The minimum wage-employment debate …. again

By Paul Walker 23/01/2013

Debates about the economic effects and the merits of the minimum wage date back at least as far as the introduction of minimum wages. In a 2008 book “Minimum Wages” by David Neumark and William Wascher it is concluded that,

“… [M]inimum wages reduce employment opportunities for less-skilled workers, especially those who are most directly affected by the minimum wage”.

In the last couple of years two studies have appeared that question the empirical methods and conclusions in much of the recent literature (Allegretto et al., 2011; Dube et al., 2010). Dube et al. (2010, hereafter DLR) and Allegretto et al. (2011, hereafter ADR) have put forward a severe critique of the state panel-data approach, including the work discussed at length in Neumark and Wascher (2008). The essence of the argument in DLR and ADR is summarized in a review of “Minimum Wages” by Dube which draws heavily on the findings from the two papers he co-authored:

” … [V]ariation over the past two decades in minimum wages has been highly selective spatially, and employment trends for low-wage workers vary substantially across states … This has tended to produce a spurious negative relationship between the minimum wage and employment for low wage workers – be it for sectors such as restaurant and retail or for demographic groups such as teenagers”

ADR argue without reservation that their results overturn the conclusion that minimum wages reduce employment of low-skilled workers:

“Interpretations of the quality and nature of the evidence in the existing minimum wage literature … must be revised substantially. Put simply, our findings indicate that minimum wage increases – in the range that have been implemented in the United States – do not reduce employment among teens” (ADR, 2011, p. 238).

Similarly, DLR conclude that there are

“no detectable employment losses from the kind of minimum wage increases we have seen in the United States” (DLR, 2010, p. 962).

Now there is a new NBER working paper, Revisiting the Minimum Wage-Employment Debate: Throwing Out the Baby with the Bathwater? by David Neumark, J.M. Ian Salas, and William Wascher, NBER Working Paper No. 18681, January 2013, that sets out to evaluate this new research because of the strong challenge it poses to the large body of prior research that found that minimum wages reduce employment of low skilled workers.

Neumark, Salas and Wascher note that

[ … ] the central element of this new research is the issue of how to construct counterfactuals for the places where minimum wages are increased. The authors of both studies argue that one must compare places that are geographically proximate to have valid controls, because, according to them, minimum wage changes are correlated with unobserved economic shocks to areas that can confound the estimation of minimum wage effects. Consequently, much of the analysis focuses on the validity of this criticism, and on the approaches these studies take to address this potential problem. The overriding concern we have with these studies is that their research designs, out of concerns about avoiding minimum wage variation that is potentially confounded with other sources of employment change, discard a great deal of valid identifying information – throwing out the identifying “baby” along with, or worse yet instead of, the contaminated bathwater.” Our findings, in a nutshell, indicate that neither the conclusions of these studies nor the methods they use are supported by the data.

In part the conclusions reached are

Throughout the long-running debate about the employment effects of minimum wages, the empirical evidence has focused on similar questions: How does a minimum wage affect employment? Which workers are affected? And how do we ensure that we are getting a valid comparison that isolates the effect of the minimum wage?

Given the ongoing ebb and flow of this debate, it would have been shortsighted to think that the 2008 book that two of us wrote (Neumark and Wascher, 2008), despite surveying a massive amount of evidence, would have settled the issue. And indeed it has not. In particular, echoing long-standing concerns in the minimum wage literature, Dube et al. (2010) and Allegretto et al. (2011) attempt to construct better counterfactuals for estimating how minimum wages affect employment. When they narrow the source of identifying variation – looking either at deviations around state-specific linear trends or at within-region or within-county-pair variation – they find no effects of minimum wages on employment, rather than negative effects. Based on this evidence, they argue that the negative employment effects for low-skilled workers found in the literature are spurious, and generated by other differences across geographic areas that were not adequately controlled for by researchers.

Our analysis suggests, however, that their methods are flawed and lead to incorrect conclusions. In particular, neither study makes a compelling argument that its methods isolate more reliable identifying information (i.e., a better counterfactual). In one case – the issue of state-specific trends – we explicitly demonstrate the problem with their methods and show how more appropriate ways of controlling for unobserved trends that affect teen employment lead to evidence of disemployment effects that is similar to that reported in past studies. In the other case – identifying minimum wage effects from the variation within Census divisions or, even more narrowly, within contiguous cross-border county pairs – we show that the exclusion of other regions or counties as potential controls is not supported by the data.

We think the central question to ask is whether, out of their concern for avoiding minimum wage variation that is potentially confounded with other sources of employment change, ADR and DLR have thrown out so much useful and potentially valid identifying information that their estimates are uninformative or invalid. That is, have they thrown out the “baby” along with – or worse yet, instead of – the contaminated “bathwater”? Our analysis suggests they have. Moreover, despite the claims made by ADR and DLR, the evidence that their approaches provide more compelling identifying information than the standard panel data estimates that they criticize is weak or non-existent.

In addition, when the identifying variation they use is supported by the data, the evidence is consistent with past findings of disemployment effects. Thus, our analysis substantially undermines the strong conclusions that ADR and DLR draw – that there are “no detectable employment losses from the kind of minimum wage increases we have seen in the United States” (DLR, 2010, p. 962), and that “Interpretations of the quality and nature of the evidence in the existing minimum wage literature …, must be revised substantially” (ADR, 2011, p. 238).

Can one come up with a dataset and an econometric specification of the effects of minimum wages on teen and low-skilled employment that does not yield disemployment effects? As in the earlier literature, the answer is yes. But prior to concluding that one has overturned a literature based on a vast number of studies, one has to make a much stronger case that the data and methods that yield this answer are more believable than the established research literature, and convincingly demonstrate why the studies in that literature generated misleading evidence. Our analysis indicates that the studies by Allegretto et al. (2011) and Dube et al. (2010) fail to meet these standards. Based on this evidence, we continue to believe that the empirical evidence indicates that minimum wages pose a tradeoff of higher wages for some against job losses for others, and that policymakers need to bear this tradeoff in mind when making decisions about increasing the minimum wage.

So the standard results still stand, but given the nature of the debate you can be sure that this is not the last we have heard of this topic.

  • Allegretto, Sylvia A., Arindrajit Dube, and Michael Reich. 2011. “Do Minimum Wages Really Reduce Teen Employment? Accounting for Heterogeneity and Selectivity in State Panel Data.” Industrial Relations, Vol. 50, No. 2, April, pp. 205-240.
  • Dube, Arindrajit, T. William Lester, and Michael Reich. 2010. “Minimum Wage Effects Across State Borders: Estimates Using Contiguous Counties.” Review of Economics and Statistics, Vol. 92, No. 4, November, pp. 945-64.
  • Neumark, David, and William L. Wascher. 2008. Minimum Wages. Cambridge, MA: MIT Press.