The Negative Effects of Minimum Wage Laws, Cato Policy Analysis No. 701

7/31/2019 The Negative Effects of Minimum Wage Laws, Cato Policy Analysis No. 701

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Executive Summary

The federal government has imposed a mini-mum wage since 1938, and nearly all the statesimpose their own minimum wages. These lawsprevent employers from paying wages below amandated level. While the aim is to help work-ers, decades of economic research show thatminimum wages usually end up harming work-ers and the broader economy. Minimum wagesparticularly stifle job opportunities for low-skill

workers, youth, and minorities, which are thegroups that policymakers are often trying tohelp with these policies.

There is no free lunch when the governmentmandates a minimum wage. If the government re-quires that certain workers be paid higher wages,then businesses make adjustments to pay for theadded costs, such as reducing hiring, cutting em-ployee work hours, reducing benefits, and charg-ing higher prices. Some policymakers may believethat companies simply absorb the costs of mini-mum wage increases through reduced profits, but

thats rarely the case. Instead, businesses rationallyrespond to such mandates by cutting employmentand making other decisions to maintain their netearnings. These behavioral responses usually off-set the positive labor market results that policy-makers are hoping for.

This study reviews the economic models usedto understand minimum wage laws and exam-ines the empirical evidence. It describes why

most of the academic evidence points to nega-tive effects from minimum wages, and discusseswhy some studies may produce seemingly posi-tive results.

Some federal and state policymakers are cur-rently considering increases in minimum wages,but such policy changes would be particularlydamaging in todays sluggish economy. Instead,federal and state governments should focus onpolicies that generate faster economic growth,which would generate rising wages and more op-portunities for all workers.

The Negative Effects of Minimum Wage Lawsby Mark Wilson

No. 701 June 21, 2012

Mark Wilson is a former deputy assistant secretary of the U.S. Department of Labor. He currently heads AppliedEconomic Strategies, LLC, and has more than 25 years of experience researching labor force economic issues.


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At $7.25 per hour,the minimumwage today in

real dollars is 85

percent greaterthan the original

benchmark.

Background

The federal minimum wage originated inthe Fair Labor Standards Act (FLSA) signedby President Franklin Roosevelt on June 25,

1938. The law established a minimum wageof 25 cents per hour for all employees whoproduced products shipped in interstate com-merce. That wage is equivalent to $4.04 in to-days purchasing power.

Originally, the FLSA covered only about 38percent of the labor force, mostly in the manu-facturing, mining, and transportation indus-tries.1 Over the years, Congress has signifi-cantly expanded the coverage and increasedthe minimum wage rate. The air transportindustry was added in 1947, followed by re-

tail trade in 1961. The construction industry,public schools, farms, laundries, and nursinghomes were added in 1966, and coverage wasextended to state and local government em-ployees in 1974. Currently, the FLSA coversabout 85 percent of the labor force.2

Since 1938 the federal minimum wagehas been raised 22 times. From 1949 to 1968the real value of the minimum wage (in 2011dollars) rose rapidly from $3.78 to $10.34, asshown in Figure 1. At $7.25 per hour, the mini-

mum wage today in real dollars is 85 percentgreater than the original benchmark, and justbelow its average for the past 60 years of $7.59.Since the 1970s, the federal minimum wagehas fluctuated around roughly 40 percent ofthe average private sector hourly wage.

The FLSA requires employers to comply withstate minimum wage laws that may set a stateminimum wage rate higher than the federal rate.3

Currently, 45 states and the District of Colum-bia have their own minimum wages, of which 18are higher than the current federal minimum of

$7.25 per hour.4

Only five states do not have theirown minimum wage laws and rely on the FLSAMoreover, even state minimum wages that arebelow the federal minimum often have an effectbecause they can apply to employers or workerswho are exempt from the federal statute.

Source: Author, based on U.S. Bureau of Labor Statistics data.

Figure 1Real Federal Minimum Wage

Real2011Dollars


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Most workersearning theminimumwage are youngworkers, part-time workers,or workersfrom nonpoorfamilies.

Currently, the highest state minimum wageis in Washington ($9.04), followed by Oregon($8.80), and Vermont ($8.46). Three otherstates (Connecticut, Illinois, and Nevada) haverates of $8.25, followed by California and Mas-

sachusetts ($8.00). Eight states have adoptedan annual inflation adjustment, or indexing,of their minimum wages.5

This year the legislatures of New Jersey,New York, and Connecticut are consideringminimum wage increases. In New Jersey andNew York the proposals would raise the mini-mum wage to $8.50 per hour. In Connecticutthe legislature is considering an increase to$9.75 per hour.

At the federal level, Sen. Tom Harkin (D-IA)has also introduced the Rebuild America Act

(S. 2252) to raise the national minimum wageto $9.80 per hour over two years, a 35 percentincrease. The Harkin bill would also index thenational minimum wage to inflation. The billwould effectively return the real value of theminimum wage to near the record high levelof 1968 and keep it there through indexing.

