Three economists were awarded Nobel prizes for their work in studying the effects of minimum wages on unemployment. The prize was awarded for their methodology. The study of economics can be enhanced by “empirical experiments” as opposed to relying on computer models which always require reliance on assumptions, which may or may not be correct.
According to NPR, “the three economists David Card, Joshua Angrist and Guido Imbens were awarded for demonstrating that precise answers to some of society’s most pressing questions can be obtained from “natural experiments.” The Royal Swedish Academy of Sciences says the three have “completely reshaped experimental work in the economic sciences.”
My colleague, who is an economist, tells me that their research work really was groundbreaking and in addition to the research on minimum wage increases they also performed research on immigration, education, and gender-and race-related differences in the labor market. I congratulate them on their body of work.
The bigger story is not the Nobel prize for their methodology. The bigger story is that economists, politicians and other who believe in government control over how much employees earn and greater government interference in the world of business are touting this study as proving that increasing minimum wages does not increase unemployment and does not eliminate jobs. Just like a German band at Octoberfest, they are slapping their lederhosen with giddy euphoria. As one article put it, “However, despite the mounting evidence, the unproven yet influential theory that raising minimum wages directly leads to job loss has continued to persist – a myth peddled by conservative economists and major industry organizations such as the American Chamber of Commerce.”
However, there is also evidence that study is deeply flawed. The study in question, co-authored by the late Alan Krueger, had college students calling store managers and assistant managers at quick service restaurants in New Jersey before and after a state minimum wage increase. The data they sought was the number of full and part-time people employed. They also called stores near the New Jersey border in neighboring Pennsylvania which had not implemented a minimum wage increase. The authors concluded that the New Jersey hike had increased employment, diverging from decades of minimum wage research. What was described as a major development in labor economics was driven by imprecise methodology and was refuted when reviewed by other economists.
The abstract from the study reads as follows: “On April 1, 1992, New Jersey’s minimum wage rose from $4.25 to $5.05 per hour. To evaluate the impact of the law we surveyed 410 fast-food restaurants in New Jersey and eastern Pennsylvania before and after the rise. Comparisons of employment growth at stores in New Jersey and Pennsylvania (where the minimum wage was constant) provide simple estimates of the effect of the higher minimum wage. We also compare employment changes at stores in New Jersey that were initially paying high wages (above $5) to the changes at lower-wage stores. We find no indication that the rise in the minimum wage reduced employment.”
If you read the study (which I did) you will quickly see that the study has numerous major flaws.
First, the study is solely focused on fast food restaurants. Yes, fast food restaurants often pay minimum wages, but fast-food restaurants don’t have many employees. The average fast-food restaurant had about 16 employees in 2004. When you consider that many fast-food restaurants are open as much as 12 to 16 hours a day seven days a week it is likely that at any given point in time, the restaurant is operating with perhaps no more than six to eight employees. The manager at my local KFC close to my house tells me he operates the store with five employees at any given point in time. Even if the restaurant operator wanted to lay someone off, it doesn’t seem feasible that you could immediately reduce your workforce significantly and still run the business (otherwise the owner would have already done so).
Second, the restaurants chosen for the study are major restaurant chains such as Wendy’s, KFC, and Burger King. By the mid-90s (the time of the study) these franchised fast food restaurants were operating tens of thousands of locations across the US and internationally. Why do you buy a franchise? For two reasons. One is for the name. Fast food franchisors spend a lot of money on advertising. The second reason is that the fast-food companies have spent millions on systems and business processes that allow for very efficient operations. Efficient operations mean that you don’t have a lot of excess labor. If KFC has one person frying the chicken, even if minimum wages go up, you can’t get rid of the chicken fryer because then you won’t have a product to sell.
Third, the study involved two interviews with each employer. The interviews were conducted eight months apart. Anyone who has ever run a business knows that eliminating labor, which is typically a function of improved business processes and automation, takes time. The average number of employees in a fast-food restaurant dropped by a little over one person between 2004 and 2018, a period of 14 years. Eight months is too short a time to increase efficiency that could involve replacing major systems (such as cooking equipment or cash registers), both from a cost and a time-to-implement perspective.
Fourth, most of the restaurants in the study were franchises. While today we have many franchisees that operate 10, 20 or more restaurants, that is more recent phenomenon. Historically franchisees owned one or two locations. Small business owners in general are less likely to lay people off because in a small business employees are like family, and in fact may be family members. The study should have included one of those restaurant chains where all the stores are company owed, as opposed to franchised.
Fifth, the study is specific to 410 fast food restaurants and the number of employees. It ignores other actions that business owners might take when wages go up such as slowing down hiring, not opening new locations, opening new locations in other jurisdictions, and not giving out wage increases that the owner might otherwise have given. Further, it ignores the stepped effect of minimum wage increases whereby when minimum wages go up, people all up the line expect, and often get increases. In fact, many union contracts are specifically tied into the minimum wage.
My economist friend points out that this study is significant because classical economic theory suggests that an increase in minimum wage results in an “immediate” decrease in employment. The study shows that there was no “immediate” decrease in employment. Given the flaws I have pointed out in the study I don’t think it can be relied upon anyway, but if he is correct and classical economic theory says the change in employment will be “immediate” then it would seem to me that none of those economists every worked in a business.
While I applaud the efforts of Card et al., the study itself is very flawed based on the conclusions the authors (and other minimum wage and government control advocates) give it. Further the study deals with one aspect of minimum wages – their effect on employment. It ignores nine other very logical reasons why we should not have minimum wages (See my article on that topic).
As a final point, there are some things you just don’t need to study. If you put ten cows in a pasture, they are going to eat grass and make cow pies. This week I parked in a parking lot with no attendant, took money out of my bank account with no teller, bought groceries with no cashier and printed out my boarding pass and baggage tags at the airport with no agent. Businesses made the decision to automate these processes due to the rising cost of labor. Doesn’t make much sense to me that the government should be engaged in passing laws that motivate businesses to replace people with machines.