Friday, October 10, 2014

Raising the floor: The impact on employment

The effects of raising the minimum wage on employment

The conventional analysis of raising the minimum wage, to put it simply, (I am not an economist) states that there are two long-term effects on employment from raising the minimum wage. The first is known as the scale effect.  The scale effect is the one oft cited by critics of minimum wage hikes, albeit, they do not call it that. Essentially, higher wages raise the costs to businesses and the businesses pass this higher cost to consumers.  Due to the higher prices, consumers will buy less from the business and so there is less of a need to hire more workers. This has the effect of both raising consumer prices and decreasing employment among both low and high income workers.
The other long-term effect is known as the substitution effect. The substitution effect is where the cost of low-wage workers are increased compared to machines, technology, and more productive higher-wage workers.  To offset the costs, the business will shift to more machines, more technology, and try to increase productivity of higher-wage workers.  With this effect, you would not see a dramatic increase in price but you would see lower employment of low-wage workers but an increase of higher-wage workers.

As the CBO points out, though, conventional analysis might not be correct in all circumstances.  After an increase in the minimum wage, employers need to increase the pay to retain their original workers regardless of if new employees are hired.  Since the cost of hiring new employees as decreased there are some economists that argue that this will lead to increased employment.  In addition to that, an increase in the minimum wage could increase employment by raising the demand for goods and services.  A higher minimum wage tends to shift income from higher-wage employees and business owners to low-wage workers. Low-wage workers are more likely to spend a larger portion of their income on goods and services which would increase employment for low-wage workers and higher-wage workers alike.  As the CBO notes, “[this] effect is larger when the economy is weaker, and it is larger in regions of the country where the economy is weaker.” 

A raise in the minimum wage would not only affect those wage-earners who earn the minimum wage but also though who earn slightly more than the minimum wage.  This should be a self-evident point but it’s often forgotten. Employers may also increase pay to keep pay differentials between positions consistent.  Some positions that are collectively bargained are tied to the federal minimum wage and those positions may see a pay increase, as well. 

Employers whose businesses are more sensitive to price increases are more likely to see a higher decrease in employment than businesses that do not face this challenge.  Employers who cannot follow the substitution effect by replacing low wage workers with technology, machines, or more productive higher-wage earners are also more likely to decrease their employment in greater numbers.  Finally, businesses that rely heavily on low-income wage earners may see a decrease in their employment numbers.  Of course, they might not, if there are fewer jobs available for low-income wage earners, they may increase their productivity and that reaction combined with the lower cost of hiring new applicants, there might be a slight increase in employment or at least a net zero gain in employment. Finally, employers that do not employ very many low-wage employees that compete against employers that do employ many low-wage employees will see demand rise as the costs rise at the employers with many low-wage employees. These employers tend to hire more low-wage workers, boosting employment.  This last example portends well for Costco compared to Wal-Mart. We may yet have a law school at Costco.

For higher-wage workers, there is some good news for employment prospects according to the CBO.  Once the minimum wage stabilizes, higher-wage employees are slightly less expensive to hire.  Employers noticing that they can hire higher-wage employees to replace less productive low-wage employees for just a little bit more will hire more higher-wage workers.  This combined with the increased demand will increase employment for higher-wage workers. 

The CBO’s central estimate found that raising the minimum wage would reduce employment by 500,000 workers.  The CBO points out that is “the net result of two effects: a slightly larger decrease in jobs for low-wage workers (because of their higher cost) and an increase of a few tens of thousands of jobs for other workers (because of greater demand for goods and services).”  Those who would lose their jobs would center on those making less than $10.10 per hour currently. Workers earning between $10.10 and $11.50 per hour may see a pay raise which could reduce their employment but employers may hire more of those employees to make up for those workers who were scheduled to make less than $10.10 per hour.  The CBO believes that the “number of such workers who were employed would probably not change significantly.”  The analysis by the CBO found that there is a two-thirds chance that the employment would be reduced between a slight reduction and a decrease of 1.0 million workers.  

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