State-imposed minimum wages that arehigher than the federal minimum place work-ers and businesses in those states at a competi-tive disadvantage. If other factors are equal,labor-intensive industries will tend to shift their

investment to states that dont impose thoseextra cost burdens. Thus, states with relativelyhigh state minimum wages may have lower jobgrowth and lower economic growth than wouldotherwise be the case. Also, workers whose em-ployment prospects are impinged by high stateminimum wages have an increased incentive tomigrate to other states to find jobs.

Who Is Paid the

Minimum Wage?Supporters of minimum wages might be-

lieve that these laws mainly help to boost theincomes of full-time adult workers in low-in-come families, some of whom are supportingchildren. However, the data generally do notsupport that view. Most workers earning theminimum wage are young workers, part-time

workers, or workers from nonpoor families.According to the Bureau of Labor Statis-

tics, 1.8 million paid-hourly employees werepaid the federal minimum wage of $7.25 in2010.6 These 1.8 million employees can be

broken down into two broad groups:

Roughly half (49.0 percent) are teenag-ers or young adults aged 24 or under.A large majority (62.2 percent) of thisgroup live in families with incomestwo or more times the official povertylevel.7 Looking just at the families ofteenaged minimum wage workers, theaverage income is almost $70,600, andonly 16.8 percent are below the povertyline.8 Note that the federal minimum

wage applies to workers of all ages.9

The other half (51.0 percent) are aged25 and up.10 More of these workerslive in poor families (29.2 percent) ornear the poverty level (46.2 percenthad family incomes less than 1.5 timesthe poverty level).11 However, evenwithin this half of all minimum wageemployees, 24.8 percent voluntarilywork part-time, and just 34.3 percentare full-time full-year employees.12

Only 20.8 percent of all minimum wageworkers are family heads or spouses work-ing full time, 30.8 percent were children, and32.2 percent are young Americans enrolledin school.13 The popular belief that mini-mum wage workers are poor adults (25 yearsold or older), working full time and trying toraise a family is largely untrue. Just 4.7 per-cent match that description.14 Indeed, manyminimum wage workers live in families withincomes well above the poverty level.

Modeling the Effects of aMinimum Wage

When economists want to understand theeffects of a policy change, they build a modelor set of equations to figure out how variablessuch as wages and prices might be affected.


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Markets oftenrespond tochanges inmandated

minimum wagesin ways that

create negativeeffects that are

unplanned andare not desired

by policymakersor the general

public.

There have been decades of research on the ef-fects of the minimum wage, and economistshave used three types of models to explorethe issue: competitive, monopsony, and insti-tutional. With each of these models, the cost

increase associated with the minimum wagechanges the behavior of firms, with resultingimpacts on workers, consumers, owners, andothers. The three alternative models empha-size different types of adjustments that em-ployers use to adapt to increases in the mini-mum wage.

Much of the empirical research has focusedon estimating how much an increase in theminimum wage will reduce employment in af-fected industries and affected groups of work-ers. Other research has examined the effects

of minimum wages on the number of hoursworked, firm profits, worker training, level ofwork effort, human resource practices, opera-tional efficiencies, internal wage structures,and other parameters. The important thing tounderstand is that markets often respond tochanges in mandated minimum wages in ways

that create negative effects that are unplannedand are not desired by policymakers or thegeneral public.

Basic Competitive Model

The competitive model has been most of-ten used for evaluating the minimum wageThis is the basic textbook model that has beentaught in university economics courses for de-cades. The core components of the model area negatively sloped labor demand curve anda wage rate that clears the market and is notcontrolled by individual agents. In competitivemarkets, the imposition of a minimum wageprovides a classic example of a governmentdistortion that creates negative side effects inthe marketplace.

Figure 2 shows a hypothetical competitivelocal labor market. The market demand curvefor labor isDD, and the market supply curveis SS. Their intersection determines the com-petitive wage, Wc, with employment Ec. If theminimum wage is set at Wm, employment isreduced to Em. The reduction in employment

Figure 2Labor Market Effect of a Minimum Wage


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Other channelsof adjustment inthe competitivemodel besidesemploymentreductionsinclude reducedjob training,reductions

in workerbenefits, andthe substitutionof more skilledlabor for less-skilled labor.

is smaller than the excess supply of labor (thedistance AC). The excess supply of labor in-cludes both a reduction in employment (fewerhours and job opportunities, or AB) alongwith a second component consisting of work-

ers who are drawn into the labor market bythe prospect of earning the higher minimumwage (BC). Although some of the workerswho are drawn into the labor market (typicallythose with higher skills) may succeed in find-ing one of the minimum wage jobs, it comesat the expense of lower skilled workers who areshut out of the labor market.

