Economics Update (July-September 1998)

Considering Minimum Wage Increases and Employment

C onventional wisdom among economists holds that increases in the minimum wage lower employment among low-wage workers. Recent research, however, has found that minimum wage hikes may not have any affect on employment. Policymakers who support raising the wage floor may accept findings that minimum wage increases do not adversely affect employment. Critics, though, have charged that these studies use poor data or incorrect methodologies. Some economists also argue that no convincing theoretical model predicts that minimum wage increases do not reduce employment.

In an article in the Atlanta Fed's Economic Review (Second Quarter 1998), economist Madeline Zavodny describes and evaluates several models that may explain controversial recent findings and proposes avenues for future research that would help determine whether these models are valid.

Two of the models Zavodny outlines seem unlikely to explain why minimum wage increases do not reduce employment. One, the price effects model, states that a decline in a firm's employment induced by a minimum wage increase will be at least partially offset by an increase in employment that occurs when the product price rises. The second model, traditional monopsony, or single buyer markets, predicts that minimum wages can raise employment over a limited range.

But Zavodny examines three other models that seem more promising. The substitution model posits that employers replace lower-skilled workers with higher-skilled workers when the minimum wage increases. The dynamic monopsony model suggests that workers have imperfect information about the job opportunities offered by different firms. The endogeneity hypothesis suggests that the level of the minimum wage may depend on the expected effect on employment. While these three models may explain why employment does not appear to fall when the minimum wage increases, Zavodny observes that further research is needed to determine the validity of each model.

The author notes that employment may not be the only area worthy of further research on the effects of minimum wage increases. She argues that the distributional consequences of minimum wage increases are at least as important as the employment effects, particularly if higher-skilled workers displace lower-skilled workers when the minimum wage rises. Minimum wage increases may also slow the rate of small business formation, a possibility that has not received much attention in the economics literature.

Zavodny concludes that recent findings should be taken as the starting point for a larger examination of the effects of the minimum wage level rather than an end to the debate.

Return to Index