Research

The Effect of Minimum Wage Increases on Retail and Small Business Employment

Joseph J. Sabia - University of Georgia • Published on

Overview

A recent study by the Fiscal Policy Institute (FPI) claims that increases in the minimum wage at the state level have had no adverse employment effects. Specifically, the FPI report concludes that states that raised their wage floor above the federal level did not experience declines in small business employment, and, in fact, actually experienced an increase in retail employment.

While the FPI study has been frequently cited by supporters of increases in the minimum wage, the study is based on faulty statistical methods, and its results provide an inaccurate picture of the effect of state-level minimum wage increases. This paper, by Dr. Joseph Sabia of the University of Georgia, presents a more careful and methodologically rigorous analysis of state-level minimum wage increases. His results confirm the consensus economic opinion that increases in the minimum wage decrease employment, particularly for low-skilled and entry-level employees.

Employment Results

Using government data from January 1979 to December 2004, the effect of minimum wage increases on retail and small business employment is estimated. Specifically, a 10 percent increase in the minimum wage is associated with a 0.9 to 1.1 percent decline in retail employment and a 0.8 to 1.2 percent reduction in small business employment.

These employment effects grow even larger for the low-skilled employees most affected by minimum wage increases. A 10 percent increase in the minimum wage is associated with a 2.7 to 4.3 percent decline in teen employment in the retail sector, a 5 percent decline in average retail hours worked by all teenagers, and a 2.8 percent decline in retail hours worked by teenagers who remain employed in retail jobs.

These results increase in magnitude when focusing on the effect on small businesses. A 10 percent increase in the minimum wage is associated with a 4.6 to 9.0 percent decline in teenage employment in small businesses and a 4.8 to 8.8 percent reduction in hours worked by teens in the retail sector.

Methodological Concerns in the Fiscal Policy Institute Report

The results in this report are all statistically significant. In both the small business and retail industry analyses conducted by FPI, however, no explicit tests for statistically significant differences in employment were presented. This is only one of the important differences between this study and the FPI report. Another is that while the FPI report chiefly examines employment changes over only two time periods (1998 and 2001), this study examines the effect of state minimum wage increases on employment across a significantly longer time period (1979-2004).

Even more troubling, the FPI analysis does not control for any changes in state-level socioeconomic or demographic characteristics that could affect both minimum wage hikes and changes in employment. For example, states may choose to raise their minimum wages when they anticipate strong economic growth in sectors that employ a large share of minimum-wage workers. If this is true, then estimates of the impact of the minimum wage on employment will be biased toward zero. Put another way, the FPI study does not hold “all else equal” in estimating the effect of the minimum wage.

By controlling for economic and demographic changes that may be associated with both the implementation of minimum wage increases and changes in teenage employment, this study is able to more credibly isolate the effect of minimum wage increases.

Conclusion

These findings provide consistent evidence that minimum wage increases result in a significant decline in retail and small business employment. This finding is robust across several model specifications. Furthermore, these findings refute many of the claims raised in the FPI study so often cited in favor of minimum wage increases at the state and federal levels. The differences between these studies are likely a result of the more careful and appropriate methodological methods utilized in this study.

Taken together with other recent work, the results of this study suggest that low-skilled employees will find themselves unable to escape adverse labor market consequences resulting from minimum wage increases. Instead of passing these politically popular but destructive mandates, policymakers should consider other programs to help the working poor such as the Earned Income Tax Credit. The EITC is a far more effective policy tool to reduce poverty among poor families. Moreover, the EITC has the advantage of avoiding the adverse employment effects described in this study.