The excess supply of labor in this exampleis dispersed in several ways: a reduction inhours, fewer job opportunities, and a shift inemployment from sectors covered by the wage

law to sectors not covered, including the un-derground economy. The employment effectsare typically the most pronounced in labormarkets for low-skilled youth.

In the case of a nationwide minimum wage,large numbers of firms will be affected, albeitby different amounts depending on the indus-try, region of the country, and other factors. Inaddition to the mandated cost increase pos-sibly causing employment reductions, a por-tion of the higher wage costs may be passedforward to consumers or backward to other

workers or suppliers of business inputs. Insome circumstances, firms may reduce workhours, such as with fixed employment costsand worker heterogeneity, but maintain head-count. The employment and hours workedmay also be affected by wage-related changesin employee productivity.

Other channels of adjustment in the com-petitive model besides employment reduc-tions include reduced job training, reductionsin worker benefits, the substitution of moreskilled labor for less-skilled labor, reduced

turnover and more selective hiring, and agreater ease in filling vacancies. If the mini-mum wage reduces profitability below thenormal level, the number of businesses andinvestment in affected industries may shrinkover time until normal returns are restored. Insum, the textbook competitive model assumesthat firms respond to minimum wage increas-

es by minimizing other production costs andby making various adjustments to offset thenegative effects on their bottom line.

Monopsony Model

Some economists think that some labormarkets may better approximate monopso-nies rather than being fully competitive, andtheir models of the minimum wage may pro-duce different results than the competitivemodels. A classic monopsony is a market withonly a few employers in a particular market-place. These firms have more market powerthan firms in competitive markets.

Since 1990 the monopsony model of labormarkets has increasingly been the focus of em-pirical minimum wage research. In newer or

dynamic versions of the monopsony model,it is labor market frictions related to hiring,turnover, search, and mobility costs on thesupply side that drive the model. Althoughthe particulars differ, the core componentsof monopsony models are an upward slopinglabor supply curve facing firms and some em-ployer discretion in wage setting.

Competitive and monopsony models of-fer different predictions about the employ-ment effects of minimum wage changes. Forminimum wage increases that push below-

competitive wages toward competitive levels,monopsony models predict employment and/or hours will rise rather than fall. However,minimum wage increases above competitivelevels will decrease employment, just as in thecompetitive model. The rise in employment inthe first case will also expand industry outputuntil the minimum wage equals the competi-tive wage and product prices should fall. In aclassic monopsony, profits fall and the firmsmay exit in the long run. In new monopsonymodels, savings from decreased turnover may

offset the profit effect. Unlike the competitivemodel, expenditures on general training mayincrease because the monopsony employercan capture some of the return.

While the results of monopsony models areinteresting, most economists dont think theresults are generally applicable because few low-wage employers are large enough to face an up-


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The mainfinding of

economic theoryand empirical

research over thepast 70 years isthat minimumwage increasestend to reduce

employment.

ward-sloping labor supply curve that typicallycharacterizes an entire labor market.15

Institutional ModelInstitutional (or behavioral) models of la-

bor markets were often used for evaluatingthe minimum wage up until the 1950s, butthis approach has gradually faded from use.The institutional model draws on the con-cepts in behavioral economics and emphasizes(1) the rejection of a well-defined downwardsloping labor demand curve, (2) the fact thatlabor markets are imperfectly competitive, in-stitutionally segmented, socially embedded,and prone to excess supply, and (3) the factthat technological and psychosocial factors infirms and internal labor markets are determi-

nants of cost and productivity.A key proposition of economists who fa-vor institutional labor market models is thatmoderate minimum wage increases may, in theshort-run, have either no employment effect ora small positive effect. The expected response ofemployers to a minimum wage increase is not tolay off workers but to search for ways to absorbthe cost impact by expanding sales, improvingservice, and general economic expansion. It isalso believed that costs from the minimumwage are partially offset by reducing organiza-

tional slack and improved productivity. Thatis achieved through tighter human resourcepractices (such as better scheduling), increasedperformance standards, increased work effort,and enhanced customer service. Costs that can-not be absorbed are passed on to customersthrough higher prices. The institutional modelalso predicts that a higher minimum wage leadsto a ripple effect in the internal wage structureas firms raise the pay of above-minimum wageemployees to maintain morale while still allow-ing for some internal wage compression among

employees with higher seniority.

