Wednesday, 14 September 2022

The minimum wage and hiring standards

A key implication of the demand and supply model of the labour market is that a firm will only hire a worker if the worker produces more additional value for the firm than what is costs the firm to employ them. In more technical language, the firm hires workers up to the point where the value of the marginal product of labour is equal to the wage. If wages go up, then firms will find that there are fewer workers who meet the higher threshold, and so firms will hire fewer workers. Firms will keep their most productive workers, and let the least productive workers go.

So, when a minimum wage is introduced, or when a minimum wage is increased, we would expect firms to adjust their hiring standards, and employ slightly more productive workers. That is the theory that is tested in this recent article by Sebastian Butschek (University of Innsbruck), published in the American Economic Journal: Economic Policy (sorry, I don't see an ungated version online).

Butschek looks at the case of Germany, which only implemented a national minimum wage in 2015 (equal to €8.50). He uses linked administrative data on around 440,000 workers at around 1500 firms, including every employee who worked at any of those firms (even if only for one day) between 2010 and 2016. To avoid picking up any anticipatory effects (as noted briefly in yesterday's post), he drops all data from 2014, and essentially compares the 'hiring standards' between firms that employ lots of workers at the minimum wage (or below, prior to its introduction) with firms that employ no workers at the minimum wage.

To measure hiring standards, Butschek first estimates a measure of productivity for each worker. He estimates a wage regression, controlling for individual characteristics of workers (like their age and education) and fixed effects for firms. The fixed effect for each worker is essentially a measure of how much different that worker's wage is, after controlling for their observable characteristics (and the firm they work for). These worker fixed effects are a good proxy for (unobserved) productivity differences between workers, and Butschek uses the average fixed effect as his measure of hiring standards for each firm.

Now, looking at how the hiring standards change as a result of the introduction of the minimum wage, the results are summarised in Figure 5 in the paper:

Notice that, relative to 2013, the average hiring standard is very similar in earlier years, but jumps up in 2014, and continues to be higher in 2015 and 2016. Using a regression model, Butschek finds that:

...the statutory minimum wage increased new hires’ minimum daily pay by about €6.60 and minimum hire quality by 0.086... The effect on hire quality corresponds to a shift of treated firms’ hiring standards from the seventh to the eleventh percentile of workers’ pre-reform productivity distribution.

So, as expected, firms respond to the minimum wage by hiring workers that are, on average, more productive. What happens to the least productive workers though? Butschek looks at them, and somewhat surprisingly finds (using a different data source) that:

...the low-skilled who would have counterfactually been hired by affected firms neither remained unemployed nor left the labor force. Instead, these [low-productivity] workers appear to have stayed with their previous employers in greater numbers and experienced less churn, obviating the need for renewed hire.

This is a surprising result, and would only make sense if the minimum wage induced low-productivity workers to work harder and be more productive. Perhaps workers anticipated that the introduction of the minimum wage put their jobs at risk. Or perhaps (following a line of argument from Nobel Prize winner George Akerlof, that employment is like a gift exchange), the workers feel better about their employer and will work a bit harder when their wage is higher. Or perhaps, it is a data issue - productivity can only be measured for those who are in the dataset for multiple periods, which may exclude those who are long-term unemployed, or new entrants into the labour market. Those are both groups that might be most negatively affected by the introduction of a minimum wage. This suggests we would need a bit more research before we conclude that minimum wages increase hiring standards, without harming low-skilled workers at all. However, it does appear that hiring standards do increase as a result of the minimum wage.

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