This report discusses the findings from the Low Pay Commission (LPC) project ‘The Impact of the National Minimum Wage on Profits and Prices’. The background to this work is that there is by now a large body of work examining the impact of minimum wages on employment, with a particular focus placed upon whether minimum wages price workers out of jobs as predicted by orthodox competitive labour market theory (Borjas, 2004; Brown, 2003), or whether there is any effect on employment at all, as stressed in the newer, so called ‘revisionist’ work (as typified by Card and Krueger, 1994). This, often controversial, research does find it rather hard to identify important job displacement effects associated with minimum wage floors.
Since it is also the case that affected workers do receive significant wage gains from minimum wages, this does beg the question as to how firms are able to sustain the higher wage costs induced by minimum wages. It is evident that, if employment effects are small, then something else has to give. One possibility is that the minimum wage eats into profit margins, or raises prices, and this is the focus of this research project.
The competitive model of the labor market predicts that the development of individual earnings over the life cycle follows the development of individual marginal productivity. Beside productivity related factors such as on-the-job learning and improvements in worker-firm matches over time, shocks to aggregate labor demand for instance due to a major recession – will also have an impact on wage rates. In a spot labor market, however, those temporary changes in labor demand are relately short lived and should not influence wages over prolonged periods of time. This view has been seriously challenged both by studies on cohort size effects (Welch, 1979) and studies on the impact of early career problems on later outcomes.
Recent papers have used shocks to the capital accumulation process to explain the Great Recession of the late 2000s, cf. Gertler and Karadi (2011) and Gertler and Kiyotaki (2011), and the following jobless recovery, cf. Shimer (2010). More generally, a number of authors have suggested that such shocks are important drivers of business cycle fluctuations, cf. Barro (2006, 2009), Gourio (2010), Justiniano, Primiceri and Tambalotti (2010, 2011) and Liu, Waggoner and Zha (2010).