The Effect of MinimumWages on Employment

Despite the use of different models to un-derstand the effects of minimum wages, all

economists agree that businesses will makechanges to adapt to the higher labor costsafter a minimum wage increase. Empiricalresearch seeks to determine what changes tovariables such as employment and prices firms

will make, and how large those changes will beThe higher costs will be passed on to someonein the long run; the only question is who. Theimportant thing for policymakers to remem-ber is that a decision to increase the minimumwage is not cost-free; someone has to pay for it

The main finding of economic theoryand empirical research over the past 70 yearsis that minimum wage increases tend to re-duce employment. The higher the minimumwage relative to competitive-market wagelevels, the greater the employment loss that

occurs. While minimum wages ostensiblyaim to improve the economic well-being ofthe working poor, the disemployment ef-fects of a minimum wages have been foundto fall disproportionately on the least skilledand on the most disadvantaged individualsincluding the disabled, youth, lower-skilledworkers, immigrants, and ethnic minori-ties.16 Based on his studies, Nobel laureateeconomist Milton Friedman observed: Thereal tragedy of minimum wage laws is thatthey are supported by well-meaning groups

who want to reduce poverty. But the peoplewho are hurt most by higher minimums arethe most poverty stricken.17

In a generally competitive labor marketemployers bid for the most productive work-ers and the resulting wage distribution reflectsthe productivity of those workers. If the gov-ernment imposes a minimum wage on the la-bor market, those workers whose productivityfalls below the minimum wage will find few,if any, employment opportunities. The basictheory of competitive labor markets predicts

that a minimum wage imposed above themarket wage rate will reduce employment.18

Evidence of employment loss has beenfound since the earliest implementation ofthe minimum wage. The U.S. Department ofLabors own assessment of the first 25-centminimum wage in 1938 found that it resultedin job losses for 30,000 to 50,000 workers, or


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The greatestadverse impactwill generallyoccur in the

poorer andlower-wageregions. Inthose regions,businesses haveto take moredramatic stepsto adjust to thehigher costs.

10 to 13 percent of the 300,000 covered work-ers who previously earned below the new wagefloor.19 It is important to note that the limitedindustries and occupations covered by the1938 FLSA accounted for only about 20 per-

cent of the 30 million private sector, nonfarm,nonsupervisory, production workers em-ployed in 1938. And of the roughly 6 millionworkers potentially covered by the law, onlyabout 5 percent earned an hourly rate belowthe new minimum.20

Following passage of the federal minimumwage in 1938, economists began to accumu-late statistical evidence on the effects. Muchof the research has indicated that increasesin the minimum wage have adverse effects onthe employment opportunities of low-skilled

workers.21

And across the country, the great-est adverse impact will generally occur in thepoorer and lower-wage regions. In those re-gions, more workers and businesses are af-fected by the mandated wage, and businesseshave to take more dramatic steps to adjust tothe higher costs.

As an example, with the original 1938 im-position of the minimum wage, the lower-in-come U.S. territory of Puerto Rico was severelyaffected. An estimated 120,000 workers inPuerto Rico lost their jobs within the first year

of implementation of the new 25-cent mini-mum wage, and the islands unemploymentrate soared to nearly 50 percent.22

Similar damaging effects were observedon American Samoa from minimum wageincreases imposed between 2007 and 2009. In-deed, the effects were so pronounced on the is-lands economy that President Obama signedinto law a bill postponing the minimum wageincreases scheduled for 2010 and 2011.23Concern over the scheduled 2012 increase of$.50 compelled Governor Togiola Tulafono

to testify before Congress: We are watchingour economy burn down. We know what todo to stop it. We need to bring the aggressivewage costs decreed by the Federal Governmentunder control. . . . Our job market is beingtorched. Our businesses are being depressed.Our hope for growth has been driven away.24

In 1977 ongoing debate about the mini-

mum wage prompted Congress to create aMinimum Wage Study Commission to helpit resolve the many controversial issues thathave surrounded the federal minimum wageand overtime requirement since their origin in

the Fair Labor Standards Act of 1938.

25

Thecommission published its report in May 1981,calling it the most exhaustive inquiry ever un-dertaken into the issues surrounding the Actsince its inception.26 The landmark reportincluded a wide variety of studies by a virtualwhos who of labor economists working inthe United States at the time.27

A review of the economic literature amassedby the Commission by Charles Brown, CurtisGilroy, and Andrew Kohen found that thetime-series studies typically find that a 10

percent increase in the minimum wage re-duces teenage employment by one to threepercent.28 This range subsequently came tobe thought of as the consensus view of econo-mists on the employment effects of the mini-mum wage.

It is important to note that different aca-demic studies on the minimum wage mayexamine different regions, industries, or typesof workers. In each case, different effects maypredominate. A federal minimum wage in-crease will impose a different impact on the

fast-food restaurant industry than the defensecontractor industry, and a different effect onlower-cost Alabama than higher-cost Manhat-tan. This is why scholarly reviews of many aca-demic studies are important.

In 2006 David Neumark and WilliamWascher published a comprehensive review ofmore than 100 minimum wage studies pub-lished since the 1990s.29 They found a widerrange of estimates of the effects of the mini-mum wage on employment than the 1982 re-view by Brown, Gilroy, and Kohen. The 2006

review found that although the wide rangeof estimates is striking, the oft-stated assertionthat the new minimum wage research fails tosupport the traditional view that the minimumwage reduces the employment of low-wageworkers is clearly incorrect. Indeed . . . the pre-ponderance of the evidence points to disem-ployment effects.30


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Some employerswill replace their

lowest-skilledworkers with

somewhat higher-skilled workers

in response toincreases in the

minimum wage.

