Evidence About Wage Rate Differences andthe Consequences of Minimum-Wage Ratesfor Unskilled Workers

In this section we use some recent research by labor economists to determine the importance of the issues raised in the last section. Much of the research refers to the increasing gap between the wages of the highest paid workers and the lowest paid workers in America over the last two decades, but the research utilizes the models employed in the last section and illuminates the issues that we have discussed.

Kevin Murphy and Finis Welch provide information about the structure of wages among white men in the United States from 1963 to 1989. They provide age profiles of average wages for four groups of workers, based on education levels. An age profile of average earnings is a graph with age on the horizontal axis and average wages for workers of each age on the vertical axis. It is expected that this relationship is concave, indicating that wages increase with experience but at a decreasing rate. Murphy and Welch break the individuals in the data set into four groups—high school dropouts, high school graduates, those with one-to-three years of college, and college graduates. They report that average earnings of the more-educated are greater than those of the less-educated, although there are many individuals who do not conform to the averages. That is, there are many high school graduates who make more than college graduates do.

Murphy and Welch use the averages for all the years as a measure of the baseline wage structure. They find that: (1) High school dropouts earn about twenty-five percent less than high school graduates earn; (2) High school graduates earn fourteen to fifteen percent less than those with some college; and (3) College graduates earn forty-four percent more than high school graduates earn. There are significant differences for specific years over the time period analyzed, but a positive relationship between wages and education levels always holds.

Experience is the second method of acquiring human capital. The age profiles for each group are concave, as expected. For the time period as a whole, Murphy and Welch (296) report that the average wages of men with sixteen-to-thirty-five years of experience exceed the average wages of new entrants (one-to-five years of experience) by seventy-to-eighty-five percent, depending on the level of schooling completed. Of the four education groups, the group with the greatest average return to experience is high school graduates (eighty-five percent). Those with some college had the lowest return to experience, at seventy percent, while the return to experience for college graduates was seventy-five percent and for high school dropouts was seventy-eight percent. Clearly, experience is an important source of income-earning ability, especially for workers with relatively low levels of education.

Katz and Murphy examine relative wage differentials from 1963 to 1987 in the United States. They report that all the major relative wage differentials increased during the time period, with the exception of the male/female wage differential. They find that the wage premium for experience expanded substantially over the entire time period, and was greatest for less-educated males from 1979–1987.¹¹ They also find that the male/female wage differentials narrowed substantially from 1979 to 1987. After analyzing the differences, using a basic supply and demand framework, Katz and Murphy conclude that the relative wages of more-educated workers and of women increased substantially from 1963 to 1987, and that the evidence indicates that there was an increase in demand for more-educated workers, women, and more-skilled workers during the time period.

Topel and Topel and Ward focus more on the roles that experience and seniority play in determining wages. Seniority refers to time spent working for one firm. Topel finds that the average returns to seniority are substantial—ten years of job seniority raise the wage of the typical male worker in the United States by over twenty-five percent compared to what he could get elsewhere. This supports the idea that the accumulation of job-specific human capital is important in generating higher wages. Topel also finds that the reward to general experience is substantial and that relative wage growth is most rapid at the beginning of new jobs.

Topel and Ward examine the effect of job mobility on wages of young men, using data from 1957–1972 for the United States. They note that the American labor market is characterized by substantial increases in wages and in job mobility, with an average worker changing jobs ten times. Further, about two-thirds of the lifetime wage growth occurs in the first ten years of a career. An important finding is:

Among the young men who comprise our sample, multiple job holding, rapid turnover, and return to past employers are common. Transitory jobs and employment spells followed by a gradual move toward stable employment characterize the prototypical career sequence.… A revealing feature of the data is that it is extremely difficult to tell when individuals leave school to enter full-time work. In some cases the break is not as dramatic as full-time schooling models suggest but, rather, seems best characterized as a gradual shift from nonparticipation to full-time employment along a path of high turnover and intermittent work.

The authors find that younger workers have a weak attachment to the labor force. Naturally, some of this effect is due to summer employment and part-time jobs held by persons in school.

Other findings of interest to our analysis are: (1) The average person holds three jobs in his first full year of actual employment; (2) The average frequency of job mobility is a declining function of current job tenure; (3) Nearly three-fourths of all first-year job endings result in a transition to nonemployment; (4) More than one-third of early career wage growth is associated with changing jobs; and (5) Larger wage gains at job transitions are associated with a decline in subsequent job mobility. Topel and Ward conclude that the data are consistent with models of on-the-job search in which a worker stops searching for a better job when he is satisfied with the job he currently has.

