C15 Lecture 1:
Minimum Wages and Economic
Outcomes
Stephen Machin,
February 2005
Issues
• Economic effects of minimum wages and
evidence on minimum wages and
employment
• The controversy on ‘conventional wisdom’
versus micro based ‘revisionist’ approach
• The introduction of the UK National
Minimum Wage
Economic Effects of Minimum
Wages
• Effect on employment/unemployment has been
central issue in debate about economic effects of
minimum wages.
• Standard textbook model of labour demand
produces one of the clearest predictions in labour
economics - minimum wages price workers out
of jobs by forcing employers up their labour
demand curve.
Standard Textbook Model
Standard Textbook Model
• Basic model rests upon several assumptions:
complete coverage; homogeneous labour;
competitive labour market; short run and long run
impact the same.
• Clear prediction: the minimum wage increase
results in reduced employment - the proportional
reduction in employment (lnEm - lnE0) equals the
proportionate wage increase (lnWm - lnW0) times
the elasticity of demand η.
• Can develop more sophisticated models, but with
assumption of perfect competition produce same
qualitative predictions.
Two Sector Model
• Basic model can be generalised in various directions. One
example is to move to a two sector model - covered/noncovered, set E0 = 1, W0 = 1.
• Demand for workers in the covered sector depends on the
minimum wage, whereas demand in the uncovered sector
depends upon the market wage.
• Minimum wage elasticity of employment =
•
cηεlnWm / [1 - c + εlnWm]
•
where c = proportion in covered sector, ε = elasticity
of labour supply.
• If c = 1, ε =   standard one sector competitive model, η
• Example: c = 0.7, lnWm = 0.6, ε = 0.3, η = -1 
employment effect = -0.26.
Implications
• Only pertinent question is ‘how negative is
the negative effect on employment?’
• Minimum wage hurts the people it sets out
to help by pricing them out of work – even
more the case since low skill people more
likely to be low paid
Evidence
• Early empirical work largely supportive of basic model →
‘conventional wisdom’.
• Usually based on aggregate time series studies of US
employment/unemployment rates and minimum wages,
usually focussing on teenagers
Yt = g(MWt, X1t,......Xkt) + et
where Yt = employment / unemployment to population
ratios (usually in logs), Xit = aggregate demand and supply
variables (teenagers in training programmes, school
enrollment, time trend), MWt = minimum wage index (e.g.
Kaitz index).
• Brown, Gilroy, Kohen (1982) Journal of Economic
Literature - say “consensus” reached: minimum wages
reduce teenage employment with elasticities in the -0.1 to 0.3 range.
Observations on Time Series
Evidence: Re-Appraisal
1). Only up to late 1970s and US minimum
wage fell strongly in real terms in the 1980s
Real Minimum Wages in 1999$
Real Minimum Wage (1999 Prices)
7.5
7
6.5
6
5.5
5
4.5
4
1960 1965 1970 1975 1980 1985 1990 1995 2000
Year
Re-Appraisal (Continued)
2). Extending the samples of teenage
employment studies
into the 1980s
produces much smaller, often statistically
insignificant,
elasticities
below
the
‘consensus’ range (around -0.07) (Card and
Krueger, 1995).
Implications of Re-Appraisal
• Minimum wage effects on employment
seem small (centring in on zero).
• Alternative theoretical explanations:
Monopsony based arguments:
Single buyer of labour (e.g. company town)
– characterised by upward sloping labour
supply curve to firm
Monopsony
Marginal cost of
labour
w
Ls
wm
w0
Marginal product
of labour
E0
Em
E
Implications of Re-Appraisal
• ‘Dynamic’ monopsony type-notions (based
on labour market frictions) can generate
non-negative employment effects of
minimum wages.
• Or – labour demand curve inelastic so that
employment not very sensitive to changes
in minimum wages.
Micro Work
• What is best conceptual way to evaluate
economic effect of minimum wage?
• ‘Before and after’ micro work more closely
approximates the theoretical approaches
that talk about labour markets with and
without minimum wage floors – sometimes
referred to as ‘revisionist’ approach.
Methodological Issues in Newer
Research
• Corresponds better to theoretical concepts as
adopts before and after approach, with treatment
and control groups.
• If E is employment, T and C denote treatment and
controls and 1 and 2 are the before and after
treatment periods then an estimate of the impact of
treatment is:
(ET2 – EC2) – (ET1 – EC1)
or
(ET2 – ET1) – (EC2 – EC1)
Micro Based ‘Before and After’
Studies
• Most famous piece is Card and Krueger’s
(1994)
New Jersey / Pennsylvania
comparison
• UK strand 1: Wages Council work
• UK strand 2: evaluations of introduction of
UK National Minimum Wage in April 1999
New Jersey/Pennsylvania
Comparison
(Card and Krueger, 1994)
• Can be viewed as case study of fast food industry.