Nearly two-thirds of the studies reviewedby Neumark and Wascher found a relativelyconsistent indication of negative employmenteffects of minimum wages, while only eightgave a relatively consistent indication of posi-

tive employment effects. Moreover, 85 percentof the most credible studies point to negativeemployment effects, and the studies that fo-cused on the least-skilled groups most likelyto be adversely affected by minimum wages,the evidence for disemployment effects wereespecially strong.

In contrast, there are very few, if any, stud-ies that provide convincing evidence of posi-tive employment effects of minimum wages.These few studies often use a monopsonymodel to explain these positive effects. But as

noted, most economists think such positive ef-fects are special cases and not generally appli-cable because few low-wage employers are bigenough to face an upward-sloping labor sup-ply curve as the monopsony model assumes.31

Other Effects ofMinimum Wages

Aside from changes in employment, em-pirical studies have documented other meth-

ods by which businesses and markets adjust tominimum wage increases. The congressionalJoint Economic Committee published a majorreview of 50 years of academic research on theminimum wage in 1995.32 The study founda wide range of direct and indirect effects ofincreased minimum wages that may occur.These include

Increasing the likelihood and durationof unemployment for low-wage work-ers, particularly during economic down-

turns; Encouraging employers to cut worker

training; Increasing job turnover; Discouraging part-time work and re-

ducing school attendance; Driving workers into uncovered jobs,

thus reducing wages in those sectors;

Encouraging employers to cut back onfringe benefits;

Encouraging employers to install laborsaving devices;

Increasing inflationary pressure;

Increasing teenage crime rates as a resultof higher unemployment; and Encouraging employers to hire illegal

aliens.33

Another channel of adjustment to minimum wage changes is labor-labor substitutionwithin businesses.34 Research finds that someemployers will replace their lowest-skilledworkers with somewhat higher-skilled work-ers in response to increases in the minimumwage. As a result, minimum wage increases

may harm the least skilled workers more thanis suggested by the net disemployment effectsestimated in many studies because more-skilled workers are replacing some less-skilledworkers. Nobel laureate economist Gary Becker has noted that this effect helps generate po-litical support from labor unions for higherminimum wages:

A rise in the minimum wage increasesthe demand for workers with greaterskills because it reduces competition

from low-skilled workers. This is animportant reason why unions havealways been strong supporters of highminimum wages because these reducethe competition faced by union mem-bers from the largely non-union work-ers who receive low wages.35

A 2011 study by Barry Hirsch and coauthorsfound yet further methods of business adjust-ment.36 Some firms partially offset increasesin the minimum wage by awarding smaller

than normal pay increases to their workerswho earn more than the minimum wage.Some firms try to increase worker productivityby requiring better attendance, insisting thatjob duties are completed faster, imposing ad-ditional tasks on workers, minimizing hoursworked with better scheduling, and terminat-ing poor performers more quickly.


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Evidence from alarge number of

academic studiesuggests thatminimum wageincreases dontreduce povertylevels.

A final method for businesses to respondto minimum wage increases is to try to pushforward the additional costs to consumers. Ifa minimum wage increase is imposed econo-mywide, it may be partly passed on in prices.

However, in a global economy, this is less likelyfor internationally traded goods because do-mestic producers facing higher labor costs willbe undercut by imports. So price effects maybe more prevalent in goods and services lesssubject to competition from imports.

In 2004 a comprehensive review of more than20 minimum wage studies looking at priceeffects found that a 10 percent increase in theU.S. minimum wage raises food prices by up to 4percent and overall prices by up to 0.4 percent.37A 2007 study from the Federal Reserve Bank of

Chicago found that restaurant prices unambigu-ously increase in response to minimum wageincreases.38And a 2011 study of quick-service res-taurants found that two-thirds of the minimumwage cost increases were offset by higher menuprices, and that higher prices rather than cuts inemployment and hours was the most importantchannel of adjustment for this type of firm.39

These results help to reconcile the few min-imum wage studies that do not find negativeemployment effects with the large majorityof studies that do. Economic theory suggests

that firms can respond to minimum wage in-creases by reducing employment, raising pric-es, or both. In the studies that find small or noemployment effects, it may be that the busi-nesses studied were able to pass on the addedcosts solely in higher prices. Indeed, the Feder-al Reserve study concluded that the results areconsistent with the small disemployment ef-fects found in some studies. Note finally thatempirical studies finding that minimum wageincreases affect prices in some cases is consis-tent with the competitive model of labor mar-

kets, but not with the monopsony model.40

The Effect of MinimumWages on Poverty

Proposals to increase the minimum wagecan be politically popular because they are

viewed as being a way of helping the poor.However, evidence from a large number ofacademic studies suggests that minimumwage increases dont reduce poverty levels.Some of the reasons include

