Economics

When wages go up, do jobs go down? Here is the Knight’s solution to the problem

Do Lower Minimum Wages for Young Workers Raise their Employment? Evidence from a Danish Discontinuity

This is a must read for those interested in labor economics. One picture summarizes this paper  well:

danish wages paper

The charts above show that as wages increase on the date of the employees’ 18th birthday, the employment rate drops dramatically. This is a perfect example of two theories I’ve put forth. The first is that large wage increases dramatically shock the economy and lead to job losses. The better solution is to have gradual, consistent wage hikes over time, such as, say, 5% per year. Now, to be fair, those who kept their jobs benefited from the higher wages.

The second theory is such that when companies are forced to make a wage hike, there will be carnage. If businesses come to the conclusion that they need a wage hike to increase productivity and decrease employee turnover, then they will raise wages on their own accord without layoffs. The below from this paper supports this assertion:

On average, the hourly wage rate jumps up by 40 percent when individuals turn eighteen years old. Employment (extensive margin) falls by 33 percent and total labor input (extensive and intensive margin) decreases by around 45 percent, leaving the aggregate wage payment nearly unchanged.

This is a great finding by these researchers because it is a reminder that businesses are not always looking to cut wages, rather they base hiring and firing decisions on output. Meaning that for wages to pick up, there will need to be an increase in demand to warrant higher wages or more hiring. Economically, to increase demand we need fiscal stimulus. Unfortunately many (most? all?) developed economies are over leveraged and increasing spending is politically dangerous. This means that tax cuts (for the wealthy) are not the solution because the government needs to capture as much tax dollars they can from the fiscal stimulus without derailing the demand side. And since the marginal propensity to save vs consume is significantly higher for the wealthy than the middle classes then giving the wealthy tax cuts does not benefit the economy. This is a difficult tight rope to walk.

One more great tidbit I want to point out from this paper is below:

Almost 20 percent of individuals leaving employment one month after turning 18 and another job in the next month. However, by one year after job separation at age 18, only 40 percent of separated individuals are employed, compared to just over 75 percent of individuals who did not experience a separation. Even two years after turning 18, individuals who kept their job at age 18 are about 20 percent more likely to be employed than individuals who did not, and employment in the job loss group is still increasing significantly over time, suggesting that these workers continue to seek jobs.

This finding is important for many reasons, but I will mention two of the most important. The first is that the increased minimum wage for those over 18 is depressing employment rates as businesses are not willing (or able) to pay the higher wage going forward. And the second important note is that being out of the workforce makes it more difficult to get a job as time goes on. Both of these trends do not bode well for economies that increase wages dramatically. Again, I must reiterate, the best solution is gradual increases to wages that do not shock the system.

Categories: Economics, Employment, Wages

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