases in the minimum wage reduce employment. The reasoning behind this prediction is simple and compelling. According to the model presented in nearly every introductory economics textbook, an increase in the minimum wage lowers the employment of minimum-wage workers. This logic has convinced most economists: polls show that more than 90 percent of professional economists agree with the prediction that a higher minimum wage reduces employment. Such a high degree of consensus is remarkable in a profession renowned for its bitter disagreements. But there is one problem: the evidence is not singularly agreed that increases in the minimum wage reduce employment. This book presents a new body of evidence showing that recent minimum-wage increases have not had the negative employment effects predicted by the textbook model. Some of the new evidence points toward a positive effect of the minimum wage on employment; most shows no effect at all. Moreover, a reanalysis of previous minimum-wage studies finds little support for the prediction that minimum wages reduce employment. If accepted, our findings call into question the standard model of the labor market that has dominated economists' thinking for the past half century.
Our main empirical findings can be summarized as follows. First, a study of employment in the fast-food industry after the recent 1992 increase in the New Jersey minimum wage shows that employment was not affected adversely by the law. Our results are derived from a specially designed survey of more than 400 restaurants throughout New Jersey and eastern Pennsylvania, conducted before and after the increase in the New Jersey minimum wage. Relative to restaurants in Pennsylvania, where the minimum wage remained unchanged, we find that employment in New Jersey actually expanded with the increase in the minimum wage. Furthermore, when we examine restaurants within New Jersey, we find that employment growth was higher at restaurants that were forced to increase their wages to comply with the law than at those stores that already were paying more than the new minimum. We find similar results in studies of fast-food restaurants in Texas after the 1991 increase in the federal minimum wage, and of teenage workers after the 1988 increase in California's minimum wage.
Second, a cross-state analysis finds that the 1990 and 1991 increases in the federal minimum wage did not affect teenage employment adversely. The federal minimum increased from $3.35 per hour to $3.80 on April 1, 1990, and to $4.25 per hour on April 1, 1991. We categorized states into groups on the basis of the fraction of teenage orkers who were earning between $3.35 and $3.80 per hour just before the first minimum-wage increase took effect. In high-wage states, such as California and Massachusetts, relatively few teenagers were in the range in which the minimum-wage increase would affect pay rates, whereas in low-wage states, such as Mississippi and Alabama, as many as 50 percent of teenagers were in the affected wage range. On the basis of the textbook model of the minimum wage, one would expect teenage employment to decrease in the low-wage states, where the federal minimum wage raised pay rates, relative to high-wage states, where the minimum had far less effect. Contrary to this expectation, our results show no meaningful difference in employment growth between high-wage and low-wage states. If anything, the states with the largest fraction of workers affected by the minimum wage had the largest gains in teenage employment. This conclusion continues to hold when we adjust for differences in regional economic growth that occurred during the early 1990s, and conduct the analysis with state-level data, rather than regional data. A similar analysis of employment trends for a broader sample of low-wage workers, and for employees in the retail trade and restaurant industries, likewise fails to uncover a negative employment effect of the federal minimum wage.
Third, we update and reevaluate the time-series analysis of teenage employment that is the most widely cited evidence for the prediction that a higher minimum wage reduces employment. When the same econometric specifications that were used during the 1970s are re-estimated with data from more recent years, the historical relationship between minimum wages and teenage employment is weaker and no longer statistically significant. We also discuss and reanalyze several previous minimum-wage studies that used cross-sectional or panel data. We find that the evidence showing the minimum wage has no effect or a positive effect on employment is at least as compelling as the evidence showing it has an adverse effect.
Fourth, we document a series of anomalies associated with the low-wage labor market and the minimum wage. An increase in the minimum wage leads to a situation in which workers who previously were paid different wages all receive the new minimum wage. This finding is difficult to reconcile with the view that each worker originally was paid exactly what he or she was worth. Increases in the minimum wage also generate a "ripple effect," leading to pay raises for workers who previously earned wages above the new minimum. More surprisingly, increases in the minimum wage do not appear to be offset by reductions in fringe benefits. Furthermore, employers have been reluctant to use the subminimum-wage provisions of recent legislation. Each of these findings casts further doubt on the validity of the textbook model of the minimum wage.