• Surveyed fast food restaurants in New Jersey and
Pennsylvania in February-March and NovemberDecember 1992.
• In April 1992 the New Jersey minimum wage
went up from the federal minimum level of $4.25
to $5.05 but the minimum in Pennsylvania
remained at $4.25.
New Jersey/Pennsylvania
Comparison (Continued)
• Two treatment versus control ‘experiments’:
a) T = New Jersey restaurants, C =
Pennsylvania restaurants
b) T = low wage New Jersey restaurants, C
= high wage New Jersey restaurants
Survey Descriptive Statistics
New Jersey/Pennsylvania
Comparison (Continued)
• Results:
i) Substantial impact on wage structure: February
1992 – 33 percent of NJ and 34 percent of Penn
restaurants had starting wage $4.25; November
1992 – 90 percent of NJ restaurants had starting
wage $5.05 and 30 percent of Penn restaurants had
starting wage $4.25.
ii) But no negative effect on employment (if
anything positive)
Wage Structure Impact
Identification of Employment
Effects
ΔEi = a + bXi + cNJi + ei
ΔEi = a’ + b’Xi + c’GAPi + e’i
Where GAP = 0 for P stores and NJ stores
with W1i ≥ $5.05 and = (5.05 - W1i) / W1i
for other NJ stores/
New Jersey/Pennsylvania
Comparison (Continued)
Employment Models
UK Wages Councils
• System of minimum wages that used to operate in
UK was a partial coverage industry based system.
• Wages councils introduced in 1909 (by Churchill)
covered workers in low wage industries (the
sweated trades). Abolished in 1993.
• At time of abolition covered around 12 percent of
workers in the labour market. Were concentrated
in low wage service sector industries. Largest was
retail trade.
UK Wages Councils (Continued)
• Dickens, Machin, Manning (1999) look at
employment and minimum wages in Wages
Council industries from 1975-92.
• Reduced wage inequality, but no evidence
of disemployment effects.
Wages Councils:
Wage Structure Impacts
Changes in Employment and
Toughness
Employment Models
The Introduction of a National
Minimum Wage in the UK
• Introduced in April 1999 at £3-60 for over
21s, £3-00 for 18-21s, none for 16-17 year
olds.
• Raised (by fairly small amounts) on an
irregular basis. Now (after last change of
October 2004) stands at £4.85 for the adult
rate and £4.10 for the development rate. And,
since October 2004, there is a rate for 16-17
year olds, of £3.00 per hour.
Introduction of NMW(Continued)
Adult rate
Development rate*
April 1999
£3.60
£3.00
June 2000
£3.60
£3.20
October 2000
£3.70
£3.20
October 2001
£4.10
£3.50
October 2002
£4.20
£3.60
October 2003
£4.50
£3.80
October 2004
£4.85
£4.10
Notes: *denotes rate for employees aged 18 to 21 and those aged 22 and over receiving accredited training and in
the first six months of employment
Introduction of NMW(Continued)
• Issues:
Who affected and wage benefits.
Evaluating the economic effects.
Initially focus on wage impact, coverage
and employment.
Introduction of NMWLow Pay Commission
• Ex-ante – Low Pay Commission (LPC) set up and
reported on evidence and how expect labour
market to be affected by NMW
Predicted 2 million workers to benefit (9 percent
of workforce), most of whom were women.
Estimated wage boost of 30 percent for those
affected
Introduction of NMW –
Low Pay Commission (Continued)
• Ex-post –
Fewer than 2 million workers benefited, more like
4 or 5 percent (due to measurement error in
earnings data).
The Office for National Statistics now put the
number of people beneath the minimum before
introduction at 1.52 million, whilst the most recent
Low Pay Commission report goes even lower at
1.3 million.
Average wage gain for beneficiaries smaller, more
like 6-10 percent
Beneficiaries of Minimum Wage
Introduction
Introduction of NMW –
Employment Effects
• Key economic question concerns impact on
employment.
• LPC stated that their view was that NMW
was set at level that would not harm jobs
(logic is idea that can have monopsony
power up to a certain level of wages so get
inverse U-shape in employment effects).
Introduction of NMW Employment Effects (Continued)
1). Macroeconomic picture
• No obvious unemployment effect from NMW
introduction.
