The Real Cost Of Minimum Wage Hikes

  • Author: William E. Even and David A. Macpherson

  • Publication Date: August 2010

  • Newspaper: Investor's Business Daily

  • Topics: Minimum Wage, Teen Unemployment

On July 24, 2009, the federal minimum wage increased to $7.25, the final step in a series of three hikes passed in 2007. Today, a year later, the unemployment rate for our nation’s teens remains stalled near 25%, with one out of every five unemployed teens searching for work for six months or more. This isn’t a coincidence.

Though intended to lift American workers out of poverty through a 40% pay raise, the major consequence of the federal wage hike instead left many Americans without a job at all — specifically, teenagers age 16 to 19.

There is plenty of debate over the relative merits of minimum wage hikes. But the majority of empirical research suggests that, other effects notwithstanding, forcing employers to pay higher wages for entry-level work leads to fewer opportunities for teens and other less-skilled job seekers.

This makes sense: Imagine that the minimum wage were suddenly raised to $50/hour. Would restaurants continue to hire teenage dishwashers, or would they invest in machinery for automation? The same thing happens, albeit on a much smaller scale, every time the minimum wage goes up.

While the federal minimum wage was climbing between 2007 and 2009, the teen unemployment rate rose from 15.3% to a shocking 24.5%. The deterioration of the U.S. labor market undoubtedly contributed to this dramatic increase in unemployment, but our research shows that the rise in the minimum wage also played an important (and unfortunate) role.

In a new study for the Employment Policies Institute, we compared the experiences of teens in various states to tease out the respective effects of the minimum wage hike and the economic recession. This was possible because the federal wage increase did not uniformly affect all states.

Prior to the first of the three federal hikes, 30 states already had minimum wages higher than the $5.85 federal minimum. For employers in these states, the first federal hike would have virtually no impact on employment. The second and third federal hikes affected more and more states, providing us with a “natural experiment.”

By comparing the employment experiences of teens in the states where the federal hikes were binding to varying degrees, and carefully controlling for state economic conditions, we were able to estimate the effect of the federal hikes on teen employment.

Over the three-year period, we estimate that the 40% increase in the federal wage caused the number of teens employed to drop by 6.9% in states where all three hikes were binding. For teens without a high school diploma, the drop was nearly twice as severe, at 12.4%. In total, the federal increase was responsible for over 114,000 fewer employed teens.

Even those estimates are likely to understate the negative impact of the wage increases because they do not reflect long-term reductions in hiring made possible by increased use of automation to replace the more expensive labor. But the fact that the minimum wage law locked at least 114,000 teens out of jobs is cause for serious concern.

Research by other economists has shown that extended periods of unemployment as a young adult can reduce future earnings and increases the risk of future unemployment.

Despite a large body of evidence, from our study and others, that minimum wage hikes put downward pressure on employment levels, there are still some who argue that mandated pay increases have merit as an effective means of fighting poverty.

Yet there is considerable economic evidence to the contrary; a higher minimum wage has minimal effects on poverty because many of the people earning the minimum wage live in families that are not in poverty (e.g., teens living with parents). Targeted policies such as the earned income tax credit can focus resources on poverty much more precisely and efficiently.

This summer’s miserable teen job market represents a tough lesson in unintended consequences for policymakers in Washington. Before throwing their support behind a future wage increase, they might want to consider the evidence that one of the best ways for workers to improve their earning power is through job experience.

Our own research suggests that nearly two-thirds of all workers earning the minimum wage receive a pay increase within a year, but increases in the minimum wage make it more difficult for teens to get that important start early in life.

• Even is the Raymond E. Glos Professor of Economics at Miami University in Ohio.
• Macpherson is the E.M. Stevens Professor of Economics at Trinity University in Texas.