Saturday 8 January 2011

Minimum wages and poverty

The general consensus of the academic economic literature is that minimum wages increase unemployment for marginal workers. And so it wasn't at all surprising that the big increase in the minimum wage affecting young Kiwi workers in 2008 led to very large increases in youth unemployment relative to adult unemployment.

What's been more ambiguous is the net effect on poverty or welfare. Sure, some folks lose their jobs. But other folks get more money.

Nick Rowe Stephen Gordon points to some work in Canada showing minimum wages increase poverty rates. Minimum wage workers are mostly second earners and young folks. The ones who lose their jobs push their families into poverty. Here's Nick Stephen:
My colleague Guy Lacroix has brought to my attention a recent study that suggests that when minimum wages are increased in Canada, the net effect on poverty rates turns out to be positive.

The study in question was written by Aninda Sen and two of his U of Waterloo colleagues, and it recently appeared in Labour Economics. (If the link to the Labour Economics site doesn't work, there's an ungated version on his web page.)

The first set of results address the question of the effects of minimum wages on teen employment (2/3 of minimum wage workers live at home or with a family member) and obtains estimates consistent with the existing literature.

Of particular interest are the results in Section 5.4 and Table 4, which estimate the effects of changes in the minimum wage on the proportion of families with income below the LICO. Here, we see that the effect of a minimum wage increase on the incidence of poverty is significantly positive, and the effect is most strongly felt in two-parent households. The effect on older workers is insignificant.

As far as I can tell, the story the authors want to get across goes something like this: most minimum wage earners are young, and the income of these workers is a significant contribution to low-income households. For families in which the minimum wage worker keeps her job, the increase in the minimum wage can increase family income above the LICO so long as hours worked are not significantly affected. For families in which the minimum wage worker loses her job and/or loses too many hours, the lost income may bring family income below the LICO. Canadian data suggest that the latter effect dominates: the net effect of an increase in minimum wages on poverty rates is positive:
From a policy perspective, a common argument has been that even if a higher minimum wage does result in lower employment for some, the corresponding welfare costs are low since the number of minimum wage earners as a proportion of the labour force is relatively low. Further, the effects of unemployment (from a minimum wage hike) may not be severe as a significant majority of minimum wage earners live with another family member. Therefore, a higher minimum wage should unambiguously make lower wage earners better off through higher earnings, and therefore, a reduced incidence of poverty.

Our results suggest the contrary. The ‘negative’ effects of an increase in the minimum wage might not be restricted to higher teen unemployment. A higher minimum wage may paradoxically result in more poverty as teen unemployment results in a drop in household income among low-income families. Therefore, the negative spillovers of a higher minimum wage may be significant and mitigate the benefits of higher earnings to the working poor who remain employed.
For once, the traditional final sentence of academic research papers is not empty boilerplate:
At the very least, the results of this study suggest the need for more research on the nexus between the minimum wages and poverty.
Indeed it does.
The Canadian study suggests a 10% increase in the minimum wage yields about a 5% increase in the percentage of families living below Canada's Low Income Cut-Off line. If those results held in New Zealand, increasing the minimum wage from $12.75 an hour to the union-demanded $15, an 18% increase, would increase the proportion of NZ families in poverty by about 9%. Results here could reasonably vary: labour demand elasticities may not be the same and incidence of the minimum wage will vary as well. But it ought to be our base guess from which we'd adjust for New Zealand conditions.

14 comments:

  1. "The general consensus of the academic economic literature is that minimum wages increase unemployment for marginal workers."

    True. However, it has been remarkably difficult to prove this proposition empirically. For the US, the accumulated evidence does not support this proposition.

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  2. Most US minimum wage changes are small so teasing out the effects can be tough. Hit Neumark and Wascher for the best survey.

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  3. With respect to how results in NZ would differ: the greater the proportion of minimum wage earners who are second earners whose earnings bring their families out of poverty, the more a minimum wage increase increases poverty. The more minimum wage earners that are sole earners and whose earnings don't reach the poverty line, the more a minimum wage increase reduces poverty.