Many poor Americans (63.5%) do notwork, and thus arent earning wages.41

Even among the working poor, therelationship between earning a lowhourly wage rate and living in pov-erty is weak and has become weakerover time. That is because most work-ers who gain from a minimum wageincrease live in nonpoor families andmost of the working poor already havewages above the required minimums.42

While an increase in the minimumwage will lift some families out of pov-erty, other low-skilled workers may losetheir jobs, which reduces their incomeand drops their families into poverty.43

If a minimum wage is partly or fullypassed through to consumers in theform of higher prices, it will hurt thepoor because they disproportionatelysuffer from price inflation.44

Relatively few poor households would ben-

efit from a minimum wage increase even ifthere were no negative employment or otheraffects. In the recent federal minimum wage in-crease from $5.15 to $7.25, only 15.8 percent ofthe workers who were expected to gain from itlived in poor households.45 In the current pro-posal to raise it to $9.50, only 11.3 percent ofthe workers who would gain live in poor house-holds.46 And of those who would gain, 63 per-cent are second or third earners living in house-holds with incomes twice the poverty line.

Since 1995, eight studies have examined

the income and poverty effects of minimumwage increases, and all but one have foundthat past minimum wage hikes had no ef-fect on poverty.47 One recent academic studyfound that both state and federal minimumwage increases between 2003 and 2007 had noeffect on state poverty rates.48 These studiesgenerally find that some low-skilled workers


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HarvardUniversitys Greg

Mankiw notes,The minimum

wage has itsgreatest impact

on the market forteenage labor.

living in poor families who remain employeddo see their incomes rise. However, other low-skilled workers lose their jobs or have theirwork hours substantially reduced, whichcauses income losses and increased poverty.

On net, some studies find that the families oflow-skilled workers and less-educated singlemothers are no better off and may be madeworse off by minimum wage hikes.49 The up-shot is that there is no free lunch to this sortof top-down mandated attempt at reducingpoverty.

What About the 1990s?

Proponents of the minimum wage often

point to the increase in U.S. employmentafter the 19961997 minimum wage hike asproof that mandating an increase does notdestroy jobs. The increase raised the mini-mum wage from $3.85 to $4.75 in 1996, andto $5.15 in 1997. Although the overall laborforce and U.S. economy did well in the late

1990s, the general improvement masked thenegative impact of the minimum wage in-crease on unskilled youth.

The 19961997 increase in the minimumwage did not have an observed effect on total

U.S. employment, which was growing rapidlyfrom the booming economy. However, whenwe look at the employment rate for teenagersit is a different story. Even in the rapidly grow-ing economy in the late 1990s, the employmentrate for teenagers was quite flat, and then it fellduring the 2000s, as shown in Figure 3.

In his best-selling economics textbook,Harvard Universitys Greg Mankiw notes:

The minimum wage has its greatestimpact on the market for teenage

labor. The equilibrium wages of teen-agers are low because teenagers areamong the least skilled and least expe-rienced members of the labor force. Inaddition, teenagers are often willingto accept a lower wage in exchange foron-the-job training. . . . As a result, the

Figure 3Effect of Minimum Wage Increases on Employment

Source: Author, based on U.S. Bureau of Labor Statistics data.

IndexofEmploymentRates,1988=100


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Milton Friedmanoted, Theminimumwage law ismost properlydescribed asa law sayingemployers mustdiscriminate

against peoplewho have lowskills.

minimum wage is more often bindingfor teenagers than for other membersof the labor force.50

In Figure 3, it is easier to see the effects

of minimum wage increases on teenage em-ployment during recessionary or stagnanteconomies, as occurred in the early 1990sand late 2000s. In those periods, teenage em-ployment levels fell more than employmentlevels for workers over the age of 25. Thisis consistent with the research by MarvinKosters and Finis Welch, which shows thatthe minimum wage hurts low-wage work-ers particularly during cyclical downturns.51During the 19901991 recession, the mini-mum wage increase at the time contributed

to the -6.5 percentage point decrease in theemployment rate for teenagers compared tothe -0.9 percentage point decline for adults.And during the 20082009 recession, theminimum wage increase contributed to the-8.9 percentage point decrease in the em-ployment rate for teenagers compared to the-3.9 percentage point decline for adults.

