Ebook How raising the minimum wage can reduce voluntary labor market segmentation
Until recently, there was a broad consensus among economists regarding the negative effects of the minimum wage on employment. According to this conventional view, a minimum wage reduces employment of low-wage, young and unskilled workers. Brown, Gilroy and Kohen [1982] express this conventional point of view when they write: «Time-series studies typically find that a 10 percent increase in the minimum wage reduces teenage employment by 1 to 3 percent... We believe that the lower half of the range is to be preferred». However, this consensus has been challenged since the beginning of the 1990s by a series of empirical and theoretical works. The most influential of these studies is due to Card and Krueger [1994] and compares employment changes at fast food restaurants in New Jersey and Pennsylvania, following an increase in New Jersey’s minimum wage in 1992. It shows that the rise in the minimum wage was not followed by a reduction in fast food employment in New Jersey. In the same line, two analyses of the 1990-1991 increases in the federal minimum wage, by Katz and Krueger [1992] and Card [1992], find no negative employment effect. But this could be caused by the low initial level of the minimum wage in the U.S.
However, in Europe, where the minimum wage is higher, several studies fail to conclude that the minimum wage has an unambiguous negative impact on employment. Dolado et al. [1996] find mixed results: recent minimum wage increases in Europe have reduced employment in some cases and increased it in others. The main conclusion is that the role of the minimum wage has certainly been exaggerated in the literature. Machin and Manning [1994] and Dickens, Machin and Manning [1998] do not find a real increase in employment in the U.K. after the abolishment of the minimum wage in 1993. Other papers give stronger evidence against the minimum wage. For example, Abowd, Kramarz, Lemieux and Margolis [1999] focus on the case of workers whose current wage will fall below the new minimum wage after the increase. They show that these individuals, «caught» by the minimum wage increase, have a lower employment probability than those who are not.
On the whole, the empirical evidence seems often contradictory and the results are difficult to interpret from a theoretical point of view. Card and Krueger [1995] summarize these recent studies in the following way: «Recent minimum wage increases have not had the negative employment effects predicted...Some of the new evidence points towards a positive effect of the minimum wage on employment; most shows no effect at all». This leads to the following question: why did studies in the 1970’s and 1980’s find an adverse employment impact of the minimum wage, while several recent works fail to detect such a negative employment effect? This paper argues that this has something to do with the recent changes in production processes and, more precisely, with the stronger strategic complementarity in new organizations.
The literature suggests three reasons for which the minimum wage may have a positive effect on employment. First, there is the well-known monopsony explanation. However, the fast food example described by Card and Krueger [1994] does not seem to fit well into this explanation. The efficiency wage theory gives a second explanation: Rebitzer and Taylor [1995] show that, in an efficiency wage model, the minimum wage may have a positive impact on employment. However, once again, this framework does not seem well-adapted to the fast food industry. Lastly, it is sometimes argued that raising the minimum wage may encourage workers to acquire more education. The mechanism is the following: workers whose current productivity will fall below the new minimum wage can choose between staying unemployed (because of their lack of education) and investing in education to become more productive. Some of them decide to acquire more education, which improves the social welfare. Nevertheless, from a theoretical point of view, raising the minimum wage could also have the opposite effect. Indeed, a higher minimum wage rises the expected wage of low-skilled workers. Thus, it lowers the return of investing in education. It is difficult to know which effect (the positive or the negative) is the most important.
In short, none of these three reasons seems able to explain why studies in the 1970’s and 1980’s find adverse employment impact of the minimum wage, while several recent works fail to detect such a negative employment effect. Another argument, more closely related to our own, is proposed by Fershtman and Fishman [1994]. They are interested in the impact of the minimum wage on search strategies in a search framework. They point out that raising the minimum wage may reduce the incentive for job search and lower the average wage when agents must invest in costly search to become informed about prices.
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