A Perfect Storm for the Minimum Wage

Includes: DIA, QQQ, SPY
by: Casey Mulligan

Textbook economic theory says that the minimum wage reduces employment according to (a) the gap between the minimum and the equilibrium wage and (b) the wage elasticity of labor demand.

By 2009, the perfect storm had formed that might even make the minimum wage noticeable from an aggregate point of view:

  • The equilibrium wage likely fell due to deflation (about -2.1% July 2008 - July 2009)

  • The equilibrium wage likely fell due to an increased supply of part-time workers, such as persons fired from their full-time jobs. Supply increased at least 10 percent in the quantity dimension, which pushed down the equilibrium real wage roughly 3 percent

  • The nominal federal minimum wage had gotten high thanks to two recent previous hikes

  • The nominal federal minimum wage was hiked again another 11 percent (from $6.55 to 7.25 per hour).

Thus, by June 2009 the federal minimum probably already exceeded the equilibrium wage for a significant number of workers, especially those part time. For example, the BLS estimates that 2.3 million part-time workers were at or below the federal minimum in 2009 (BLS does not specify which month or months, but I presume March gets a lot of weight), as compared to 1.4 million a year earlier.

So let's say that 2 million workers were affected by the 11 percent hike on July 24, 2009. With a labor demand elasticity of -3 (that's what Cobb-Douglas would predict), the textbook theory says that a half a million part-time workers would lose their jobs (or fail to be hired) due to the July 24, 2009 hike (525,177 = [1-(6.55/7.25)^3]*2,000,000).

Interestingly, the national data do suggest that about 500,000 part-time jobs were lost.

Without this perfect storm, the minimum wage would not be something of interest to macroeconomists, but "just" to observers of low-skill labor markets. Conversely, don't expect to see aggregate effects of the minimum wage unless the storm is as perfect as this one.