Fifth, we find that recent increases in the minimum wage have reduced wage dispersion, partially reversing the trend toward rising wage inequality that has dominated the labor market since the early 1980s. Contrary to popular stereotypes, minimum-wage increases accrue disproportionately to individuals in low-income families. Indeed, two-thirds of minimum-wage earners are adults, and the earnings of a typical minimum-wage worker account for about one-half of his or her family's total earnings. In states in which the recent increases in the federal minimum wage had the greatest impact on wages, we find that earnings increased for families at the bottom of the earnings distribution. The minimum wage is a blunt instrument for reducing overall poverty, however, because many minimum-wage earners are not in poverty, and because many of those in poverty are not connected to the labor market. We calculate that the 90-cent increase in the minimum wage between 1989 and 1991 transferred roughly $5.5 billion to low-wage workers (or 0.2 percent of economy-wide earnings) — an amount that is smaller than most other federal antipoverty programs, and that can have only limited effects on the overall income distribution.
Sixth, we examine the impact of news about minimum-wage legislation on the value of firms that employ minimum-wage workers. Stock market event studies suggest that most of the news about the impending minimum-wage increases during the late 1980s led to little or no change in the market value of low-wage employers, such as restaurants, hotels, and dry cleaners. In contrast, more recent news of possible increases in the minimum wage may have led to small declines in shareholder wealth — 1 or 2 percent, at most.
If a single study found anomalous evidence on the employment effect of the minimum wage, it could be easily dismissed. But the broad array of evidence presented in this book is more difficult to dismiss. Taken as a whole, our findings pose a serious challenge to the simple textbook theory that economists have used to describe the effect of the minimum wage. They also provide an opportunity to develop and test alternative theories about the operation of the labor market. As a step in this direction, we present and evaluate several models that depart only slightly from the textbook model, and yet are capable of explaining a broader range of reactions to the minimum wage.
Why Study the Minimum Wage?
Economists in the United States have been fascinated with minimum wages at least since 1912, when Massachusetts passed the first state minimum-wage law. During the next decade, 16 states and the District of Columbia adopted legislation establishing minimum pay standards for women and minors in a variety of industries and occupations. The constitutionality of minimum-wage legislation was challenged almost immediately, and in 1923, the U.S. Supreme Court declared the District of Columbia's minimum-wage law unconstitutional. The effects of this ruling were far-reaching and essentially struck down or curtailed most of the state laws (Davis [1936]). The Court reconsidered the issue several times before finally reversing itself in 1937, upholding a Washington state law and setting the stage for the national minimum-wage regulations that were enacted as part of the Fair Labor Standards Act of 1938. This law, as amended, forms the basis for federal minimum-wage legislation today.
At the heart of economists' interest in the minimum wage is the prediction that an increase in the minimum wage will destroy jobs. Indeed, this hypothesis is one of the clearest and most widely appreciated in the field of economics. Figure 1.1 illustrates the impact of the minimum wage on covered employment in a stylized market, using the conventional supply and demand apparatus. In the absence of a minimum wage, wages and employment are determined by the intersection of the supply and demand curves. Introducing a minimum wage forces employers to move up the demand curve, reducing employment and increasing unemployment. Note that this prediction holds regardless of the precise magnitude of the parameters that determine the shape of the supply and demand curves. If a minimum-wage increase does not reduce employment, the relevance of the textbook supply-and-demand apparatus seemingly is called into question.
The minimum wage is also of obvious importance to policymakers. Countries around the world, including the United States and most other member nations of the Organization for Economic Cooperation and Development, maintain minimum-wage laws. Figure 1.2 shows the quarterly value of the U.S. minimum wage in constant 1993 dollars, from the the first quarter of 1950 to the last quarter of 1993. The minimum wage currently is at a relatively low level, and federal and state legislators recently have debated increases in the minimum. Each time an increase is discussed, there is renewed debate about whether minimum wages help or hurt the disadvantaged, and whether the labor market functions as smoothly as economics textbook writers assume.
