The dynamic age of the minimum wage

Has there ever been a better time to study the minimum wage? The federal minimum has not changed since 2009—a flat landscape upon which state and local governments have layered dozens of policy experiments. In the past nine years, 28 states and 48 localities have changed their minimum wage laws, in some cases more than doubling the federal level of $7.25 per hour. A $15 minimum is now part of a national debate, with the reported support of two-thirds of Americans.

“After being told in graduate school that we know everything there is to know about this topic and we should not waste our time, the flow of papers is tremendous,” said economist David Neumark of the University of California, Irvine. Neumark joined more than a dozen top minimum wage scholars in Minneapolis for a spirited two-day review of the latest evidence, theory, and statistical methods on the subject.

The rush of minimum wage innovation and data overlaps with two years of high inflation and the Fed’s fastest monetary tightening in 40 years. Better understanding of the minimum wage “affects directly monetary policy discussions and deliberations,” said Minneapolis Fed Research Director Andrea Raffo, opening the conference. Yet “the evidence points in different directions.”

Fittingly, each conference day began with a just-released paper measuring the outcomes from large, ongoing minimum wage hikes—one focused on Minneapolis and St. Paul, the other on New York and California. Both studies employ a similar, state-of-the-art statistical approach but reach contrasting results.

Stark findings in Minneapolis and St. Paul

Minneapolis and St. Paul began stepped processes in 2018 and 2020, respectively, to raise minimum wages to $15 an hour (Table 1). The current Minnesota minimum wage for large employers is $10.59 an hour.

Both cities engaged the Minneapolis Fed for a 10-year study of the effects in sectors with high proportions of low-wage workers. The latest reports from economists Anusha Nath, Jeremy Lise, and Loukas Karabarbounis find that, on average, the minimum wage increases resulted in wage gains but losses in jobs, hours worked, and worker earnings compared with a hypothetical scenario without the new policies.

The report finds no significant effect through the end of 2021 in most sectors, including health care and administrative services, both of which employed many workers earning below $15 an hour in 2017. But the researchers do measure a striking loss of jobs and hours worked in retail and restaurants (Table 2). Wages for employed workers in these sectors did increase significantly as the local minimum wage laws took effect.

The results in Table 2 reflect wage gains and job losses compared with an estimate of what would have happened without each city’s minimum wage policy—an insight made possible through a statistical technique known as a “synthetic control.” The outcomes in Minneapolis and St. Paul are compared against hypothetical versions of the two cities, carefully constructed from a weighted combination of other Minnesota zip codes that did not have minimum wage increases. The actual and synthetic versions match well until 2018, when they begin to diverge. Thus, “anything that happens after 2018, we can attribute to the change in the minimum wage,” said Nath. The analysis is made possible by detailed data on employers and individual workers, information the researchers believe is uniquely available in Minnesota.

The economists find that effects began in 2018 and continued through the end of 2021, the end of the period of their study. Starting with 2020 data, the economists face the challenge of controlling for civil unrest and the effects of a pandemic that shuttered many stores and restaurants. To address where civil unrest occurred, they compare establishments with others in the same zip code. To capture the impact of pandemic policies that affected some sectors but not others, they compare establishments and workers with others in the same sector. The results largely affirm the primary findings. In addition, the results show that the effects remain similar over time—there is no acceleration of minimum wage effects in the post-pandemic period.

At the local-economy level, the Minneapolis Fed economists calculate that the minimum wage increases led to 1.7 percent fewer jobs in Minneapolis and 2.2 percent fewer in St. Paul by the end of 2021, and small increases in the average hourly wage (less than 1 percent). In St. Paul, where the policy was announced two years before implementation, the researchers find the adverse effects of the minimum wage began in anticipation of the actual change.

The economists acknowledge their findings are among the largest in the economics literature. In papers studying minimum wages and restaurant workers, “most estimates are small and negative” for job losses, said Karabarbounis. “Our time series is a huge negative.” Nath notes that the minimum wage changes underway are large and fast, and that the effects are highly concentrated among sectors, establishments, and workers most exposed to the increases: Prior to the change, for example, 80 percent of Minneapolis–St. Paul fast food workers made less than $15 an hour, with a median wage around $11. Nath also cautions that this is an early report in a long-term study. Future reports will allow the team to explore the long-run costs and benefits as the minimum wages reach $15 an hour and economic effects play out over time.

Similar method, contrasting findings?

The synthetic control approach also powers the quite different findings presented by Michael Reich and Justin Wiltshire, written with their fellow University of California, Berkeley, economist Carl McPherson. The economists look at the outcomes for fast food workers in two populous states that both reached a $15 minimum wage in 2022: California and New York. The economists compare long-term outcomes in 47 counties with a weighted, synthetic control built from otherwise-similar U.S. counties that did not experience a minimum wage increase during this time.