Conclusions

In the American economy, low wages areusually paid to entry-level workers, but thoseworkers usually do not earn these wages for ex-tended periods of time. Indeed, research indi-cates that nearly two-thirds of minimum wageworkers move above that wage within oneyear.52 For full-time minimum wage workers,research has found that the median first-yearraise is about 14 percent.53

While they are often low-paid, entry-leveljobs are vitally important for young and low-skill workers because they allow people to es-

tablish a track record, to learn skills, and toadvance over time to a better-paying job. Thus,in trying to fix a perceived problem with mini-mum wage laws, policymakers cause collateraldamage by reducing the number of entry-leveljobs. As Milton Friedman noted, The mini-mum wage law is most properly describedas a law saying employers must discriminate

against people who have low skills.54

Seventy years of empirical research general-ly finds that the higher the minimum wage in-crease is relative to the competitive wage level,the greater the loss in employment opportuni-

ties. A decision to increase the minimum wageis not cost-free; someone has to pay for it, andthe research shows that low-skill youth pay forit by losing their jobs, while consumers mayalso pay for it with higher prices. Moreover, ev-idence from a large number of academic stud-ies shows that, even if there were no negativeemployment or other affects, minimum wageincreases dont reduce poverty levels. Only11.3 percent of the workers who would gainfrom a recent proposal to increase the mini-mum wage to $9.50 an hour even live in poor

households.55

Some current proposals on Capitol Hill andat the state level to raise minimum wages couldnot come at a worse time. In June, the unem-ployment rate for teenagers is 24.9 percent, andthis groups employment rate is near its recordlow of 25.4 percent. For minority youth the sit-uation is even worse. The unemployment ratefor minority teenagers is 38.2 percent, and theemployment rate is just 15.5 percent.

In these tough economic conditions, em-ployers are simply not going to hire workers

whose labor produces less than the cost ofhiring them. Employers will not pay $8.25 anhour to hire a worker whose hourly effortsbring in $7.25. A higher minimum wage willprice even more low-skilled individuals out ofa job. Although a small share of workers willget a raise, others will lose opportunities foremployment. Minimum wages generally dontdistribute income to workers from employers,but to a small group of lucky workers from theunlucky workers who lose jobs.

Rather than pursuing policies such as mini-

mum wage increases that create winners and los-ers, policymakers should focus on policies thatgenerate faster economic growth to benefit allworkers. While minimum wages may be a well-meaning attempt to help workers, economic re-search clearly shows that somebody must pay theprice for any increase, and it is usually the leastskilled and least fortunate among us.


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12

Notes1. Finis Welch, Minimum Wages: Issues andEvidence, American Enterprise Institute, 1978.

2. The self-employed are the largest group of

workers not covered by the Fair Labor StandardsAct, followed by federal employees and certaintransportation employees.

3. Fair Labor Standards Act, 29 USC 218(a).

4. U.S. Department of Labor, Wage and Hour Divi-sion, Minimum Wage Laws in the States January 1,2012, www.dol.gov/whd/minwage/america.htm.

5. The federal minimum wage is not indexed forinflation.

6. Bureau of Labor Statistics, Characteristicsof Minimum Wage Workers: 2010, February 25,2011, www.bls.gov/cps/minwage2010.pdf.

7. Authors analysis of the Bureau of Labor Sta-tistics Current Population Survey data for March2010.

8. Ibid.

9. A minor exception is the 90-day trainingwage of $4.25 per hour allowed for youth under age20. After the 90-day period, youth must be paid thefull minimum wage.

10. Authors analysis of the Bureau of Labor Sta-

tistics Current Population Survey data for March2010.

11. Ibid.

12. Ibid.

13. Ibid.

14. Ibid.

15. Madeline Zavodny, Why Minimum WageHikes May Not Reduce Employment, FederalReserve Bank of Atlanta, Economic Review, SecondQuarter 1998.

16. Standard economic theory predicts that mini-mum wage increases do not reduce profits becauselow wage firms are usually too small and too compet-itive to absorb the extra costs. It is then not surprisingthat empirical evidence is scanty on profit effects.Sara Lemos, The Effect of the Minimum Wage onPrices, Institute for the Study of Labor (Germany),Discussion Paper no. 1072, March 2004.

17. Milton Friedman, quoted in Keith B. Leffler,

Minimum Wages, Welfare, and Wealth Transfersto the Poor,Journal of Law and Economics 21, no. 2(October 1978): 34558.

18. Randall K. Filer, Daniel S. Hamermesh, andAlbert E. Rees, The Economics of Work and Pay (NewYork: HarperCollins, 1996).

19. Thomas Rustici, A Public Choice View ofthe Minimum Wage, Cato Journal5, no. 1 (Spring-Summer 1985): 10331. Rustici points out that theDOLs estimates of job losses were likely too lowHe cites reports that in Texas alone the impositionof the minimum wage dislocated 40,000 workersfrom pecan-shelling plants. The introduction ofmechanical pecan- shelling equipment, which re-placed manual shelling, closely followed the imple-mentation of the minimum wage, despite the factthat the automated process produced a lower qual-ity product (more broken nuts and shell pieces).

20. The total labor force in 1938 was about 54million, including agricultural, self-employed, gov-ernment, professional, administrative, and mana-gerial workers, as well as unemployed persons.

