Increases in the minimum wage are effectively paid by consumers, but they lower inequality anyway

This post includes some good news, and some bad news, about increases in the minimum wage. Tobias Renkin's (University of Zurich) job market paper, co-authored with Claire Montialoux (UC Berkeley), and Michael Siegenthaler (ETH Zurich), has the details. In the paper, Renkin et al. estimated the pass-through of increases in the minimum wage into grocery store prices. In other words, they estimate whether it is consumers (full pass-through), grocery stores (no pass-through), or some combination of the two, that faces the costs of increases in the minimum wage for grocery store employees. Why care about grocery stores? The authors explain:

Grocery stores employ a substantial number of minimum wage workers, and their marginal costs are therefore likely affected by minimum wage hikes. Moreover, groceries make up a large share of consumer expenditure, especially in poor households and grocery prices thus substantially affect the real incomes of workers.

Most studies of the minimum wage look at hospitality (e.g. restaurant) workers, so it's good to have an alternative. Their price data contains U.S. data on:

...weekly prices and quantities for 31 product categories sold at grocery and drug stores between January 2001 and December 2012. On average, the sample covers 1,916 stores and 60,600 products over this period... Stores are located in 530 counties, 41 states and belong to one of about 90 retail brands... The data covers 17% of US counties which are home to about 29% of the overall population.

Unlike previous studies though, the authors argue that the date at which grocery stores make their price adjustments is the date that the minimum wage increase is announced, rather than the date it takes effect (which is usually some time later). Their analysis seems to back this up, with statistically significant effects on and around the date of the legislation, and less so around the date of implementation, of minimum wage increases.

The key results are for the minimum wage elasticity of grocery prices. That is the percentage change in grocery prices divided by the percentage change in the minimum wage, and can be interpreted as the percentage increase in grocery prices that would result from a one percent increase in the minimum wage. The results suggest that this elasticity is around 0.02. That is, a 1 percent increase in the minimum wage would increase grocery prices by around 0.02%. That doesn't sound like a lot, but the authors explain that:

In our sample, the average minimum wage legislation increases the minimum wage by about 20% in several steps. Our estimates suggest that such an increase raises prices in grocery stores by about 0.4% over three months at the time when legislation is passed. By the time the minimum wage has actually risen to the level set in the new legislation, price adjustment is already long complete.

There are lots of robustness checks that demonstrate the result is fairly robust. To work out how much of the minimum wage increase is passed through to consumers though, we need to also know what the minimum wage elasticity of grocery store costs is. That is, we need to know how much grocery store costs increase by when the minimum wage increases by one percent, and then compare that to the minimum wage elasticity of grocery prices. They authors find that:

Our estimate for pass-through based on our baseline specification amounts to 1.1. We cannot reject the hypothesis that pass-through is equal to 1...

In other words, all of the increase in the minimum wage is passed through to consumers. Grocery stores essentially pay none of the cost of the minimum wage increase. That is the bad news.

That might make you wonder then, since low income households spend the highest proportion of their income on food, and minimum wage increases are passed through in higher prices to those households (and richer households, of course), is the minimum wage increase entirely eaten up by higher prices? The authors address this question as well, and find that:

Expressing the costs as a percentage of annual household incomes reveals the regressive impact of the price response. The costs make up about 0.2% of annual income for households in the poorest bracket, and just one tenth of that, i.e. 0.02% for households in the richest bracket.

As a percentage of household income, the increase in grocery store prices are disproportionately borne by lower income households. However, the good news is that:

As expected, minimum wages reduce income inequality... In terms of nominal gains, households in this bracket gain an additional 1.5% of household income over an inequality neutral policy. Taking into account the price response in grocery stores reduces the additional gains to 1.34% and further taking into account restaurants reduces the gains to 1.15%.

Even though lower income households spend a higher proportion of their income at grocery stores than higher income households, they also benefit proportionately more from the increase in the minimum wage, and the increase in household income is not all eaten up by increases in grocery prices.

[HT: Marginal Revolution]