Econ 539 - Public Policy Analysis: Minimum Wages, Part 2

Quite a while ago now, a 'friend-of-the-blog' in the restaurant industry e-mailed to ask about what I thought of the relatively high minimum wage in Oregon and the additional aspect of Oregon's minimum wage that it cannot be reduced for those that earn tips.  California and Washington also have high minimum wages and do not allow for a 'tip credit,' of this sort so we are not alone, but these are three of eight total states (that I was able to determine) that do not allow credit for tips.

The question was essentially, what did I think of the effect on unemployment in Oregon and what did I think of the specific impact on the restaurant industry?  I punted on the question at the time as it required too much time to read up on the literature just for the purposes of the blog which is, after all, not my real job.  But happily my real job has converged with the blog and doing a week on minimum wages in Public Policy Analysis required my familiarity with the literature and I have learned a few things.  Not enough to synthesize into a strong opinion, but enough to list some empirical evidence of the impact of minimum wages:

1.  Minimum wages, if they are designed to combat poverty are a pretty poor way to do so.

This table, from a Congressional Budget Office report on the effectiveness of the minimum wage relative to an expansion of the Earned Income Tax Credit (EITC), shows that just $1.6 billion of almost $11 billion would go to households classified as below the poverty line.

To get virtually the same amount of money going to impoverished households, you could do a $2.4 billion expansion of the EITC.

Why is it so bad as an anti-poverty measure?  Well, it didn't used to be, but it turns out that a very small fraction of impoverished households (or those within double the poverty line) actually work for the minimum wage.

Here is a table from a report done by Burkhauser and others in 2005:

From this table you can see how the persons making the minimum wage have evolved through time and now (or by 2003 at least) few of the households in or near poverty rely on a minimum wage job.  More and more, minimum wage earners are teenagers and part-timers. Which brings me to my next observation:

2. Minimum wages may distort the incentives for kids to invest in education.  By raising the opportunity cost of schooling, kids may be induced to leave school and not continue their education.  In fact Neumark and Wascher (AER 1995) have found such effects.  They find that minimum wages "...increase the probability that teenagers leave school to become employed or work more hours, and they increase the probability that teenagers leave school to become non-employed or non-enrolled."

3. But what about the big question of minimum wages and unemployment?  The evidence is decidedly mixed and the effects appear to be small, with a preponderance of the evidence suggesting an elasticity of teen workers at about -0.2 (though some notable studies even find positive employment effects, like the famous Card and Krueger 1994 AER paper).  However, many have pointed out that studies that fail to find any effect are unlikely to be published leading to a type of bias.  Given this, most studies of the effectiveness of the minimum wage (like the CBO one above) go with the zero employment affect assumption.

4. As for restaurants and the minimum wage: Oregon is already the second highest minimum wage state in the nation and added to that we have a no tip allowance so it is likely that we pay more for our restaurant food and that we have fewer restaurants than we would have in absence of a minimum wage.  Empirical evidence has found the minimum wage-price link to be strong.  This, of course (from the law of demand), means that we probably have fewer restaurant jobs than we would have in the absence of a minimum wage, but it does not mean we have lower employment overall, as well-paid restaurant employees spend their income as well and the net effect is, as mentioned above, a matter of some debate.

5. The last observation I have is that the big question to which their seems to be no good evidence is if states with relatively high minimum wages suffer higher unemployment and lower growth because of their minimum wages.  This is a very tricky empirical puzzle to solve so it does not surprise me that there is a lack of convincing evidence, but it would be extremely useful to know.  In other words, the graph I made for my last minimum wage post is really totally meaningless as far as a causal link goes.

My conclusion is that for me the main rationale for a minimum wage is to provide a 'living wage' - meaning to fight poverty - and that I think it is not a particularly effective way to do so, the EITC is much better, for example.  The minimum wage does, however, have the advantage of being practically costless to administer, while the EITC does not.  Still, from my perspective, if I were to think about further expansion, I would go for the EITC before the minimum wage.