Evidence on Minimum Wages

New research on Seattle's recent minimum-wage hike shows some unexpected -- and unintended -- consequences.

By Peter Cappelli

Democratic efforts to raise the federal minimum wage have stalled since last November's election, but they continue at the state level and especially in cities where Democrats make up a big majority of voters, many of whom likely hold the belief that government can and should do something to help low-income workers.

The minimum wage may not be the ideal instrument for helping low-wage workers, but it has the advantage of already being on the books and accepted. It has also been the subject of lots of studies in labor economics, not so much because of its practical importance but because it butts up against central debates in economics about how much markets matter in employment.

So into this comes a report on the efforts in Seattle to raise the minimum wage to $15 per hour, arguably the most aggressive effort to raise wage levels in the country. What should we expect the result to be? 

Simple economic theory says that if you raise the price of something, the demand for it should fall, so forcing up wages for the lowest-paid workers should lead to a drop in those jobs. The important question, though, is by how much? The evidence, virtually all for state minimum wages, said, not by very much.

Seattle raised the minimum hourly wage by $1.50 in 2015 and then by $2.00 to $13 in 2016. This study from economists at the University of Washington found very little effect on employment from the first increase but a very big effect from the second. That second increase was associated with a reduction in hours worked for low-income workers of 9 percent and a rise in hourly wages of only 3 percent, so the net effect actually lowered total income for those individuals.

If you live in a theoretical world -- many pundits and policy thinkers do -- these results are puzzling: Why should there be very little effect from the first increase but a really big one for the second? A further puzzle within the study is that there was almost no effect of either increase on the fast-food industry, which has been the focus of much of the efforts to raise wages. And why did hourly wages only go up by 3 percent when the minimum wage increased by 18 percent?

The answer to the last question is easy: Most low-income workers were already being paid above the minimum wage, so raising it didn't increase wages for everyone. But that makes it even more surprising that a small wage increase led to such a big drop in work hours.

Change is difficult for employers, and the kind of changes you'd need to respond to higher wages can be hard to do. The reason that there was no effect of this wage increase in the fast- food industry begins with the fact that these businesses can't move: Manufacturers and most service providers could just relocate outside the Seattle city limits, but fast-food restaurants in particular serve very local customers, and they would lose them by moving. Fast-food restaurants are also fairly automated already, so they are unlikely to add more equipment and shrink their human workforce.

Other employers are more able to move, a response that is particularly easy to do for city -- as opposed to state -- minimum wages. Moving is a big decision, though; It takes time, and it's much more likely to happen when costs go up a lot, especially when you can see that happening over time. We might not do that for the first wage increase, but if we see a second one coming then next year when we can plan for it, we might well think of moving.

Employers respond in other ways as well. One of the biggest findings in the Seattle study I believe is that jobs appeared to increase for higher-paid workers, those making about $19 per hour. Why is that?

Here's an analogy: If the car companies suddenly increased the prices of their entry-level cars and only those cars, we would expect to see fewer of them sold. But we might also expect more intermediate-level cars to be sold, because if we really need a car, the step up in price to get an intermediate model is now smaller. If the Ford Escape jumps in price, why not get a slightly larger Ford Explorer?

Paradoxically, the main beneficiary of the increase in Seattle's minimum wage is not low wage workers, but intermediary workers because they have better skills, more experience and now cost only marginally more.  

What's the takeaway here? Democrats had been winning the policy debate around the minimum wage because it didn't look as though the downsides of raising it were very big. That may have been true when the increases were one-time and small in size. The Seattle story gives some ammunition to Republicans who oppose minimum-wage increases, at least for municipalities. Another lesson might be that employers are likely to react disproportionately when costs jump a lot and when they can see them coming.

Peter Cappelli is the George W. Taylor Professor of Management and director of the Center for Human Resources at The Wharton School of the University of Pennsylvania in Philadelphia. His latest book is Will College Pay Off? A Guide to the Most Important Financial Decision You'll Ever Make.


Jul 11, 2017
Copyright 2017© LRP Publications