Chapter 11: Minimum Wage and Unemployment – Comprehensive Notes

Key Concepts

• Minimum wage as a price floor for labor

• Price floors in general tend to create surpluses (more supply, less demand) when set above the free-market-clearing price

• In labor markets, a wage floor above the market wage translates into unemployment (surplus of labor) rather than a surplus of a tangible good

• The “real minimum wage” can be thought of as zero for many workers because unemployment or failure to find work erodes the intended effect of the law

• The discussion integrates theoretical, empirical, and historical perspectives on how minimum wages affect employment, especially for younger, less skilled, or minority workers

The Economics of Price Floors in Labor Markets

• Minimum wage laws make it illegal to pay less than a government-specified wage for labor

• By the simplest economics, raising a price artificially tends to increase supply and decrease demand relative to a free market outcome

• Result in labor markets: an employment surplus is created in the form of unemployment rather than a crude surplus of goods

• Basic model (labor market):

  • Let $Q_d = D(w)$ be the quantity of labor demanded at wage $w$, with D'(w) < 0 (demand falls as wage rises)

  • Let $Q_s = S(w)$ be the quantity of labor supplied at wage $w$, with S'(w) > 0 (supply rises as wage rises)

  • In free market: $D(w^<em>) = S(w^</em>) = Q^<em>$ at equilibrium wage $w^</em>$

  • With a wage floor w_f > w^*:

  • $Q<em>d = D(w</em>f)$, the quantity of labor employers are willing to hire

  • $Q<em>s = S(w</em>f)$, the quantity of labor workers are willing to supply

  • Unemployment (or unemployment duration) $U = Q<em>s - Q</em>d = S(w<em>f) - D(w</em>f) \ge 0$

• Implication: a higher legal wage does not necessarily reflect productivity; if workers’ productivity is lower than the wage floor, many workers are priced out of jobs

• Related ideas:

  • Higher mandated benefits (pension, health, etc.) can have a similar economic effect to higher minimum wages, by increasing employer costs

  • The level of unemployment depends on whether the wage floor is binding for significant portions of the labor force (especially low-skilled and younger workers)

Empirical Evidence and Country Comparisons

• Countries with no explicit minimum wage and/or different benefit structures have varied unemployment experiences:

  • Switzerland: no minimum wage; unemployment around $3.9\%$ in Feb 2003 and $3.1\%$ in Jan 2013; labor unions sought a wage floor but cabinet rejected in 2013

  • Singapore: no minimum wage; unemployment $2.1\%$

  • Hong Kong (1991): unemployment under $2\%$

  • United States (Coolidge era): unemployment as low as $1.8\%$ before federal minimum wage law

• Costs of mandated benefits vs minimum wage:

  • Explicit minimum wages are not the only form of labor cost; government-mandated benefits (pensions, health) raise employer costs similarly to a higher minimum wage

  • In Germany, mandated benefits accounted for about half of average hourly labor cost; in Japan and the U.S. the share was much lower

• Europe and Canada vs the U.S.:

  • Average hourly compensation in EU manufacturing higher than in the U.S. or Japan, and unemployment tends to be higher in Europe as a whole

  • Canada, over a five-year span, had minimum wage rates as a higher share of output per capita than U.S. states, with higher unemployment and longer average duration of unemployment; some Newfoundland unemployment peaked at $16.9\%$

• Long-run and cross-country patterns:

  • Since the 1970s, in many European countries, higher minimum wages and more extensive employer-paid benefits coincided with higher long-term and short-term unemployment, while the U.S. moved toward less government and union influence on labor markets

  • A National Bureau of Economic Research (NBER) review (2006) of dozens of U.S. and international minimum-wage studies concluded a solid tendency: minimum wages reduce employment among low-skilled workers, despite methodological differences across studies

• Specific country observations on youth and overall unemployment:

  • Australia (early 2000s): relatively high minimum wage (about 60% of median wage) but youth unemployment under 25 never fell below $10\%$; overall unemployment seldom exceeded $10\%$ in that period

  • France (early 2000s): national unemployment ~$10\%$, but youth unemployment under age 25 exceeded $20\%$

  • Belgium and Italy (early 2000s): youth unemployment under 25 around $22\%$ and $27\%$, respectively

  • EU downturn around 2002-2009: overall unemployment for those over 25 around $21\%$ in 2009; Italy and Ireland exceeded $25\%$; Spain over $40\%$ for youth

  • U.S. youth (ages 25–34) unemployment rose from historically lower levels in 2000 to higher levels by 2011 relative to peers in Britain, Germany, France, Japan, and Canada

• Unemployment by age, race, and education:

  • Historically, teenage unemployment rates among Black and White youths in the late 1940s were relatively similar when there were no broad minimum-wage laws; by the late 20th century, teenage unemployment soared in many places, with larger gaps for certain groups

  • In the U.S., the Fair Labor Standards Act of 1938 established a national minimum wage; wartime inflation in the 1940s raised wages in the free market above the legal minimum, rendering the law less relevant by the late 1940s; the minimum wage was later escalated in 1950

  • By 1948, Black teenage unemployment (ages 16-17) was $9.4\%$ vs White teens $10.2\%$; for ages 18-19, Black teens $10.5\%$ vs White teens $9.4\%$; these figures show teenage unemployment rates that were relatively low at the time but not representative of later decades

  • In the 1990s and 2000s, a consistent pattern emerged where minimum-wage increases disproportionately affected younger, less-experienced, and minority workers