21. Robert S. Goldfarb, The Policy Content oQuantitative Minimum Wage Research, Proceed-ings of the Industrial Relations Research Associa-tion, 27th Annual Meeting, San Francisco, Decem-ber 2829, 1974.

22. Rustici, pp. 10331.

23. Public Law 111-244, September 30, 2010.

24. Governor Togiola Tulafono, testimony beforethe Subcommittee on Fisheries, Wildlife, Oceansand Insular Affairs, House Committee on NaturalResources, The Impact of Minimum Wage In-creases on American Samoa, September 23, 2011.

25. Minimum Wage Study Commission,Report ofthe Minimum Wage Study Commission (WashingtonGovernment Printing Office, 1981), vol. 1, p. xiii.

26. Ibid., letter of transmittal.

27. David Neumark and William L. Wascher,Minimum Wages (Cambridge, MA: MIT Press, 2008).

28. Charles Brown, Curtis Gilroy, and AndrewKohen, The Effect of the Minimum Wage onEmployment and Unemployment, Journal of Economic Literature 20, no. 2 (June 1982): 487528. Thisresearch survey was a substantial revision of theprevious work the authors conducted for the Mini-mum Wage Study Commission.

29. David Neumark and William WascherMinimum Wages and Employment: A Reviewof Evidence from the New Minimum Wage Re-


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13

search, National Bureau of Economic Research,Working Paper no. 12663, November 2006.

30. Ibid.

31. Zavodny.

32. Joint Economic Committee, 50 Years of Re-search on the Minimum Wage, February 15, 1995,http://web.archive.org/web/20110629183749/http://www.house.gov/jec/cost-gov/regs/minimum/50years.htm.

33. Joint Economic Committee, 50 Years of Re-search on the Minimum Wage, February 15, 1995,http://web.archive.org/web/20110629183749/http://www.house.gov/jec/cost-gov/regs/minimum/50years.htm.

34. Ibid.

35. Gary Becker, On Raising the Federal MinimumWage, November 26, 2006, www.becker-posner-blog.com.

36. Barry T. Hirsch, Bruce E. Kaufman, and TetyanaZelenska, Minimum Wage Channels of Adjust-ment, Institute for the Study of Labor (Germany),Discussion Paper no. 6132, November 2011.

37. Lemos.

38. Daniel Aaronson, Eric French, and James Mac-Donald, The Minimum Wage, Restaurant Prices,and Labor Market Structure, Federal Reserve Bankof Chicago, WP 2004-21, rev. August 3, 2007.

39. Hirsch, Kaufman, and Zelenska.

40. Daniel Aaronson and Eric French, OutputPrices and the Minimum Wage, Employment Pol-icies Institute, June 2006.

41. Authors analysis of the Bureau of Labor Statis-tics Current Population Survey data for March 2010.

42. Richard V. Burkhauser and Joseph J. Sabia.The Effectiveness of Minimum Wage Increases inReducing Poverty: Past, Present, and Future, Con-temporary Economic Policy 25, no. 2 (April 2007).

43. Richard V. Burkhauser and Joseph J. Sabia,Minimum Wages and Poverty: Will a $9.50 Fed-eral Minimum Wage Really Help the WorkingPoor? Southern Economic Journal77, no. 3 (January2010).

44. Lemos.

45. Ibid.

46. Ibid.

47. Ibid.

48. Ibid.

49. Ibid. See also Richard Vedder and Lowell Gal-laway, Does the Minimum Wage Reduce Poverty?Employment Policies Institute, June 2001; Jill Jen-kins, Minimum Wages: The Poor Are Not Win-ners, Employment Policy Foundation, January 12,2000; and Ronald B. Mincy, Raising the MinimumWage: Effects on Family Poverty,Monthly Labor Re-view 113, no. 7 (July 1990).

50. Mankiw quotes from his textbook at GregMankiw, The Minimum Wage Debate, April 23,2006, http://gregmankiw.blogspot.com.

51. Marvin Kosters and Finis Welch, The Effectsof Minimum Wages on the Distribution of Chang-es in Aggregate Employment, American Economic

Review 62, no. 3 (June 1972): 32332. See also FinisWelch, Minimum Wage Legislation in the Unit-ed States, Economic Inquiry 12, no. 3 (September1974): 285318.

52. William Even and David Macpherson, RisingAbove the Minimum Wage, Employment PoliciesInstitute, January 2000.

53. Ibid.

54. Interview with Milton Friedman, Living withinOur Means, Richard Heffners Open Mind, Decem-ber 7, 1975, www.thirteen.org/openmind/public-affairs/living-within-our-means/494/.

55. Burkhauser and Sabia, Minimum Wagesand Poverty.


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The Negative Effects of Minimum Wage Laws, Cato Policy Analysis No. 701

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