A Missing Dimension of the Minimum Wage Discussion

by Reihan Salam

My recent discussion of President Obama’s call for raising the federal minimum wage neglected an extremely important aspect of the larger minimum wage debate. Arpit Gupta noted the possibility that while an increase in the minimum wage might not have a discernible impact in the aggregate level of employment, it might nevertheless have an impact on the composition of the employed population. It is also possible that while an increase in the minimum wage might not lead to layoffs of existing employees, it might discourage firms from hiring new employees. Last year, two economists at Texas A&M University, Jonathan Meer and Jeremy West, explored this latter possibility in a working paper on “Eff ects of the Minimum Wage on Employment Dynamics”:

To date, nearly all empirical studies of the minimum wage and employment have focusedon how a legal wage oor a ects the employment level, either for the entire labor force ora speci c employee subgroup (e.g. teenagers or food service workers). We argue that, in a Diamond (1981)-type worker search and matching framework, an eff ect of the minimum wage should be more transparent in employment dynamics. The basic intuition is that, while a minimum wage is unlikely to a ffect employment in an abrupt, discrete manner, it may act on the job creation margin to alter the long-run rate of net job growth. We additionally document several empirical reasons for the minimum wage to be more likely to impact job growth than the employment level.

Meer and West exploit differences in state-level minimum wages to gauge their potential impact on gross job creation, gross job destruction, total employment, net job growth, and the reallocation rate. (Reallocation is a particularly interesting phenomenon, as the reallocation of workers from declining firms to growing firms appears to play a significant role in driving productivity growth. This is one reason why efforts to prop up declining firms might prove counterproductive.) They also gauge whether or not state-level minimum wages have an impact on the entry and exit of establishments, which are best understood as discrete places of business (one firm can have one or more establishments, e.g., factories or retail outlets, etc.). 

We find that the minimum wage signi cantly reduces gross hiring of new employees but that it has no e ffect on gross separations. While increases in the legal wage floor insignificantly aff ect the employment level, they directly reduce job growth. Employee reallocation does not appear to be aff ected, nor does entry or exit of establishments. These results have several implications. Most importantly, we show that, in a particular way, the minimum wage does a ect employment.

Given that the minimum wage debate has attracted the intense interest of labor economists, one assumes that this won’t be the last word on the minimum wage and employment dynamics. But Meer and West’s findings deserve to be part of the ongoing empirical discussion. That an increase in the statutory minimum wage won’t necessarily decrease employment levels is not terribly comforting news in light of the persistence of high unemployment, particularly if it is likely to reduce net job growth. Policymakers would instead be well-advised to pursue policies that will tend to actually increase net job growth.

Meer and West’s findings regarding gross separations make sense if we consider the “stickiness” of employment, i.e., the cost of training workers and integrating them into the operation of an establishment might be high enough that employers are reluctant to let go of employees unless it’s absolutely necessary, hence the interest among policymakers in Kurzarbeit and other work-sharing schemes that are designed to mitigate the private and the social cost of separations. 

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.