Another reason for the prominence of the minimum wage in economics and policy discussions is the fact that, at some time during their lives, most individuals are paid the minimum wage. Indeed, we estimate that more than 60 percent of all workers have worked for the minimum wage at some time during their careers. On any given day, however, only about 5 percent of U.S. workers earn the minimum wage. Because those who earn the minimum wage tend to be disproportionately from low-income and minority families, the minimum wage has attracted the attention of social activists, as well.
What Does the Minimum Wage Do? Economists' Perspectives
If we imagine the total output of the economy as a pie, then the minimum wage can accomplish two things. First, it can alter the size of the overall pie. Second, it can change the size of the slice that different groups — low-wage workers, high-wage workers, and business owners — receive. Conservative economists generally argue that the minimum wage helps no one. They argue that it substantially shrinks the size of the overall pie and reduces the size of the slice that low-income people receive. For this reason, George Stigler called Michael Dukakis's support for a minimum-wage increase during the 1988 presidential campaign "despicable." Finis Welch (1993) went even further, calling the minimum wage, "one of the cruelest constructs of an often cruel society."
Many liberal economists also find fault with the minimum wage. They argue that, even though the minimum wage might give a slightly larger slice of the pie to some low-wage workers, other, equally deserving workers are shut out of the labor market by the minimum. In the 1979 edition of their introductory textbook, William Baumol and Alan Blinder explained, "The primary consequence of the minimum wage law is not an increase in the incomes of the least skilled workers but a restriction of their employment opportunities." Similarly, Robert Heilbroner and Lester Thurow (1987) wrote, "Minimum wages have two impacts. They raise earnings for those who are employed, but may cause other people to lose their jobs."
On the other side of the debate, social activists, policymakers, and other noneconomists often argue for an increase in the minimum wage. Advocates of the minimum wage have included Franklin D. Roosevelt, Martin Luther King, A. Philip Randolph, Walter Reuther, Edward Filene, and Beatrice and Sydney Webb. Within academia, social scientists from outside the field of economics often support minimum-wage legislation. Many noneconomists are skeptical of economic theory and downplay the predicted employment losses associated with a higher minimum wage, while emphasizing the potential pay increases for low-wage workers.
Most significantly, the general public does not widely share the negative opinion of the minimum wage that most economists hold. Surveys find that a majority of the public often supports increasing the minimum wage. A 1987 poll (Gallup [1987]), for example, found that three-fourths of the U.S. population favored an increase. Polls find even stronger support for the minimum wage among the low-income population, the group that many economists argue is hurt by the minimum. The general public is more evenly divided over the question of whether a minimum-wage increase reduces employment. A 1987 poll found that 24 percent of the public "agree a lot" with the statement that "raising the minimum wage might result in some job loss," whereas 22 percent "disagree a lot" with the statement.
Where Do Economists' Views of the Minimum Wage Come From?
How can the general public, most governments, and many other social scientists disagree with the negative view of the minimum wage that is so widely held by economists? First, one should recognize that economists' views of the minimum wage are based largely on abstract theoretical reasoning, rather than on systematic empirical study. Indeed, introductory economics textbooks rarely cite any evidence for the hypothesized negative impact of the minimum wage. As we shall see throughout this book, close examination of the evidence reveals considerable uncertainty over the employment effect of the minimum wage.
Second, psychologists have found that people have a tendency to see patterns that support simple theories and preconceived notions, even where they do not exist. For example, the belief that basketball players shoot in streaks is widespread, even though empirical research has found no evidence of the so-called "hot hand" (Tversky and Gilovich, 1989). As another example, some investors continue to follow strategies that are based on recent trends in the stock market, even though economists have found that short-run stock market returns are essentially unpredictable. The weakness of this tendency is that researchers might discover patterns that support their theories, even if the theories are inaccurate. One way to overcome this shortcoming is to focus on empirical methods that all sides agree can provide a test of a particular theory before collecting and analyzing the data. In our view, this is an attractive aspect of the methodology used in our research, which relies on relatively simple comparisons among workers, firms, and states that were affected to varying degrees by a particular increase in the minimum wage.
(Continues...)
Excerpted from Myth and Measurement by David Card, Alan B. Krueger. Copyright © 1995 Princeton University Press. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
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