If Increasing the Minimum Wage Doesn’t Cost Jobs, How Does It Get Absorbed?

August 14th, 2013 at 5:42 pm

As I stressed in a recent post, the economic arguments against moderate increases in the minimum wage lack robust empirical support.  Most importantly, the majority of studies looking for the job- loss effects that opponents assert will be large enough to offset the benefits to low-wage workers come up short.  Such “disemployment” effects hover about zero, as shown in Figure 1 from economist John Schmitt’s recent review of the literature.

This fact raises another question: if not through job loss, how is the mandated wage increase absorbed?  It’s got to come out somewhere.  Have economists identified the absorption channels?

We have, though there’s more evidence for some absorption channels than others.  Here’s a quick primer on what we know and what we suspect.

First, as alluded to at the end of my earlier post, the initial question you want to ask is what share of the workforce is in the affected range and just how “affected” are they?  A small increase, particularly one that’s come after many years of inaction, will affect few workers and in such cases there’s just not that much absorption that needs to take place. 

Moreover, once a worker is in the “sweep” of the higher minimum (i.e., their hourly wage is between the old and new wage), there’s the issue of where they are in the sweep.  If their wage puts them a few pennies below the new minimum, we’d expect less of an impact than if it will take $1 to bring them up to the new floor.

Schmitt examines this question from various angles in the context of recent minimum wage increases (see his table 1).  Starting in the late 1980s, he finds 6% or less of the workforce has been in the sweep, with the average hourly wage increase ranging from around thirty to fifty cents.  Is this a lot or a little? 

History suggests that it’s a small enough impact that the wage increase tends to be absorbed not by job loss but by the various mechanisms discussed next.  Let’s start with the three p’s: profits, productivity, and prices.  Increased labor costs can be offset by:

shaving profit margins: This is an attractive alternative right now, as the profit share of national income is at an all-time high while the compensation share is at a 50-year low.  As James Surowiecki points out, this mechanism is limited by the fact that profit margins are thinner at retail and fast food companies than at tech firms and investment banks.  Still, the fact is that Walmart, for example, is a highly profitable enterprise with low-labor costs as a key part of their model. 

There’s little evidence for this mechanism, though a recent study from the UK finds a significant effect.  You ask me, the fact that the affected lobbies fight so hard against higher minimum wages is pretty strong circumstantial evidence that this channel is at work.

A related mechanism emphasized by Schmitt is wage compression, i.e., along with some redistribution from profits to wage, there’s some empirical support for “…the possibility that employers may compensate for higher wage costs at the bottom by cutting wages of workers who nearer to the top.”

higher productivity: One of the inefficiencies that low-wage firms face is high rates of turnover and vacancies.  Raising the wage floors can help offset such costs by making easier to recruit, train, and hold onto workers.  Schmitt cites numerous studies as this process at work, as labor turnover has been found to decrease substantially following an increase in the wage floor.

higher prices: This one has been carefully studied, and the results show that part of the cost of the wage increase is passed through to higher prices.  The literature finds small overall effects on the price level: a 10% increase in the minimum is associated with less than half a percent increase in the overall price level, though larger increases are found in low-wage labor intensive industries (around 1-4%).

Schmitt ticks through other possible absorption sources but there’s either little research on them or what there is doesn’t find much impact, including reduced hours, lower non-wage benefits, less spending on training, or greater product demand by recipients of the now-higher paychecks. 

So there are lots of ways in which firms and economies absorb minimum wage increases.  Not all are benign—higher prices, lower profits—though the fact that some of increase is absorbed by squeezing inefficiencies out of the low-wage labor market seems like an unequivocal plus.  But at the end of the day, what’s most important here is that the research supports the contention that the benefits of the increase in the wage floor to low-wage workers significantly outweigh the costs.

That’s why you see such workers and their advocates pressing hard for the increase.  And to the lobbyists who say they’re really just trying to protect these benighted workers from the unintended consequences of the increase, I’m quite certain they’d say, “thanks, but no thanks…we got this.”

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8 comments in reply to "If Increasing the Minimum Wage Doesn’t Cost Jobs, How Does It Get Absorbed?"

  1. Mark Jamison says:

    Two questions Dr. Bernstein. The first is obvious but maybe not, when accounting for an increase of say fifty cents which is relatively small are economists also accounting for increased employer withholding costs?
    Has anyone looked at wage increase policies within these firms? You speak of wage compression but are employers extending periods between raises or increases for the low wage workers after a minimum wage increase? That may not have been an issue when most low wage workers were teenagers in part-time jobs but the composition of the low wage workforce has changed. Have bonus or profit sharing incentives changed – some low wage employers like Wal-Mart have programs like these although they work more as incentives than as real increases.

  2. John Reagan says:

    There is one other factor that seems to be left out of the mix and that is in a sweeping ‘catch up” to right the delays in cost of living minimum wages, there is a large influx of previously unearned dollars now in circulation. Poor people spend their salaries and that means greater sales for businesses that cater to them and the various businesses that support them. I can’t recall where I read it, but I believe the concept was, for every dollar put into the economy, it has a 1.4 times multiplier. Short changing employees is counter productive.

  3. Kevin Rica says:

    What the heck is wrong with allowing wages to rise the old-fashioned way: create a labor shortage?

    Of course that would mean restricting immigration and upsetting Nancy Pelosi and MSNBC. But what the heck is wrong with that?

  4. urban legend says:

    Besides the offsets to the cost of an increase from lower turnover, severance and job-training costs, the job-loss theory seems to be based on a fixed-pot concept of money. Extra money for workers comes out the pockets of the employers, period. It denies the dynamic effects we know exist. Higher wages at the lowest level, likely buttressed by an upward cascade effect as employers try to maintain pay-grade relationships and competitiveness for talent, means a theoretical transfer from a small group with a lower propensity to spend and a higher likelihood that it will be spent outside the community or even the country, to a much larger group who will spend every cent and mostly in the local community. The extra spending increases business and profits, which in turn offsets any forbearance of higher immediate income by those with high incomes.

    The pot, therefore, becomes bigger and everyone wins. It’s a back-door stimulus program.

  5. Fred Donaldson says:

    Do not ignore the result of a higher minimum wage is an upward drift in all lower middle class income, which means less expense for SNAP, housing subsidies, Earned Income Tax Credits, and other social programs. If folks go well above the poverty line they don’t need taxpayer funded welfare.

    The current system rewards employers for low wages by using taxpayer money to keep low paid workers fed and housed. Higher wages decrease the burden on taxpayers, require fair pay for labor from employers, and will generate more tax revenue, more consumption and more savings. If the down side to this is slightly less wealth for asset owners, it is a small price for a great benefit.

  6. Spencer says:

    Opponents of the minimum wage do not want to use negative impact on profits because it does not have much political appeal.

  7. Carlos Morales says:

    Dr. Bernstein,

    What about countries like Mexico that have based their economic development by attracting foreign investment due the extreme low-wage cost, when do this vicious circle could be broken?



  8. Steven Rogers says:

    The assumption that minimum wages can be absorbed by slightly decreased profit margins because “the profit share of national income is at an all-time high while the compensation share is at a 50-year low” relies on the unsupported assumption that the companies earning the profit are the same ones that hire minimum wage workers. Aside from being unsupported, that assumption is insupportable. It’s useless to assess the impact of a minimum wage increase in the context of the overall profit share, you have to look at the profitability of those businesses that actually employ minimum wage workers, which leaves you looking at SMEs and micro-enterprises. AQre these really profitable enough to absorb a wage increase?

    Any discussion of the impact of minimum wage increases has to look at the profile of the minimum wage worker. That is conspicuously lacking here.