The effect of minimum wage on employment has been one of the most explored topic in the discipline of labor economics. During the global recession that plagued the world recently, the rate of employment for the low-skilled and young workers (who comprise the largest component of all minimum workers) worsened disproportionately. Traditionally, some economists have argued that the imposition of a minimum wage that is above the market clearing equilibrium wage reduces employment and at the same time contributes to unemployment particularly among the relatively unskilled as well as the young workers. This is quite ironical given that this is the group of people the minimum wage is supposed to help in the first place. In recent days, however, studies by various economist have seemed to indicate that an increase in the minimum wage may not necessarily have a negative effect on employment patterns. These economists claim that there is no explicit evidence to show that minimum wage has an employment reducing impact and on the contrary, an increase in the minimum wage may in actual sense cause an increase in employment. The government is always at the forefront of formulating economic policies that are aimed at increasing the standards of living of the poor. Policies on minimum wage have a huge potential to influence the standard of living for poor households. However, before any policies on minimum wage can be effected, there is a need to develop a more conclusive understanding of the effect or impact of minimum wage on employment (Meer and West 1).
As mentioned previously, a large section of economists have argued that increasing the minimum age essentially results in a decrease of employment especially for the low-skilled workers and the young workers. In fact, many neo-classical competitive models of organizational behavior forecast that an increase in wages reduces the quantity of labor demanded by a firm and holding the wage rate constant, the workers who are least valued to a firm are usually the ones who are first to be fired and usually the last to be hired (Burkhauser, 16). Unfortunately, in many occasions, the least valued workers are usually the minimum wage workers. A federal increase of the minimum wage, would inadvertently lead many firms, especially small business to reduce their overall demand for labor. This can, for instance, emanates from the fact that small business cannot be able to sustain the new labors costs and still make a profit. In such a situation, the firm has no option but to reduce its overall labor demand and therefore lay off some its already existing workers while at the same time curtailing on the employment of others. Here, an increase of the minimum wage is seen to have a direct effect on the employment in that it reduces employment.
Several economists have studied this relationship. According to Zadovny, “the competitive model posits a downward sloping labor demand curve and an upward-sloping supply curve” (731). Organizations usually demand less labor when the cost of this labor increases and as the number of workers increases due to the increased wage. An increase in the minimum wage usually means that firms become imposed on this binding minimum wage, and this consequently decreases the total labor quantity that firms demand and increases the quantity of labor that is supplied. The result is a fall in the quantity of total employment as the minimum wage rises (Zadovny, 731). This is because many employers are forced to lay off or fire the workers whose marginal revenue product is less that the amount of wage given.
According to Zadovny, if employees are paid their marginal revenue product, then those employees who are initially paid less than the new minimum wage should not be employed any longer unless their marginal revenue product actually increases. Unfortunately, unless the company engages in a new strategy or diversifies, it is very unlikely that the current workers are going to increase their contribution in the form of profit or revenue. This results in a situation whereby the employer has no choice, but to lay off workers. In a nutshell, dis-employment effects are usually felt more or are expected to be larger among those workers who were being paid lower than the new minimum wage or were earning a figure that is close to this minimum age. Unfortunately, most of the workers in this category are the young and the lowly paid, and when this happens, most of them become unemployed and chances of re-employment are significantly slim. On the other hand, higher paid workers experience very little (if any at all) negative effects of increased minimum wage. Many economists have used this argument to show the negative effect of minimum wage increase on unemployment.
However, most of the current literature is dominated by studies that seems to indicate that increase of minimum wage have very diminished and insignificant effect on employment of young people and low skilled workers (Burkhauser, 17) A few others seem to show that increase of minimum wage have a positive effect in employment.
Many of these studies have use a pooled, time series cross-sectional approaches to estimate the effects that minimum wage increases have on employment changes (Burkhauser, 17). The studies also primarily utilize data from the CPS as well as cross state variation in minimum wages to identify the impact on employment. In addition, most of the studies focus on teenagers, young adults and relatively low-skilled workers (Dube 946).
Neumark and Wascher are particularly two of the most renowned economists who have conducted extensive studies on the impact of minimum wage increase on employment. The two economists have utilized the Kaitz index to measure increases of minimum wage and have found that this particular variable has a negative and significant effect on employment (Burkhauser, 18).
Based on the Kaitz index’s estimated coefficient, Neumark and Wascher conclude that the effect of minimum wage increase on young people is both negative and significant. For example, Neumark and Wascher report elasticities that range from -0.1 to -0.2 (for teenagers) and -0.15 to -0.2 (for teenagers and young adults) (Burkhauser, 18).
While this sign of elasticities may be consistent with the notion that increases of minimum wage result in employment decreases, Neumark and Wascher do not find explicit evidence to show that these effects are particularly large among young and less skilled workers (Burkhauser, 18).
