The minimum wage juggernaut
The case for a minimum wage seems to have been strengthened by the growing discontent over inequality in the Western world, especially after the great financial crash of 2008
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A move to raise the federal minimum wage in the US by roughly 30% to $10.10 per hour failed on Wednesday after Republicans in the Senate opposed the move. The move, backed strongly by US President Barack Obama, may yet be revived. But irrespective of its fate in Washington DC, several states in the US are already moving ahead to raise the minimum wage floors in their respective states, the New York Times reported.
The US is not the only economy to see a vigorous push to raise the wage floor. In a historic decision last month, German Chancellor Angela Merkel introduced the country’s first minimum wage at $8.5 euros per hour. Later this month, Switzerland will be voting on whether it too should be setting a national wage floor for the first time in its history.
The case for a minimum wage seems to have been strengthened because of the growing discontent over inequality in the Western world, especially after the great financial crash of 2008. While political rhetoric has played a part in driving the minimum wage campaign in the Western world, the role of rigorous empirical economics has been pivotal in overturning long-held theories about the minimum wage, and its supposedly harmful effects on aggregate employment.
Before the French economist Thomas Piketty enthralled the world with his audacious attack on the edifice supporting neoclassical economic theory to argue that capitalism may have a natural tendency to perpetuate inequality, it was an economist of Indian origin, Arindrajit Dube, whose empirical research challenged the conventional economic wisdom about the minimum wage. Dube, along with fellow economists T. William Lester and Michael Reich, authored a widely cited research paper in 2010 that showed that raising minimum wages had no discernable impact on employment after accounting for other factors that determine employment levels in a particular region.
Dube, an associate professor of economics at the University of Massachusetts, Amherst, used data on contiguous county pairs across state borders during the time when one state had raised minimum wages to isolate the impact of the minimum wage increase on employment from other influences. Dube’s path-breaking research has helped shift the consensus within the economics profession on the issue of minimum wage, and led him to testifying before the US Senate committee on health, education, labour and pensions.
Of course, the debate on the impact of minimum wage increases is not settled yet. But the very fact that the weight of empirical evidence seems to tilt against conventional wisdom on minimum wages is significant. The textbook economic model of labour markets has held for long that at an aggregate level, firms will hire fewer workers if wages are pushed up artificially. Higher the minimum wage, bigger the job losses, the story went. For long, this was held to be an inviolable principle. A section of economists still supported the minimum wage in the past, on the grounds of fairness and the right of workers to a ‘living wage’ despite conceding that such standards may lower aggregate employment.
The new findings have challenged the basic contention about wage hikes leading to job losses, shifting the grounds of the debate, and adding a powerful weapon in the hands of minimum wage proponents. A few weeks back, the National Restaurant Association (a lobby group for restaurants, the largest employers of minimum wage workers) issued a statement opposing a minimum wage increase with signatures from 500 economists, including four Nobel laureates. The progressive Economics Policy Institute struck back with another letter advocating the hike, signed by over 600 economists, including seven Nobel laureates. Bloomberg Businessweek called the exchange an ‘arms race for economists’.
The first empirical challenge to the textbook model of minimum wages sprang from two renowned labour economists, David Card and Alan Krueger, whose case-study of a minimum wage hike in New Jersey in 1992 showed that it actually had raised the number of jobs. Two other economists, David Neumark and William Wascher, studied the same example using what they claimed were more accurate methods to show exactly the opposite: the minimum wage hike had reduced employment. Almost a decade later, the two sets of researchers examined each others’ methodologies, and toned down their respective findings to argue that the hike may not have had as much impact as they had thought earlier. The two sets of researchers continued to differ on the direction in which employment moved, though.
It is in such a context that Dube’s work holds appeal. Dube argues that both the case-study and cross-sectional approaches favoured by earlier researchers are flawed because they ignore other important factors (such as the stage of the business cycle) which have a large bearing on employment numbers, and which vary from region to region. Dube’s paper combines both approaches to show that employment effects of minimum wage hikes in the US are not very significant. In a more recent paper co-authored with Lester and Reich, Dube points to evidence suggesting that raising minimum wages may actually improve labour market outcomes by lowering turnover rates of low wage workers, who have greater incentive to stay in their jobs when they are paid a decent minimum wage. The textbook model does not work because of labour market frictions, Dube argues. Dube is of course cautious enough to point out that there can be too much of a good thing: beyond a point, minimum wage hikes can begin to hurt. He advocates indexing of minimum wages to inflation to ensure predictability of minimum wage hikes .
Many readers will be familiar with the work of one of Dube’s students at Amherst, Thomas Herndon, and two of his colleagues, Michael Ash and Robert Pollin, who produced that devastating critique of Carmen Reinhart and Kenneth Rogoff’s work on debt last year. The trio’s paper shook the world of macroeconomics by challenging Reinhart and Rogoff’s celebrated hypothesis that beyond a threshold level, a country’s indebtedness pulls down growth. But it was Dube’s empirical analysis that showed that the causality could run the other way: it is slow growth that leads to accumulation of debt and not the other way around, Dube’s research suggested.
After the Reinhart-Rogoff controversy broke, Dylan Mathews of the Washington Post wrote a very interesting profile of the unconventional economics department at Amherst which is producing such offbeat econometric results.
Both Piketty and Dube seem to represent a new generation of post-Marxist economists whose rejection of Marxist economics have not turned them blind to the faults of capitalism or of economic policies as they exist today. Unlike an earlier generation of Cold War era scholars, which felt compelled to either defend antiquated Marxist notions about inequality or to attack them, the newer generation feels free to eschew such rhetoric and get their hands dirty with data. Dube, a Ph.d from the University of Chicago, considered the high temple of conservative neoclassical economics, for instance tells Mathews in the piece cited above that he is not particularly interested in ‘labels’ and never aimed to be a ‘good Chicago economist’.
The willingness of policymakers to embrace the heterodoxy among the rising stars of economics today perhaps springs from the disappointment of the great financial crash of 2008. Many feel that the origins of the financial crisis lay in the intellectual capture of policymaking by one dominant school of thought.
Economics Express runs every Friday, and features interesting reads from the world of economics and finance.