In yesterday's post, I made reference to this 2021 article by Jeffrey Clemens (University of California at San Diego), published in the Journal of Economic Perspectives (open access). Clemens puts forward an interesting perspective on the debate about the observed employment impacts of the minimum wage (or lack thereof):
...I contend that controversies over the economics of minimum wages stem, to a surprising degree, from a common but under-considered assumption. The assumption of interest is that when studying labor markets, output prices and nonwage aspects of jobs (which include benefits and working conditions) can be taken as fixed. In standard diagrams of the labor market, this assumption implicitly underlies each supply or demand curve. When these curves are held fixed, output prices and nonwage aspects of jobs have also, whether implicitly or explicitly, been held fixed...
...textbook models of both perfectly and imperfectly competitive labor markets sweep many factors under the rug. Benefits, including employer-provided health insurance, account for around one-third of compensation costs... Working conditions, including safety measures and flexible schedules, can also have value to workers while generating costs to firms... In the jargon of undergraduate instruction, the ceteris paribus assumption (that is, “other things held constant”) that professors invoke when we draw labor supply and demand curves is unlikely to describe the real world.
Clemens then goes on to show how changes in the non-wage aspects of jobs affect employment, using the standard supply and demand model. I'm going to reproduce that here, but with a couple of modifications. First, I'll show an increase in the minimum wage in each diagram (Clemens shows changes without changing the minimum wage). Second, I'll explain the changes using the language I use in my ECONS101 and ECONS102 classes, to make it more familiar for my students (past and future - my first ECONS101 class for 2025 starts two weeks from today).
The standard demonstration of the effect of an increase in the minimum wage is shown in the diagram below. The equilibrium wage, W0, is the wage where the quantity of labour supplied (Q0) is exactly equal to the quantity of labour demanded (Q0). Economists say that the market clears. Every worker who wants to work for the wage W0 is able to find a job that pays W0. Now consider the effect of a binding minimum wage, WMIN1, which is higher than the equilibrium wage. The quantity of labour supplied increases to QS1, because more workers want to work (or because already-employed workers want to work even more) at the higher wage. The quantity of labour demanded decreases to QD1, because employers want to employ fewer workers as they are now more expensive. The difference between QS1 and QD1 is structural unemployment arising from the minimum wage. The decrease in employment as a result of the minimum wage is the difference between Q0 and QD1. If the government increases the minimum wage from WMIN1 to WMIN2, then the quantity of labour supplied increases even more (to QS2), and the quantity of labour demanded decreases even more (to QD2). Structural unemployment increases (to the difference between QS2 and QD2), and the employment impact of the minimum wage increases as well (to the difference between Q0 and QD2). The employment impact of the higher minimum wage (compared to the lower minimum wage) is the difference between QD1 and QD2.
Now consider alternative firm responses to an increase in the minimum wage. The first example that Clemens uses is pass-through of the increased costs onto consumers:
If demand for a firm’s output is not perfectly elastic, it can raise prices while losing some, but not all, of its customers. A price increase in response to a minimum wage increase is often called pass-through: that is, the minimum wage’s cost passes through the firm to its consumers. An increase in output prices implies an outward shift of the labor demand curve...
The demand curve shifts out to the right because, if the firm increases the price that it sells its output for, each worker now produces more value for the firm, and so the firm will want to hire more workers. This is shown in the diagram below. At the same time that the minimum wage increases from WMIN1 to WMIN2, the demand for workers increases from D0 to D3. Now, although the quantity of labour supplied still increases to QS2, the quantity of labour demanded only decreases to QD3. Structural unemployment increases, but by less (to the difference between QS2 and QD3), and the employment impact of the higher minimum wage (compared to the lower minimum wage) decreases to the difference between QD1 and QD3.
Notice that firms' ability to pass-through the higher minimum wage onto consumers in the form of higher prices will make it more difficult to detect any employment impact. Not all firms can pass-through higher costs equally. Clemens notes that the price elasticity of demand for the firm's output matters:
Firms that produce widely traded goods or services may face large demand elasticities and thus have little capacity to raise prices. By contrast, firms that produce “nontradable” goods and services may face smaller demand elasticities and have more substantial scope for passing cost increases to consumers... Standard examples of non-tradables include beauty services, meals at restaurants, and home construction, which are more or less constrained to be provided where they are consumed. Pass-through may also depend on whether the minimum wage is increased at the city, state, or federal level. When a minimum wage increase is localized, there is greater scope for importing products from unaffected firms.
