Tuesday, October 12, 2010

Latest on the Minimum Wage Studies

The famous Card and Krueger study examined the effects of a minimum wage increase in New Jersey by comparing workers hired there with workers hired in the neighboring state of Pennsylvania. What makes this study noteworthy is that despite its good design, its conclusion defied economic theory: the minimum wage didn't increase unemployment.

There are lots of studies showing the opposite but Card and Krueger was noteworthy not just in its conclusion but in its approach: they looked at local effects. Economist Arindrajit Dube did a more systematic study, looking at several state borders. His confirms the Card and Krueger study. Dube recently spoke to the Real News:
Dube’s findings indicate that a higher minimum wage helps service retailers attract and retain employees, increasing their productivity. He said that a restaurateur, for example, is likely to reduce his employees when the wage goes up if only one restaurant raises their wage, but if most of them raise it, the added cost is passed on to the consumer who is likely to absorb it without decreasing their demand.
In other words, people are very sensitive to the increases in price of one store but less sensitive to the increase in price of all similar stores. That makes sense: there are fewer substitutes for all stores than for one store. I wouldn't say "without decreasing their demand" as I'm sure it's decreased somewhat, but that's probably a media translation, not Dube.

But it still doesn't make sense. The idea of offering a higher wage, even one above what we would typically call a market wage, to attract good workers isn't a new idea in economics or business. Economists call it an efficiency wage: higher wages attract better workers which increases the chance that you'll hire a good worker. (It's hard to tell good workers from bad ones.) Firms use efficiency wages all the time because a good worker is a huge advantage over a competitor. The higher productivity worker pays for the higher wage. There's no reason why in this scenario a firm increasing their wages would feel the need to cut employment. Each worker pays for himself. You don't need a sector-wide increase. In fact, you prefer it. If everyone's getting the benefit of the higher wage, then much of the competitive advantages drain away. (It's not all the competitive advantage, though, as you attract workers from other sectors.)

That Dube was able to replicate the Card and Krueger study makes me less suspicious of it (as the study, while well designed, wasn't perfect...though no interesting study is!) and I'm more open to the idea that minimum wage laws can increase employment than I was yesterday. But I have yet to hear solid economic reasoning as to why this would occur.

HT: Mark Thoma

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