• The “living wage” and political dynamics:

  • Despite the political appeal of a living wage, many minimum-wage workers are not supporting a family; a large share live with parents or relatives, and only a minority are financially supporting themselves and dependents

  • Some cities implement local living-wage laws, extending wage floors beyond federal or national minimums

• Real-world examples illustrating the mechanism:

  • West Africa (colonial era): a economist (PP Bauer, London School of Economics) observed high money wages relative to productivity and high unemployment in underdeveloped sectors; this reflected external pressure to maintain high wages

  • Nigeria (tobacco factory): a manager described ongoing applications for employment despite not expanding the labor force, illustrating the mismatch between wage levels and productive expansion

  • South Africa in the 1990s and early 2000s: multinational firms shifted production to Poland where labor costs were lower, due in part to high South African minimum wages and labor costs, leading to capital-intensive production in other regions

  • The Tiger Wheels case: a high labor cost environment in South Africa prompted expansion in Poland instead of South Africa, illustrating the real-world impact of wage floors and benefits on firm location and employment

  • The general point: for larger populations, artificially high wages can benefit insiders (employed workers or unions) while outsiders (unemployed or underemployed workers) lose, and consumers bear the cost of reduced output and higher prices

• The quality versus price intuition applied to labor markets:

  • A price floor suppressing demand can lead to a deterioration in product quality if buyers are forced to accept lower-quality options due to scarce high-quality suppliers

  • Conversely, a price floor above the market can enable buyers to cherry-pick and demand higher-quality outputs, which in labor markets translates to higher qualification requirements and potential unemployability for lower-productivity workers

Employment Duration and Dynamics

• Unemployment is not only about the quantity but also the duration; countries that raise labor costs via minimum wages or generous mandated benefits tend to experience longer-duration unemployment

• In some cases, long-term unemployment (e.g., >1 year) is more prevalent in countries with higher ongoing labor costs and stronger unions; in the U.S., long-term unemployment share rose as policy and market conditions evolved

Methodological Issues in Studying Minimum Wages

• Studies that survey employers before and after a minimum-wage increase can suffer from survivorship bias: they often only include firms that survived between periods

• If high-wage/high-cost sectors fail and new firms enter, cross-sectional survivorship samples may misstate industry-wide effects

• Analogy used: surveying only survivors is like playing Russian roulette – it can mislead about the danger of the practice

• Important implication: industry-wide effects may be larger (more unemployment) than what survivor-based surveys suggest

Policy Implications and Alternatives

• The preponderance of evidence across multiple countries supports the view that minimum wages tend to reduce overall employment, especially for youths, the unskilled, and minority workers

• Policy responses discussed include:

  • Reconsidering the reliance on explicit minimum wages to protect low-wage workers

  • Using targeted measures or subsidies to support low-income workers without pricing them out of the labor market

  • Considering inflation-adjusted real minimum wages to avoid erosion through price-level changes instead of explicit repeal

  • Recognizing the role of unions and their influence on wage-setting, and how this interacts with employment outcomes

• Several economists across countries (Britain, Germany, Canada, Switzerland, the United States) have expressed concerns about the employment impact of minimum wages; however, some economists in France and Austria did not find the same effects in their surveys

Case Studies and Anecdotes

• Tiger Wheels (South Africa): a major plant expansion in Poland rather than South Africa due to high labor costs and restrictive labor laws; example of how minimum wage and related costs shape firm location decisions and national economic outcomes

• Colonial West Africa (mid-20th century): widespread high money wages in some sectors but high unemployment due to productivity constraints and external wage pressures

• Germany (late 20th/early 21st century): no national minimum wage, but strong job-security laws and union presence kept labor costs high; by a February snapshot, >50% of unemployed had been unemployed for a year or longer

• United States (across eras): the wartime inflation era led to wages rising above the nominal minimum, reducing the policy’s relevance; post-1938 FLSA and subsequent escalations influenced long-run employment dynamics

Connections to Foundational Principles and Real-World Relevance

• The debate centers on the fundamental economic principle: prices (including wages) coordinate supply and demand

• Minimum wages represent a political mechanism to set a price floor; the economic consequence is a potential mismatch between price and productivity, leading to unemployment in some segments of the labor force

• The evidence across countries points to a recurring pattern: higher labor costs via minimum wages or mandated benefits tend to correlate with higher unemployment and longer unemployment durations for low-skilled or younger workers

• The empirical literature (notably the 2006 NBER review) emphasizes the overall tendency for minimum wages to reduce employment among low-skilled workers, though research methodologies vary and some studies report little or no impact in specific contexts

Summary Takeaways

• A wage floor above the market-clearing wage tends to create unemployment among workers whose productivity is below the floor level

• The strongest employment effects are observed among younger, less skilled, and minority workers

• Real-world data across many countries show associations between higher minimum wages or higher mandated benefits and higher unemployment or longer unemployment durations, though the magnitude and specifics vary by country, sector, and time period

• Methodological challenges (like survivor bias) complicate the measurement of employment effects, but the weight of evidence supports the basic economic intuition

• Policy responses include careful design of wage policies, consideration of inflation-adjusted real wages, and targeted approaches to protect workers without pricing them out of the labor market

Qd = D(w), \ Qs = S(w), \ w^:\ D(w^) = S(w^), \ wf > w^:\ Qd = D(wf), \ Qs = S(wf), \ U = Qs - Qd = S(wf) - D(w_f) \ge 0.