Like the Minneapolis Fed researchers, they believe their approach substantially controls for pandemic-driven effects. In contrast to those findings, however, “the minimum wage increases caused substantial and significantly higher earnings for fast food workers, without any evidence of negative effects on fast food employment,” they write. They calculate that minimum wage increases raised fast food employment by 9.1 percent and overall earnings of these workers by 16.7 percent.

Notably, Reich and co-authors find muted employment effects for counties in California and New York that adopted local minimum wages higher than the state minimum. When the authors remove these counties from their analysis, they detect a stronger positive employment effect across the rest.

Why might their findings differ from prior minimum wage research that has found small negative employment effects or none at all? “We are examining minimum wage increases over a seven-and-a-half-year period—much larger than the earlier literature,” said Wiltshire. They also look in detail at a sector known to be highly exposed to minimum wage changes, whereas broader studies might wash out these effects. Another possible factor: The large changes in Minneapolis and St. Paul were at the city level, while California and New York implemented their $15 minimum across the state. The ease with which employers can shift operations outside local borders could affect outcomes for workers.

A story of employer power

As economists like to say, What’s the story here? How could raising wages for millions of fast food workers lead to more jobs? “[Our] results really are consistent with a story of employer power,” said Wiltshire. Their paper was one of many at the conference to grapple with the role of “monopsony” in labor markets, in which employers have some market power to hire fewer workers, at lower wages, than they would in a competitive market.

However, Minneapolis Fed Senior Research Economist Simon Mongey, who presented just after Wiltshire, finds “a pretty narrow window” for low-wage workers—and the U.S. economy—to gain from using a minimum wage to erode monopsony power. This is because the minimum wage tends to drive the smallest, lowest-productivity firms out of business—think the “corner store”—while affecting much less the larger, higher-productivity businesses that already pay higher wages. Above a federal minimum wage of $8.27 an hour, job losses for workers outweigh any gain from higher wages, according to Mongey’s research.

Looking beyond the effect on jobs

Minimum wage studies have focused heavily on whether jobs are gained or lost, an outcome with clear relevance to worker welfare. However, workers and policymakers may care about other outcomes as well.

Jobs are what economists call the “extensive margin” of change. However, the most important action could be happening on the “intensive margin”—do workers remain employed but see reductions in their hours? Most published articles have not tracked hours, said University of Washington economist Jacob Vigdor. Hourly data is often unavailable; when it is, it is often self-reported by workers and tends to bunch unhelpfully at round numbers (especially 40 hours a week).

Consider the practical question driving the headcount at many restaurants, Vigdor said: “How many workers do you want when you are at your busiest?” Even if minimum wages rise, businesses will keep staff on payroll to handle the evening or weekend rush. But they could reduce hours for everyone in less-busy times. Like the Minneapolis Fed studies of the Twin Cities, Vigdor has led a team tracking the outcomes from minimum wage hikes in Seattle, which found little change in ongoing employment but some reduction in hours, especially for the least-experienced workers. Because hourly wages went up, total earnings saw small increases. “Earning the same money in less time is not a bad thing,” Vigdor noted in his presentation.

“The focus on employment effects can distract from some key issues,” said economist Jeffrey Clemens of the University of California, San Diego. Along with cutting hours, do businesses cut back on non-wage benefits? Do they take other cost-cutting measures that make jobs less pleasant? Do they pass costs on to customers in the form of higher prices, indirectly harming the same people whom minimum wage laws are intended to help? “The consumption bundles of low-income people tend to be more concentrated in the goods and services produced by firms that tend to employ minimum wage workers,” Clemens said.

Less hiring, more robots

Along with effects on existing jobs, what about job openings? Research presented by Murat Tasci, until recently with the Cleveland Fed and now at JPMorgan Chase, looks at job postings between 2005 and 2018 for industries most likely to be impacted by increases to the minimum wage. Tasci and his co-authors found postings dropped 2.4 percent in the near term for each 10 percent increase in a state minimum wage; one year later, postings fell as much as 4.5 percent. They also found evidence that employers were cutting new hiring up to three-quarters before minimum wage hikes took effect. “If you are ever going to find anticipation effects,” Tasci said, “this is one variable where it is going to show up.”

What the reduction in postings and hirings means for employment levels is not yet clear. It could be that employment is declining, but Tasci noted the findings are also consistent with a scenario in which higher pay is leading to lower employee turnover.

Over the longer term, however, businesses may respond to higher labor costs by altering their investments in capital: equipment, computers, and work processes that assist employees (or take over some job duties altogether). This dynamic is the heart of research from Minneapolis Fed Monetary Advisor Patrick Kehoe, Stanford economist Elena Pastorino, and co-authors. Over time, in their model, employers switch to capital that is compatible with higher-educated, higher-paid workers—especially at higher levels of the minimum wage.

