Does Raising the Minimum Wage Increase Unemployment?

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Conventional wisdom holds that instituting or raising the minimum wage will increase unemployment. But a recent paper by Jeremy Magruder, an economist at Berkeley, finds the opposite effect. Magruder examines the case of Indonesia in the 1990s, “where real minimum wages rose rapidly in a varied way and then dropped quickly with the inflation rate in the South East Asian financial crash.” Here’s an excerpt:

When minimum wages rose in one district relative to their neighbors, that district observed an increase in formal sector employment and a decrease in informal employment. It also observed an increase in local expenditures, which is consistent with the hypothesized mechanism of the big push: that local product demand increases labor demand. Moreover, this increase was only observed in local industries which can be industrialized and do supply local demand, supporting the model further. Tradable manufacturing firms saw no growth in employment, and un-tradable, but non-industrializable services saw an increase in informal employment.

Of course, few modern-day economists argue that an increase in the minimum wage will actually create jobs in America, and such policies failed dismally during the Great Depression. Magruder explains why the policy may have worked in Indonesia, but not in Depression-era America:

One, as a less-developed country receiving substantial foreign investment, Indonesia may have had new access to potential, unadopted, and profitable technologies that simply needed a market. A second is that much of the 1990s were a time of growth in Indonesia, when sticky wages may have limited wage growth (the opposite of conditions in the depression). Finally, Harrison and Scorce (2010) show that anti-sweatshop activism also raised labor standards in foreign firms without an accompanying drop in employment. This indicates that wages may have indeed been below marginal products in the 1990s, reducing coordination and creating an opening for policy.

(HT: Chris Blattman)

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  1. jonathan says:

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    • frankenduf says:

      yeah, i agree- any statement beginning with, “of course, few modern-day economists argue…” is a rhetorical cover for lack of substance- bottom line is that poor people spend $ when they get it, and the minimum wage simply redistributes wealth downward after it has been redistributed upward by the exploitation of labor to increase profits

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      • Nick says:

        While I agree that increasing wages on the poorest will yield “stimulation” of the economy, as they’re the most likely to spend every next dollar they’re paid (whereas the comfortable would more likely sock it away), here we run into a diseconomy of thrift: if one firm increases wages, it becomes less competitive, even if it’s accomplishing an admirable social and macroeconomic goal, all things equal.

        I guess that’s what we meant by talking about the “minimum wage,” ie the lowest wage permissible by the government.

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  2. Greg says:

    Apples and oranges. No comparison at all, really, and not controlled for the other variables like inflation. Pretty disappointed, usually freakanomics does better.

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  3. Min says:

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    • Rob says:

      Every academic study you have looked at? Do you look at academic studies on this subject with your eyes closed? I mean, seriously. This is one of the most widely studied issues by economists, and there are literally dozens of studies showings its negative effects on employment, especially among teens and African-Americans. At best, the overall research is inconclusive.

      No matter what, employers can not afford to employ people when they have to pay them a wage that exceeds the value of their output. If a person was producing $6 an hour in output and now they have to pay them $8, it won’t be long before the person is either forced to increase their output or they will be fired (or else the company just shuts down completely).

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      • Vince Skolny says:

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      • criolle johnny says:

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    • Nick says:

      I’ve heard one must test assumptions by going to extremes in moral questions; maybe it’ll work for economic ones as well:

      If you’re paying 1 worker $10/hr to make $200/hr of merchandise from $10/hr of materials, you’re generating $200 in sales for every $20 you spend on inputs: $180/hr profit.

      If you’re paying 1 worker $100/hr to make $200/hr of merchandise from $10/hr of materials, you’re generating $200 in sales for every $110 you spend on inputs: $90/hr profit.

      Now, *there’s the human interest side of paying someone a wage on which they can actually live*, but there are upper limits. However, if the worker were instead a machine, no boss would hesitate to reduce costs by 90% if they could, and still produce the same product. Profits aren’t a given in business, they’re the product of many decisions and much work.

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  4. Randall Hoven says:

    It should say something that a guy has to focus on Indonesia in the 90s to find what he’s looking for. Not enough US data? How about American Samoa?

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  5. Elena says:

    In a place like Indonesia where there is such a large informal sector, intuitively it makes sense that the jobs in the informal sector could truly compete with those in the formal sector. Generally a raise in the minimum wage leaves businesses with the ability to employ less labor given the same overall budget, however if the labor will be employed anyway; the raise in minimum wage could allow formal businesses to compete with informal in wages and bring a greater labor demand to the suddenly more lucrative jobs in the formal sector.

    Given the much smaller infrastructure of the informal sector in the US compared to Indonesia, I do not think policy suggestions taken from the Indonesian context can be applied here.

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  6. Eric M. Jones. says:

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  7. Karl Baker (@kbaker6) says:

    In 2010 about 2,5 percent of workers earned wages at the Federal minimum of $7.25 an hour.

    It seems it’s largely those individuals we’d be concerned about if the minimum wage increased (some earn less due to exemptions in the law).

    Companies held to the Federal minimum are those who sell items out-of-state or have revenues in excess of $500,000, so your small mom and pop restaurant probably isn’t subject to these standards.

    Instead, it’s the Wal-marts of our economy who are constrained by this price floor. So, would Wal-mart, for example, lay off some of it’s low paid workers if the minimum wage was increased?

    If it did, how would that affect its already lackluster service and, consequently, its competitiveness? Would Costco, who pays higher wages, take some of its market?

    I think businesses in competitive sectors would be better off dipping into their profits to maintain the quality of their products and their market share, rather than laying off employees to avoid a small increase in labor costs. And, as we’ve heard so often in reports, companies are sitting on record levels of cash.

    Although if Congress were to increase the wage, I would like to see them also increase the limit for the exemption from $500,000 in revenue to possibly $1,000,000.

    Karl Baker

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  8. Nosybear says:

    Why does it appear to be a novel idea that providing more funds at the bottom of the economy grows it more than providing funds to the top? Those at the bottom are consumers. You increase their resources, they spend them, not only increasing their standard of living but those who provide them goods and services. The statement that raising the minimum wage increases unemployment is a political meme: Demand for goods and services is increased by the increase in wages but the net cost of those goods and services is raised less. This is not difficult to understand. Easy to deny for political purposes, yes but not difficult to understand.

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