Card and Krueger's paper (AER 1994, "Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania") uses a difference-in-difference identification strategy to identify the causal effect of a minimum wage increase on unemployment. (A summary can be found here.) The main finding was that the increase in the minimum wage had a negligible or even non-existent effect of employment. There have been several criticisms to the paper---including criticizing the quality of the data or the fact that employers might have anticipated the change.

My question is, what are the main economic explanations for why employment did not significantly fall? What other evidence could be used to test these explanations?

  • In an interview, David Card said that their argument wasn't about "the minimum wage increases employment", but rather why did they get this paradoxical results (measurement errors, etc.). That is, you and them ask the same question. – Anton Tarasenko Nov 29 '14 at 7:25
  • How much of the increases wages spend on Fast-Food? – Ian Ringrose Dec 30 '14 at 14:16

Isaac Sorkin, a grad student at Michigan, has addressed this. Here is Miles Kimball blogging it, link. Main argument there is that previous work measures short run elasticities, which are less responsive than in the long run. You can surely find more by checking Sorkin's citations.

To the extent that there is an economic explanation for their findings, it's something along the lines of costs of changing prices and employment are large enough relative to the increase in the minimum wage observed that producers choose instead to take a large amount of the cost of minimum wage increases on themselves. The alternatives would be 1) they decrease employment 2) they increase prices 3) they close branches or reduce entry. None of that seems to have happened.

I think Pburg is right that one possible bone to pick with this result is that the short run response is not representative of the possible long run reaction. Another possibility is that the increase in the minimum wage was too small. \$4.25 to \$5.05 (the increase they observe) is very different from \$7.25 to \$10.10. This is my where my concerns would lie.

It's possible there were also confounding legal changes, which would violate the parallel trends assumption, but I find this less plausible.

First, we need to assume that the minimum wage is an "effective constraint", i.e. that in the cases examined people are paid the minimum wage. I guess this holds.

Second, the negative relation between demand for labor (for the services sold by workers) and wage (its price), depends on an assumption of a smooth such relation. In turn, such a smooth relation depends on substitutability of factors of production: in order to decrease labor employed, one needs to increase capital employed (if it has no reason to alter the production level).

Is it the case that the services offered by minimum wage workers in the study mentioned, could be readily substituted by capital? If not, here is one explanation.

Another way for a firm to respond to a minimum wage increase, is to try to increase the intensity of work, so it could fire people and maintain essentially the same level of services with fewer workers that are paid the higher minimum wage, keeping the total cost the same.

Is it the case that minimum wage workers in the study mentioned worked with some slack, and there was still room to press them to work harder? If not, here is another explanation.

So it may be the case, that the firms have done their "profit making job excellently", and have managed to have the lowest operationally possible level of labor, by extracting full efficiency from it, but also from the point of view of factors substitution capabilities... and then came the minimum wage increase. The firms simply had no options, (at least in the short run), than, perhaps, to pass the cost over to consumers, or live with lower profits, because they were already operating at their efficiency frontier with the minimum feasible amount of labor.

In such a case, the minimum-wage increase has a pure income-redistribution effect.

No one else has mentioned another possible explanation: that there was an increasing labor shortage in New Jersey at the time of the minimum wage increase. This caused minimum wage employment to increase. This was not a result of the minimum wage increase but of the demand increase. I.e. the demand curve moved up and to the right. This caused the intersection with the supply curve to move up and to the right as well (the supply curve itself did not change, only the intersection with the demand curve).

Another possibility is that people were switching from lower wage Pennsylvania jobs to higher wage New Jersey jobs. This would cause employment to fall in Pennsylvania relative to New Jersey. The Card and Krueger study would not have caught this, as they surveyed managers not employees. This would explain why the differential went in a different direction than expected.

In support of either or both of these hypotheses, when the subsequent federal minimum wage increased such that New Jersey and Pennsylvania had the same minimum wage, there was no repeat of the increase shown in the original study. This is consistent with the first hypothesis that there was a special occasion at the time of the first increase. It is also consistent with the second hypothesis, since there would be no need to move to get the better wage. The study is discussed on Wikipedia.

  • I'm having a hard time understanding your first explanation. Can you describe/post a picture of what's happening in the supply and demand picture? You aren't describing an increase in demand--you're talking about labor supply. – Pburg Nov 19 '14 at 22:22
  • @Pburg Is this any better? – Brythan Nov 19 '14 at 22:34
  • Ah sorry, I thought you were saying the increase of people looking for min wage jobs was the demand shift. Now I see you are just positing an accompanied change in demand. – Pburg Nov 19 '14 at 22:37

Not a serious answer, but these two incendiary quotes were by two Nobel laureates (Wall Street Journal, 25th April, 1996) and so perhaps worth listing here.

James Buchanan:

The inverse relationship between quantity demanded and price is the core proposition in economic science, which embodies the presupposition that human choice behavior is sufficiently rational to allow predictions to be made. Just as no physicist would claim that "water runs uphill," no self-respecting economist would claim that increases in the minimum wage increase employment. Such a claim, if seriously advanced, becomes equivalent to a denial that there is even minimal scientific content in economics, and that, in consequence, economists can do nothing but write as advocates for ideological interests. Fortunately, only a handful of economists are willing to throw over the teaching of two centuries; we have not yet become a bevy of camp-following whores.

Merton Miller:

Years ago, economists used to believe there was no such thing as a free lunch. Some now seem to have found one, however, in the proposed increase in the minimum wage. Raising the minimum wage by law above its market determined equilibrium, they argue, actually costs nobody anything. (Or at worst, costs nobody very much because it's only a small, marginal increment, after all.) Is all this too good to be true? Damn right. But it sure plays well in the opinion polls. I tremble for my profession.

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