Can the minimum wage create jobs?
If one cannot produce enough of value to justify being paid a living wage, nothing we do to the minimum wage will help
One million unemployed young people. It had been coming for a while, but when the news broke in November that the number of 16- to 24-year-olds looking for work had reached seven figures, the number retained its power to shock.
Almost 300,000 students seeking part-time work are included in the total, and although directly comparable data are not available, the situation was almost certainly worse in the 1980s. Nevertheless, given the evidence that graduating during a recession can affect one’s earnings for far longer than the recession itself, the case for doing something looks urgent. But what?
To some, such as the Institute for Economic Affairs, the answer is simple: abolish the minimum wage. This is unlikely. Minimum wages gradually fell into disuse after Winston Churchill introduced a minimum wage system in 1909. Yet after Labour introduced a national minimum wage in 1999, grumblers have kept a low profile. David Cameron said in 2005 that it had been a success, while in 2008 George Osborne said that “Modern Conservatives acknowledge the fairness of a minimum wage.”
But that is an odd comment, because the case against the minimum wage was always that the law itself was unfair. A minimum wage forbids workers to sell their labour below a certain price, and therefore would be expected to create unemployment for low-productivity workers. Employers use machines instead.
The theoretical argument is simple and compelling. But is it true? Back in 1994 a remarkable article was published by economists David Card and Alan Krueger. They performed a statistical analysis and concluded that not only did the minimum wage not cost jobs – it might even create them. Amazing.
Extraordinary claims demand extraordinary evidence, and while many economists casually dismissed Card and Krueger, commentators on the left also seized uncritically on the results. Both attitudes are a shame because the research paper is too interesting to ignore. Card and Krueger were pioneers in using what economists call a “natural experiment”: the rise of minimum wages in New Jersey, while in neighbouring Pennsylvania they did not move. They surveyed more than 400 fast-food restaurants in New Jersey and east Pennsylvania and found no great difference between employment trends. Nor did higher-wage establishments display different employment trends to those who had to raise wages relative to the minimum. These methods broke new ground and have been much emulated.
It’s fair to say that not every statistical study has come to the same conclusion. But why might Card and Krueger be right in some cases? If employers have market power in the labour market then they might actually offer a lower wage than the balance of competitive supply and demand would produce. Some workers would rather keep looking or sign up for welfare payments, and so employment is lower at this level. Introduce a minimum wage and both wages and employment increase, while profits fall.
Of course this analysis is time and place specific. Since its introduction in the UK, the minimum wage has outpaced consumer price inflation by about 20 per cent. Even if a minimum wage can offer income for the poor without destroying jobs, it would be complacent to assume this will remain true regardless of economic conditions. The Low Pay Commission has been allowing the minimum wage for younger workers to lag behind. No wonder.
But if a young adult cannot produce enough of value to justify being paid a living wage, nothing we do to the minimum wage will help. He, the institutions which trained him and the society in which he lives, have far bigger problems.
Also published at ft.com.
11 Comments
James says:
As always, education is the answer. However, education reform might only be effective if the attitudes of young people change.Maybe high youth unemoyment is the markets way of telling young people to stop playing the playstation and read a few books!!
14th of January, 2012Alexis Pavlou says:
Game theory tells us that ‘forbidding workers to sell their labour below a certain price’ is the perfect way to stop exploitation. Without the NMW, inequality in the UK would be even wider that the obscene levels we see today.
Year 1 A Level economics tells us that the lowest paid have the greatest multiplier, so the NMW is good for Aggregate Demand too.
14th of January, 2012Daniel Earwicker says:
“But if a young adult cannot produce enough of value to justify being paid a living wage… He, the institutions which trained him and the society in which he lives, have far bigger problems”
Do they? We (assuming we’re all nice enlightened liberal people) wouldn’t say that about a severely disabled person who is therefore unable to work. Okay, we might in abstract refer to the “problem” of how to feed and clothe them, but we’d accept it as “our problem”, and all chip in our taxes, as a civil society.
How does this square with the Homo Economicus who finds himself living in the highly-developed, highly automated economy of 2050? He might be the kind of person who could acquire the skills needed to earn a decent crust in 1980, but the economy of the future may simply have no where to slot him in – unless he’s prepared to charge less for his labour than some fancy self-repairing machine does!
And if this might be true to a large extent in the near future, might it be already true to a limited extent today?
Is it really safe to assume that we know how to “educate” people reliably so that they all become the kind of high-flying people who can acquire high-valued skills? I see little to inspire that confidence. It seems more likely that we’re always going to have people with a range of abilities, and as the economy develops, it will have need of the productive labour of an ever smaller elite subset of those people in order to yield a huge surplus.
In which case, we have to come to terms with the welfare state. It’s here to stay and it’s only going to get bigger.
14th of January, 2012Roald says:
As Fransisco de Vitoria stated, 200 years before Adam Smits; the Just Price equals the local market price. Forget this axiom, whether it is manipulating or fixing the price of milk, labour or the most important one interest on money, and you will create structural problems to the economy, as we can see everywhere in the world (except perhaps in NewJersey fastfood chains)
15th of January, 2012registradus says:
James I think you missed the part where “graduating during a recession can affect one’s earnings for far longer than the recession itself” where is the motivation for gaining an education when its not going to improve your chances of a good career? Better to enter a trade or stay home and play playstation…
15th of January, 2012Duncan says:
Card and Krueger’s dif-in-dif approach was flawed as the ‘common trends’ assumption was violated – employment in Pen was decreasing where in NJ it was flat…or so my ‘metrics lecturer told me today!
16th of January, 2012Simon Rogers says:
In a society where we pay in-work benefits, the net effect of abolishing the minimum wage is to subsidise badly paying employers. This is a terrible idea economically.
20th of January, 2012Flora says:
Doesn’t this view of the minimum wage ignore the benefits for businesses and the economy as a whole of higher incomes for the poor? Aren’t the low paid more likely to spend a wage increase than save it, thus boosting aggregate demand? On a separate note, pay in many companies is completely divorced from the value of the thing the worker produces- take most CEO’s pay packets which have seen massive inflation in recent years even when profits fall. That is the problem of our system which grossly rewards failure at the top and imagines itself unable to afford the meager pay-packets of those at the bottom of the food chain.
20th of January, 2012shodanalexm says:
The problem for Card and Krueger is that they challenged some very deeply held beliefs rooted in conventional micro. Subsequent testing of the arguments runs up against the same problem.
The following is an interesting attempt to get to grips with the biases in the literature:
Doucouliagos, H. and Stanley, T. (2009) Publication selection bias in minimum-wage research? A meta-regression analysis, British Journal of Industrial Relations, 47, 2, 406-428.
20th of January, 2012SirenofBrixton says:
It’s self-defeating to have people who can’t take care of themselves. The cost of cleaning up the mess – health care, prisons, social services etc – is insane. Far better if we gave everyone the opportunity to have a living wage (not just minimum!) and pay tax, there’s plenty of churn in the system, plus we can have smaller government. But of course, some people profit from cleaning up the mess. It’s very much in their interest to keep wages low.
20th of January, 2012Confused says:
How are you getting 150m? By my calculations, you’d have to discount the cost (which I’m taking as 25bn) at 9% to reach a DPC of 150m after 60 years, using R/(1+i)^t
21st of January, 2012