• Aggregate employment rates (%): 1998 – 73.5,
1999 – 73.9, 2000 – 74.4, 2001 – 74.4;
Unemployment rates (%): 1998 – 6.3, 1999 – 6.0,
2000 – 5.4, 2001 – 5.1.
(Source: Labour Market Trends, March 2003)
Introduction of NMWEmployment Effects (Continued)
2). Micro studies with treatment-control design.
• Stewart (2004) looks at individual-level data
sources to appraise the impact of NMW
introduction
on
individual
employment
probabilities.
• Explicitly looks before and after minimum wage
introduction using longitudinal data on people
(from Labour Force Survey, British Household
Panel Survey and New Earnings Survey).
Introduction of NMWEmployment Effects (Continued)
• Stewart (2004) presents difference-indifference estimates for four groups: adult
men, young men (<22), adult women,
young women (<22).
• Also cross-area paper (Stewart, 2002)
where uses geographical variation in the
proportion affected (across 140 areas) to
identify any minimum wage effect.
Introduction of NMWEmployment Effects (Continued)
• Stewart (2004) approach is to compare
those workers affected by the minimum
wage with workers above the minimum
wage floor.
• Looks at differences-in-differences across
these groups (again ‘treatment’-’control’
type comparison).
Introduction of NMWEmployment Effects (Continued)
• Step 1 looks at wage effects.
Introduction of NMWEmployment Effects (Continued)
• Step 2 looks at differences in employment
probabilities.
Introduction of NMWEmployment Effects (Continued)
• In both papers fails to find negative effects
on employment from NMW introduction.
• Across all workers no evidence of an
adverse effect on employment resulting
from NMW introduction.
Introduction of NMWEmployment Effects (Continued)
3). Employment Effects in a Vulnerable Sector –
Care Homes
• Machin, Manning and Rahman (2003) look for
minimum wage effects in one of the sectors most
vulnerable to employment losses induced by
minimum wage introduction, the labour market for
care assistants.
• Carried out own survey to collect data on workers
and homes before and after minimum wage
introduction.
Introduction of NMWEmployment Effects (Continued)
• Why is this a useful research exercise?
1). The sector contains many low-wage workers, so
the minimum wage has real potential to have a
noticeable important impact on outcomes.
2). The sector is not unionised.
3). It consists of large numbers of small firms
(average employment being somewhere in the
range of 15-20 workers) doing a very
homogeneous
activity
in
geographically
concentrated markets.
4). The product market side of this sector is
interesting. An important fraction of the residents
of these homes have their care paid for by the
Department for Social Security (DSS).
Introduction of NMWEmployment Effects (Continued)
• Therefore provides good testing ground for trying
to identify minimum wage effects on employment.
• Carried out survey of all UK residential care
homes before and after introduction. Asked for
information on all workers in each home.
• Then considered wage and employment effects
using methodology that relates changes in wages
and employment before and after the minimum
wage introduction to the fraction of low paid
workers in the pre-minimum wage period.
Introduction of NMWEmployment Effects (Continued)
• Impact on Wages
• Approach 1: look at percent below minimum
before introduction and for spike at minimum after
• Approach 2: estimate statistical models, relating
the change in the average wage before and after
minimum wage introduction to the proportion of
workers paid less than the minimum wage in the
period before introduction.
Introduction of NMWEmployment Effects (Continued)
• Impact on Wages, Approach 1:
Introduction of NMWEmployment Effects (Continued)
• Impact on Wages, Approach 1:
Introduction of NMWEmployment Effects (Continued)
• Impact on Wages, Approach 2:
Estimate home-level wage change models
Introduction of NMWEmployment Effects (Continued)
Impact on Employment:
• Study whether homes where wages went up by
more experienced employment falls.
• Slight evidence of job losses, but moderate given
scale of wage gains.
• Even in this most vulnerable sector hard to find
employment losses due to minimum wage
introduction.
Introduction of NMWEmployment Effects (Continued)
Distributional Impact
If employment effects moderate then one
may be interested in distributional
consequences of minimum wage floors:
1) Wage inequality
2) Family income distribution
Wage Inequality
• Dickens-Manning – impact limited further up
distribution (small spillovers).
Income Distribution
• Need to be careful what group to study. If
households with someone in work:
Current Research
• Moving on from employment effects.
• Particular focus on firm outcomes (like
prices, profitability).
• Also work on training, crime impacts.
Summary
Economics of minimum wages is interesting
area to illustrate:
i)
How basic first order principles of economics
can be evaluated.
ii) How economics can link closely to issues of
public policy.
iii) How evidence based policy formation can be
useful.