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  4. Thanks Eric. But that was posted by Stephen Gordon, not me. I wouldn't want to steal his credit.

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  5. The Neumark and Wascher survey is not that impressive. Seems like they see what they want to see.

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  6. "The Neumark and Wascher survey is not that impressive."

    Looks pretty straightforward to me.

    In chapter 9 “Summary and Conclusions” Neumark and Wascher write

    “Three conclusions, in particular, stand out. First, as indicated in chapter 3, the literature that has emerged since the early 1990s on the employment effects of minimum wages points quite clearly – despite a few prominent outliers – to a reduction in employment opportunities for the low-skilled and directly affected workers”. (p. 286)

    Also from Table 9.1 page 287 when dealing with the effects on employment, under the ‘Summary of evidence’ heading Neumark and Wascher write

    “Minimum wages reduce employment of low-skilled workers; adverse effects even more apparent when research focuses on those directly affected by minimum wages.”

    In short: minimum wages increase unemployment for marginal workers.

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  7. Hi Paul. They reach these conclusions through their (admittedly expert) reading of the evidence. No statistical analysis of the accumulated evidence is undertaken.

    Take a look at the meta-analyses that have been done on the topic. A completely different answer emerges: There is no evidence that min wage in the US has had an adverse effect on employment.

    Now, this does not mean that it doesnt have an effect in the US. Just means that it has not been established in the literature.

    Perhaps the effect is too small to be detected by available data and estimators.

    The whole min wage evidence issue seems to me to be similar to the climate change 'science'. Lots of people taking a certain position - man causes climate change, min wages cause unemployment.

    The evidence for both is rather weak.

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  8. @Anon: The metastudies are talking about overall employment, not employment of marginal groups, right? I can buy it on overall employment in the US: the minimum wage isn't binding on enough folks for small changes to show up in overall figures.

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  9. @Anon: Eric's point is a good one. Minimum wages have little effect on overall employment levels, their effects get lost in the noise, but do effect certain groups, eg the low-skilled or young workers, within the labour force. Hence Neumark and Wascher write

    “Minimum wages reduce employment of low-skilled workers; adverse effects even more apparent when research focuses on those directly affected by minimum wages.”

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  10. I will want to re-check Neumark and the metastudies though. This stuff seems set to be important here....

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  11. Most discussion on the minimum wage misses some very important flow-on effects, as is the case here.

    If the minimum wage is increased, marginal labour saving capital equipment becomes economical, thus making the whole workforce more productive (including minimum wage earners). While there may be a short term cost of unemployment where some marginal jobs have disappeared, the overall change in productivity will lead to growth in demand for labour, which will then offset any small declines.

    Also, there is the issue of the market power of employers hiring unskilled, and typically uninformed, workers. Not everyone is savvy enough to negotiate their own conditions, especially the low skilled whose options for employment are limited.

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  12. Doesn't that require that firms are stuck at local optima - they could do better individually by moving to more capital-intensive processes? Or are you reckoning on some kind of network effect?

    On market power - that's possible, and especially so with monopsonistic employers. But isn't that an argument not for minimum wages but for minimum work conditions, which tend to be handled through health and safety regs anyway?

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  13. Not everyone is savvy enough to negotiate their own conditions, especially the low skilled whose options for employment are limited.

    what do you mean by their own conditions? there will always be a lowest quintile, who must deal with the lowest conditions.


    If the minimum wage is increased, marginal labour saving capital equipment becomes economical, thus making the whole workforce more productive (including minimum wage earners). While there may be a short term cost of unemployment where some marginal jobs have disappeared, the overall change in productivity will lead to growth in demand for labour, which will then offset any small declines.

    this claim is not backed up by history. Ultimately a minimum wage leads to a reduction in the demand for labor and an increase in the supply of labor in the relevant market — usually, the market for low-skill workers. It removes the ability of some workers to compete by accepting lower wages and shuts them out of the labor force. As a result, it reduces job opportunities for these workers.

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