Lower-skilled workers are steadily displaced, exacerbating income inequality. However, the authors also find that modest minimum wage increases can be complementary to other policies that support low-income workers. “A world in which a smaller increase in the minimum wage is married with the Earned Income Tax Credit is the best of all possible worlds,” Pastorino said.

The policy landscape: A broad view of worker and household well-being

Pastorino’s comment highlights that minimum wages are one policy among a suite of options policymakers can consider. For each option, economics can help identify and quantify: Who benefits? Who pays?

One group that too often finds itself near the bottom of the earnings distribution is Black workers. In 1967, Congress added federal minimum wage coverage for previously excluded sectors where Black workers were prominent, including agriculture, hotels, restaurants, and nursing homes. The raise (to $1 an hour, with a subsequent schedule of increases) was a big one for many, but especially for Black workers, who generally earned much less than White workers. Analysis by Princeton economist Ellora Derenoncourt finds that the minimum wage reform led to a 10 percent increase in Black earnings—twice as much as workers overall. She calculates this increase can explain around 20 percent of the substantial decline in racial earnings inequality during the ’60s and ’70s.

“This project uncovers a role for the minimum wage to play in addressing racial inequality in the United States,” Derenoncourt told her fellow researchers. “This ought to prompt research [on] when minimum wage policy can have this other beneficial effect of reducing racial gaps.”

Another group that deserves more study is young workers who are just embarking on their work life, said University of California, Los Angeles, economist Lee Ohanian during the policy roundtable moderated by Minneapolis Fed President Neel Kashkari. Getting that first job helps them accumulate experience and human capital. “We live in an economy where people are taking new jobs all the time, particularly when they’re young. So a lot of the minimum wage workers today will not be the minimum wage workers of tomorrow or two years from now,” Ohanian said. High minimum wages may price these inexperienced workers out of the labor market.

To better appreciate these trade-offs, “I’d like to place minimum wage in the context of other federal policies,” said Will Carrington, former principal analyst for the Congressional Budget Office. The minimum wage is one way to increase the after-tax income of low-wage workers. However, Carrington said, one critique of minimum wage policy is that many minimum wage workers don’t live in poor households. Relative to the minimum wage, the Earned Income Tax Credit “is better targeted towards poverty,” Carrington said.

For policymakers considering minimum wage policy, “the benefit is the welfare effects on vulnerable, low-wage workers,” said Laura Feiveson of the U.S. Department of the Treasury. Participants in the conference pointed to some ways the minimum wage could improve the lives of low-wage workers beyond a paycheck. Rajesh Nayak, assistant secretary for policy at the U.S. Department of Labor, highlighted some of these benefits in his discussion of a recent executive action that raised the minimum wage for employers on federal contracts. This boosts employee health and morale, Nayak said, while reducing absenteeism and turnover.

Does the minimum wage help transmit monetary policy?

Monetary policymakers have no role in setting minimum wage rules. However, as Research Director Andrea Raffo pointed out during his introductory remarks, monetary policy works differently when different labor market institutions are in place. In fact, research presented by University of California, Los Angeles, economist Brian Wheaton finds that the federal minimum wage was responsible for almost 40 percent of monetary policy’s effect on employment from 1975 to 1990.

The reason is that monetary policy works best on “rigid” prices that are hard to change. If the Fed loosens or tightens monetary policy but prices instantly adjust, no one’s economic situation changes. But the minimum wage is set by law. When the Fed tightens policy by raising interest rates, as it did from 1975 to 1980, firms are squeezed by borrowing costs and lower demand from consumers. One way firms could adjust is by lowering wages. But “firms can’t lower the wage of their minimum wage workers,” Wheaton said. “Instead, they may fail, leading more than just minimum wage workers to become unemployed.” Rising unemployment and reduced output cool the economy.

Based upon their research, “the minimum wage is an important transmission mechanism for monetary policy,” Wheaton said, and has been most potent during times—and in locations—where more workers are paid at or near the minimum wage. However, the share of workers earning the federal minimum wage has been falling over time, in part because it is not indexed to inflation. This decline could be one reason why monetary policy has become less effective than in the past, Wheaton suggested.

The U.S. first implemented a federal minimum wage 85 years ago. Today, even in places with the lowest cost of living in the United States, working 40 hours a week, 52 weeks a year for the federal minimum of $7.25 per hour amounts to only 80 percent of food, housing, and transportation costs for a single adult, Feiveson said. Raising that bar but stopping before job losses start, she said, could be a place where the benefits outweigh the costs.

The fractured minimum wage landscape in the U.S. provides an opportunity for economists to study where that sweet spot may be.

The event was jointly hosted by the Minneapolis Fed and the Minnesota Economics Big Data Institute at the University of Minnesota.