However, the results found by Neumark and Wascher have been directly countered by research by other economists. An example is Card, Katz, and Krueger in 1994. These three researchers are particularly very critical of the research and results by Neumark and Wascher (1992). They argue that the variables that Neumark and Wascher used including the Kaitz index were inappropriate and were responsible for driving the results in a particular direction.
According to Card, Katz and Krueger, the Kaitz measure is an ineffective and flawed measure of the impact and effect of minimum wage increase (Burhauser, 18). Therefore, the three provide an alternative to this measure, and this is an algorithm of the higher of the federal or the state minimum wage (Burkhauser, 18).
This argument definitely captured the attention of Neumark and Wascher who in the same year responded in an article in 1993 where they tried to justify their previous argument and to show that it was indeed accurate.
For instance, Card, Katz and Kruger had argued that the Kaitz index (also referred to as the coverage adjusted relative minimum wage variable) was flawed because it is in negatively correlated with mean wage of the young adults or the teenagers, who were the main focus of this study (Neumark and Wascher 3). However, Neumark and Wascher counter argue this by stating that “a negative correlation between the relative minimum wage variable and the mean teen or young adult wage does not contradict the suitability of the Kaitz index” (Neumark and Wascher 3).
Neumark and Wascher then go on to give an example where they state if the nominal minimum wage was for instance fixed, an appropriate variable of minimum wage should go down when the mean wage of a young worker rises. This is because the minimum wage’s real value falls (Neumark and Wascher 3).
However, this new alternative measure proposed by Card, Katz and Krueger was later used by Neumark and Wascher in a study that they conducted in 1994. In this particular study where they used the model by Card, Katz, and Krueger, they found that increases of minimum wage has almost insignificant effect on young people employment.
The debate on the effect of minimum wage can also be approached from another angle, and this is job turnover. As observed, an increase of the minimum wage leads to a relative increase in the likelihood of laying off and firing workers due to decreased demand of labor in a firm or an organization. The low-wage labor market is usually characterized by high turnover rates.
Minimum wage workers are always seeking for better opportunities where their minimum wage is higher. A minimum wage earner may, for instance, hear of a vacancy in another place where the rate being paid is significantly higher or where the working conditions are better. This earner may leave their current position at any time and go seeking for employment in the other place.
This is also made easier by the fact that many minimum wage jobs do not involve any contractual agreements which makes it easier for workers to job from one job to another. An increase of the minimum wage increases job uncertainty and workers may have reservations when it comes to abandoning one job for another. Workers may choose to remain at their current place since they know that they may move to another place that pays significantly higher only to be laid off a few days later.
In addition, a high minimum wage usually makes it very easy for employers to hire workers and retain them. This is because a high minimum wage is likely to attract a lot of prospective workers. It also leads to a lowering of the turnover cost.
The ultimate meaning or effect of this is that the costs savings accrued may be used to compensate for the increased wage costs (Schmitt 21). This then allows employers to maintain the employment levels at the company. In addition, if an increased minimum wage leads to a reduction in both the number as well as the duration of vacancies, then the employment response to an increase in minimum wage would be positive in nature (Schmitt 21).
The above discussion shows that the debate on minimum wage is over. Increase in minimum wage is usually implemented to enable workers in this job category to make substantial earnings that can support their daily needs or improve their current standards of living. However, as shown above, there have been studies conducted in the past that have sought to show that increase in minimum wage has an overall negative effect on the low-wage labor market whereby levels and amount of employment is significantly slashed. These researchers have used various models to shows increased minimum wage leads to progressive reduction in the level of employment, mainly due to firings and lays offs as well as reduced incidences of hiring. There is however other studies that have sought to show that minimum wage increases have very little effect if any to the total employment levels in the labor market. Some have even argued that increased minimum wage increases the level of employment in the labor market. Once again, these researchers have used credible numbers and data to back up their argument. At the moment, it is difficult to prove who is correct but with proposals to increase the current minimum wage being in place, the long-term effects will be seen in the future.
Burkhauser, Richard V., Kenneth A. Couch, and David C. Wittenburg. "Who minimum wage increases bite: An analysis using monthly data from the SIPP and the CPS." Southern Economic Journal (2000): 16-40.
Dube, Arindrajit, T. William Lester, and Michael Reich. "Minimum wage effects across state borders: Estimates using contiguous counties." The review of economics and statistics 92.4 (2010): 945-964.
Meer, Jonathan, and Jeremy West. Effects of the minimum wage on employment dynamics. No. w19262. National Bureau of Economic Research, 2013.
Neumark, David, and William Wascher. Employment effects of minimum and subminimum wages: reply to Card, Katz and Krueger. No. w4570. National Bureau of Economic Research, 1993.
Schmitt, John. "Why does the minimum wage have no discernible effect on employment?" Center for Economic and Policy Research (2013): 22.
Zavodny, M. (2000). The effect of the minimum wage on employment and hours. Labour Economics, 7(6), 729-750.