Wednesday, September 17, 2014

The Law of Demand and the minimum wage: It applies to number of hours worked, not the level of employment | AEIdeas

Let me attempt to reconcile the apparent inconsistency between: a) economic theory, which clearly predicts a negative relationship between the minimum wage and the quantity of unskilled workers demanded by employers, and b) some of the empirical evidence that finds no negative employment effects following minimum wage hikes. Here’s the key point: The negative relationship predicted by economic theory is not: a) between minimum wage hikes and the number of unskilled workers employed, but b) between minimum wage hikes and thenumber of unskilled work hours demanded by employers.The two charts above help to illustrate that difference:
In the top chart, we see a negative relationship between an increase in the minimum wage and the number of hours of unskilled work demanded by employers in the 12-month period following the increase in the hourly price of unskilled labor (to capture the effects on future hiring). Like an increase in the cost of any other labor input or other input like food, energy, raw materials, machinery, equipment rental, or building rent, employers facing a 39% increase in the cost of unskilled labor (from $7.25 to $10.10 an hour) would have no other choice than to reduce the number of unskilled work hours – it would simply be a necessary strategy for survival. As I pointed out recently, a minimum wage increase to $10.10 per hour would be the equivalent to an annual tax of more than $6,000 per full-time worker earning the minimum wage.
The various strategies employers might use to reduce their demand for unskilled work hours over the 12-month period following a 39% minimum wage hike might include: a) reducing the number of hours worked per week by entry-level unskilled workers, e.g. cutting their hours from 40 to 30 per week, or from 30 to 20, etc., b) reducing the number of unskilled workers currently employed through layoffs, c) reducing the number of unskilled workers that employers might have previously been planning on adding to staffing levels in the future, d) substituting skilled workers for the now relatively more expensive unskilled workers, and e) investing in technologies that would substitute automation, mechanization, robotics, and self-serve options for unskilled workers. Although the effect of a 39% minimum wage hike on employment levels might be uncertain, the negative effect on the number of hours of unskilled labor demanded by employers would be much more certain and predictable according to the Law of Demand. The bottom chart shows graphically how it would be possible that an increase in the minimum wage might not adversely affect the number of unskilled workers employed by looking at the relationship between the average weekly compensation for unskilled workers (and not the hourly monetary wage) and the number of unskilled workers.
Suppose that employers realistically respond to a 39% increase in the minimum wage by: a) cutting hours for minimum wage employees and b) reducing or eliminating  non-monetary forms of compensation that might include free or reduced cost food, merchandise, uniforms or parking, bonuses/profit-sharing, educational reimbursement, paid holidays and company parties/picnics, health care benefits, etc. Following a reduction in hours and non-monetary benefits, the average compensation per minimum wage employee might be unchanged, as could be the number of workers employed at the minimum wage. That is, if the employer can completely offset the monetary increase in the minimum wage by a reduction in hours and fringe benefits, there will be no need to reduce overall staffing levels. In that case, empirical evidence may find no negative relationship between increases in the minimum wage and employment levels, even when there’s a predictable and negative effect on the number of hours of unskilled work demanded by employers.Bottom Line: It’s more accurate to say that the Law of Demand predicts: a) a negative relationship between higher wages and the number of hours of unskilled work demanded by employers, rather than b) a negative relationship between higher wages and the number of unskilled workers employed. Therefore, it’s possible that a minimum wage hike won’t always negatively affect employment levels for entry-level unskilled workers, but will affect thenumber of hours demanded by employers for unskilled labor. That’s how we can reconcile the apparent inconsistency between economic theory and some of the empirical evidence…..

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