Perils of the minimum wage

Could the minimum wage in Kazakhstan destroy as many jobs as textbook theory predicts?

In the transition to market economies, the ex-Soviet countries did not lift all price controls immediately. One surviving control is the minimum wage -- the lowest legal wage. In Kazakhstan, this wage varies with the industry. In theory, when the minimum wage exceeds the one that clears the labor market, then more workers will seek jobs than firms will hire. Unemployment will result.

In principle, the minimum wage may be most pernicious for workers who already face discrimination, because it cuts the cost to the boss of exercising his prejudices. To paraphrase an example by Walter Williams: Suppose that an employer in Kazakhstan harbors a bias against female workers. Suppose that a female would work for 300 tenge an hour and a male for 400 tenge. In a free labor market, the cost to the boss of discriminating against females is 400 tenge minus 300, or 100 tenge. But if the minimum wage is 400 tenge, then the cost of discriminating is zero.

In addition, the minimum wage may prevent an inexperienced worker – like a teen – from getting a job by offering to work for low pay in exchange for on-the-job training, noted José Gómez-Ibáñez and others.

That the minimum wage may destroy jobs for the unskilled remains standard fare in freshman economics. Two effects may dominate.


First, since the minimum wage applies mainly to the unskilled, it lowers the relative wage paid to the skilled, inducing the firm to substitute them for the unskilled. Suppose that without the minimum wage, the hourly wage paid to the unskilled in Kazakhstan would be 300 tenge; and the wage for the skilled, 600 tenge. Then the relative wage paid to the skilled is 600 / 300, or 2; that is, the actual cost of hiring a skilled worker for an hour is that you must forego two hours of unskiled labor. Now suppose that the government imposes a minimum wage of 400 tenge. The relative wage paid to the skilled falls to 600 / 400, or 1.5. This reduction makes it cheaper now for the firm to hire skilled workers rather than unskilled ones. For that matter, the firm may also substitute machines for unskilled workers.

Second, the minimum wage raises the cost of production for the firm. It will try to pass on this cost increase to consumers. The product price will rise, discouraging sales. Output will fall, so the firm will lay off workers, some of them unskilled.

In short, the minimum wage may injure the very workers that it was intended to help. So says the theory. What are the facts?

Since 1970, economists in the United States have published more than 40 relevant studies. Most found that a higher minimum wage either had no effect on employment or reduced it, particularly among teen workers, concluded a textbook author, William McEachern. The employment effect may have been particularly large – due to automation as well as to the direct destruction of jobs -- when the New Deal introduced the minimum wage in 1938, noted Andrew Seltzer, who studied two low-wage (and labor-intensive) industries -- hosiery and lumber -- in the South, which was the poorest region of the U.S. at that time.  Seltzer viewed his study as a kind of experiment, with low-wage workers as his treatment group and high-wage workers the control group. 

Perhaps some studies found no effect because employers do not always respond to the higher wage by destroying jobs. Instead, they may substitute part-time jobs for full-time ones. Or they may hire better workers than they did when wages were low – say, college students rather than high-school dropouts; this would favor young workers over old. Finally, employers may trim benefits, although William Alpert’s study of U.S. restaurants did not find that the minimum wage clearly affected most fringe benefits, according to Alan Krueger’s review of the book.

By the late 1990s, many studies in the U.S. tended to conclude that the impact on employment of raising the minimum wage was proportionally smaller than the change in the minimum wage itself. In 1982, Daniel Hamermesh concluded that a 10 percent increase in the minimum wage could reduce teen employment by 1 percent. Displacement of adult workers was not a serious problem, he found. A 2000 study, by Richard Burkhauser and coauthors, estimated that the reduction in teen employment was more like 2% to 6%. In short, empirical studies of the minimum wage suggest that the reduction in employment may be less than proportional to the increase in wages.


The Texas riddle


A recent study may pertain to Central Asia. Lawrence Katz and Alan Krueger telephoned fast-food restaurants in Texas – which had plenty of low-wage workers – to find out whether a steep rise in the U.S. minimum wage in 1990-1, from $3.35 to $4.25, caused restaurants to lay off workers. To the contrary, they found that the restaurants that had to raise their wages by the most in order to satisfy the new minimum wage also added the most jobs.

Why? Maybe the restaurants had long paid the workers much less than they were worth, the economists speculated. Forcing the restaurants to pay a little more, by raising the minimum wage, might attract more applicants. And the restaurants would hire them, since the workers would still worth be more than they were receiving.

Or, if the restaurants weren’t tyrannical employers, maybe they were just survivors, Katz and Krueger suggested. The U.S. economy tanked briefly in 1990-91. A higher minimum wage might have bankrupted some fast-food restaurants. The workers then might have taken jobs at the surviving restaurants. Those were the restaurants that Katz and Krueger surveyed, since they focused on firms that were in business both before and after the hike in the minimum wage.