The studies discussed above illustrate several things about the U.S. labor market:

For young workers, there is substantial turnover and movement into and out of the labor force.

These findings suggest that an important factor in the long-term economic viability of a young person, especially a young person without college, is the ability of the person to obtain a first job. Without the acquisition of human capital provided by additional schooling, the individual needs work experience to acquire human capital and to command higher earnings in the future. For low-skilled workers, that is, young, relatively poorly educated workers, obtaining job experience is crucial. If firms will not hire low-skilled workers because they are forced to pay a relatively high minimum wage, the low-skilled workers cannot get the job experience that would enable them to later obtain a job that pays a substantially higher wage. The question is, then, What are the effects of increases in the minimum wage on employment?

Until recent years, economists were almost uniform in agreement about the effects of minimum-wage legislation—increased unemployment of the least-skilled workers, who tend to be young workers, especially minority young people. Basic supply and demand analysis implies that a wage set above the market-clearing wage will generate unemployment.¹⁶ Welch is an example of the work that economists relied upon to arrive at their conclusions regarding the effects of higher minimum wages. Welch focuses on teenagers in the analysis of the minimum wage.

He concludes: (1) Minimum-wage legislation reduced employment of teenagers; (2) Minimum-wage legislation made teenagers more vulnerable to the vagaries of the business cycle; (3) Minimum wages have large effects on the distribution of teenage workers across industries. (This is because minimum-wage legislation in the United States did not cover all industries, so that teenagers moved into the industries not covered by the legislation to find work); and (4) There is evidence that minimum-wage legislation disproportionately affected minority teenagers and workers above the age of sixty-five. Welch also notes that there is evidence that teenagers who worked full-time earned a higher wage rate than those who worked part-time. If the part-time wage is raised through minimum-wage legislation, students who rely on part-time work to pay for schooling and who lack alternate sources of support may have to quit school in order to work full-time.

Economists debated the effects of the minimum wage again in the 1990s because of the work of some economists who found that increases in the minimum wage did not increase unemployment and may actually have increased employment.¹⁹ However, the emerging consensus is that of the traditional view—minimum-wage legislation reduces employment of teenagers and other low-skilled workers. Deere, Murphy, and Welch examine the effects of the increases in the federal minimum wage in 1990 and 1991 that raised the minimum wage more than twenty-five percent. They find that teenage employment grew from 1985 to 1989, then decreased in 1990, 1991, and 1992. The decrease was greater for those aged fifteen to seventeen than for those aged eighteen to nineteen. They also divided the sample on the basis of race, ethnicity, education, and marital status, and found that the subgroups with more low-wage workers in 1989 experienced larger declines in employment after the minimum-wage increases.

For example, the reduction in employment after the increase in minimum wage was greater for blacks than for whites, for Mexican-Americans than for other Spanish-speaking Americans, and for high-school dropouts than for those who did not drop out of school. While the research focus is usually on teenagers, low-skilled workers of all ages tend to be adversely affected by increases in the minimum wage.

In another study, Neumark and Wascher find that minimum wages increase the probability that teenagers leave school in order to work and increase the probability that lower-wage employed teenagers become both nonenrolled in school and nonemployed.²¹ Neumark and Wascher note that the aggregate effects of an increase in the minimum wage can be small or almost nonexistent, yet have significant effects for some. They state, “… in a model with heterogeneous workers, only those with a market wage at or near the minimum wage should be disemployed by a higher minimum wage, and the net disemployment effect for all teenagers may be small if there is substitution toward higher-wage teenage workers. Our evidence is consistent with this model.” That is, the overall employment of teenagers may not change much as the least-skilled teenagers lose jobs and are replaced by more productive teenagers. In the United States, this suggests that minimum wage increases may increase the employment of white, middle-class teenagers and decrease the employment of minority teenagers.

In a world where young people regularly continue with their education until they graduate from high school or college, the long-term effects of changes in the minimum wage may be minor. However, in a world where many teenagers drop out of high school or graduate from high school with a relatively poor education, the long-term effects of the minimum wage may be severe. By making it difficult for low-skilled workers to obtain a job, the potential-workers are prevented from acquiring human capital through experience (or additional, part-time education) that would make them more productive in the future. Without obtaining the first job, many low-skilled workers may never be able to find a job that pays a living wage. Yet, if they have the opportunity to obtain a low-paying job while young, their skills can be increased and they can eventually earn a wage that will support them and their families. The adverse effects of imposing a living wage in order to provide just remuneration would likely be much greater than the adverse effects of increases in the minimum wage in the past, because the living wage would require a bigger wage increase than previous increases in minimum wages.