The second example that Clemens uses is 'non-cash compensation', which is essentially the additional benefits that firms provide to workers. These may include health insurance, contributions to retirement savings, travel allowances, a company vehicle, and so on. If firms respond to higher minimum wages by reducing the value of non-cash compensation, then this:
...can shift both the supply curve and the demand curve...
From the perspective of firms, lower noncash compensation implies a higher labor demand curve because it increases revenues net of nonwage costs. From the perspective of workers, lower noncash compensation implies a higher labor supply curve, since a higher wage is required to make employment attractive when nonwage benefits are lower.
These combined effects are shown in the diagram below (and we are now ignoring any pass-through of the higher minimum wage to consumers). The demand curve increases to D4, and the supply curve decreases to S4. The overall effect of the higher minimum wage, compared with the lower minimum wage, is no effect on either the quantity of labour supplied (which remains QS1) or the quantity of labour demanded (which remains QD1), and so there is no effect on structural unemployment and there is no effect of the higher minimum wage on unemployment (compared with the lower minimum wage). However, this outcome is purely an artefact of how I have chosen to draw the diagram (as was the case in Clemens' article). If the effect of lower non-cash compensation was larger for workers than shown in the diagram, then the shift in supply will be larger, and structural unemployment will increase (although the employment impact of the minimum wage would still be unaffected). The reverse is true for a smaller effect for workers. And, if the effect of lower non-cash compensation was larger for employers than shown in the diagram, then the shift in demand will be larger, and structural unemployment will increase (and the employment impact of the minimum wage would be negative). The reverse is true for a smaller effect for employers (and in that case the employment impact of the minimum wage would be positive). [*]
Finally, Clemens discusses employer changes in 'productive disamenities' and 'unproductive amenities':
Conceptually, a firm facing minimum wage increases might seek to offset some of the increase in costs by raising productive disamenities (like effort requirements) and reducing unproductive amenities (like the quality of office furniture). As with changes in noncash compensation, these changes will shift both the supply curve and the demand curve...
Increases in productive disamenities... imply upward shifts in the labor demand curve (due to an increase in marginal product) and upward shifts in the labor supply curve (due to an increase in disutility from work effort).
I'm not going to draw a new diagram for this situation, as the third diagram above already shows the effect of increasing the demand for labour (which would happen if firms increased productive disamenities) and decreasing the supply of labour (which would happen if firms decreased unproductive amenities). Clemens notes that there is little empirical evidence
...little, if any, empirical evidence on the minimum wage’s effects on scheduling, workplace safety, workplace comfort, and other related margins.
However, Clemens' article was published in 2021, and the literature has moved on. These firm responses relate directly to the new empirical evidence I discussed in yesterday's post about workplace safety. The Davies' et al. paper showed an increase in workplace injuries, and suggested that it arose because of firms demanding increased effort from workers (an increase in a productive disamenity). The Liu et al. article showed an increase in workplace injuries, and instead suggested that it arose because firms were spending less on workplace safety (a decrease in an unproductive amenity).
Finally, Clemens turns to other adjustments that firms might make, including changes in profits, firms shutting down, changes in job design and production technologies, and firms' compliance with the minimum wage (the latter of these will be the subject of my post tomorrow). It is clear that there are many ways that firms can respond to a higher minimum wage, and that changes in employment are not the only relevant margin that researchers should be considering. In fact, changes on these other margins may cause researchers to erroneously conclude that there are no employment effects of a higher minimum wage, when they solely focus on the number of jobs.
[HT: Marginal Revolution, which reminded me that I hadn't read the Clemens article]
*****
[*] I haven't drawn all of these alternative scenarios, but I am confident that you can imagine smaller or larger shifts in the demand or supply curves, and their effects. Otherwise, this would turn into an even longer post than it already is!
Read more:
- A bunch of research findings on minimum wages in New Zealand
- The disemployment effects of Canadian minimum wages
- Jeffrey Clemens on the disemployment effects of the minimum wage
- The impact of an online minimum wage
- Seattle's minimum wage, revisited
- The latest evidence supports negative employment effects of the minimum wage
- Latest research suggests the minimum wage DOES reduce employment
- More empirical support for the disemployment effects of the minimum wage
- The minimum wage and job vacancies
- The minimum wage and hiring standards
- The employment effects of the minimum wage, from American Community Survey data
- The minimum wage and homelessness
- New York restaurants find a new way to respond to the minimum wage
- The minimum wage and workplace safety
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