Here’s another possibility: When low-tech employers found that they had to pay their new workers more, they made up for the cost by cutting back on training; their new hands didn’t need to know much to flip burgers, anyway. Thus the cost of hiring a new worker didn’t really change. And so they hired about as many as before. If this is the main reason why firms don’t lay off workers when the minimum wage rises, then we should see that, eventually, a hike in the minimum wage will have a real bite. When fast-food bosses no longer train their new workers, a higher minimum wage will cause them to hire more slowly.

Finally, the higher wage might have encouraged teens to stay longer on the job rather than quit and look for another.

The picture painted by Katz and Krueger is surprisingly Marxist. A few surviving employers squeeze their workers, either by paying them less than they deserve or by training them less. They don’t really compete for workers.

In that sense, the Texas market for unskilled labor may not be competitive from the worker’s point of view. The fast-food bosses can always threaten to hire undocumented immigrants rather than teens. The Texas study is relevant for Kazakhstan, since many local labor markets here too are ruled by employers.


Lemon workers


In Kazakhstan, the minimum wage has been set several times higher than the poverty line, which is the income that one needs in order to survive over time. In principle, the government could set, for groups that would be hurt by the minimum wage, a lower wage that still sustains the worker. Maybe this “subminimum wage” would avoid some unemployment.

In the U.S., a subminimum wage in the 1990s was not wholly successful. In their book, David Card and Alan B. Krueger concluded that the rate at which firms used subminimum options for youths and training was “extremely low.”

Maybe the Nobel laureate George Akerlof identified a reason, in his analysis of lemon cars. Suppose that the auto buyer can’t tell the difference between a good car and a bad one. Then the owner of a bad car will take advantage of that blindness. He will sell his car at the same price as everybody else. Thus good cars and bad will sell at the same price – say, $15,000. The owner of a turnpike turkey will want to sell his car for $15,000, turn around and buy another car for $15,000. After all, the second car would have some chance of being good; he knows that his first car has no chance of lasting another mile on the highway. But the owner of a good car has no reason to sell; he can’t sell the car for what it’s worth, and he might wind up buying a lemon. As a result, nobody buys a car.

In the same way, the owner of a restaurant might not hire any teen at a subminimum wage. He figures that the low wage will attract a lot of kids from bad schools and maybe a few from good schools. Because he can’t tell the difference between a good school and a bad one, he uses the going wage instead as a criterion. If you want to work for only $3 an hour, you must come from a bad school. Hard-working teens don’t get a chance. – Leon Taylor, tayloralmaty@gmail.com


Good reading


George A. Akerlof. The market for “lemons”: Quality uncertainty and the market mechanism. Quarterly Journal of Economics 84: 3. Pages 488-500. August 1970. Reprinted in Akerlof, An economic theorist’s book of tales. Cambridge University Press. 1984.

Charles Brown. Minimum wage laws: Are they overrated? Journal of Economic Perspectives 2: 3. Pages 133-45. Summer 1988.

David Card and Alan B. Krueger. Myth and measurement: The new economics of the minimum wage. Princeton University Press. 1995. From their statistical studies, the authors conclude that “it is very unlikely that the minimum wage has a large, negative employment effect.”

Ronald G. Ehrenberg and Robert S. Smith. Modern labor economics: Theory and public policy. Ninth edition. Boston: Pearson Education. 2006. Surveys work on the minimum wage.

Lawrence F. Katz and Alan B. Krueger, The effect of the minimum wage on the fast-food industry. Industrial and Labor Relations Review 46: 1. Pages 6-21. October 1992.

Review symposium: Myth and measurement: The new economics of the minimum wage.  Industrial and Labor Relations Review 48: 4. Pages 827-849. July 1995.

Andrew J. Seltzer. The effects of the Fair Labor Standards Act of 1938 on the southern seamless hosiery and lumber industries. Journal of Economic History 57: 2. Pages 396-415. June 1997. Ehrenberg and Smith discuss this study.


References


William T. Alpert. The minimum wage in the restaurant industry. New York: Praeger. 1986.

Richard V. Burkhauser, Kenneth A. Couch and David C. Wittenburg. A reassessment of the new economics of the minimum wage literature with monthly data from the Current Population Survey. Journal of Labor Economics 18: 4. Pages 653-680. October 2000.  Ehrenberg and Smith discusses this study.

José A. Gómez-Ibáñez , Vlad Jenkins, Joseph P. Kalt, and Dorothy Robyn. The Urban League and the youth sub-minimum wage. In Gomez-Ibanez and Kalt, eds., Cases in Microeconomics. New York: Prentice Hall. 1990. Discusses the link between the minimum wage and discrimination, including the example from Walter Williams.

Daniel S. Hamermesh. Minimum wages and the demand for labor. Economic Inquiry 20: 3. Pages 365-380. July 1982.

Alan B. Krueger. Review of Alpert, The minimum wage in the restaurant industry. Journal of Economic Literature 25. December 1987. Pages 1891-3.

William A. McEachern. Microeconomics: A contemporary introduction. Mason, Ohio: Thomson Southwestern. Sixth edition. 2003.