What is the optimal minimum wage?
The European Commission advocates a adequate minimum wage, which can be 60% of the median salary. A recent independent report published by the UK’s HM Treasury recommended a similar level. The German Minister of Labor and Social Affairs has engaged at a minimum wage of €12 per hour and the Wage Increase Act raise the US federal minimum wage from $7.25 to $15 per hour by 2025. Gabriel Ahlfeldt, Duncan Roth, and Tobias Seidel explore whether such ambitious increases in the minimum wage improve the living conditions of low-wage workers as advocates advocate, or lead to massive job loss as opponents fear.
There is a large literature on the employment effects of minimum wage increases. It is fair to say that the empirical results are mixed. Furthermore, while this literature seeks to identify the causal effects of minimum wages on employment with an increasing degree of sophistication, minimum wages affect many other economic outcomes. It is therefore difficult to conclude whether higher minimum wages would be desirable on the basis of the existing literature. Thus, we take a different approach to answering this question in a recent discussion paper.
We develop a quantitative spatial model in which workers decide where to live, if they want to work, how far to travel and how much to consume of tradable goods and housing. In doing so, we capture many of the indirect effects of the minimum wage documented in the literature, including effects on labor force participation, tradable goods prices, housing rents, travel costs, and worker matching. -business. This allows us to derive a measure of worker welfare that incorporates all of these general equilibrium channels as well as the effects on wages and employment probabilities. We also allow a monopsonistic labor market, which means wages are not necessarily “fair”. Employers can exploit their bargaining power to pay wages below the values that workers generate for the company. This is why a minimum wage need not necessarily reduce employment in our model. In fact, it may even increase employment if the minimum wage induces some workers to start looking for work.
To discover the optimal minimum wage, we calibrate the model to German micro-regions using a unique dataset that covers almost 30 million workers and 20 million real estate transactions. We then simulate the effects of a range of minimum wage levels. The figure below summarizes our simulation results at the national level. Simulated regional effects on several outcomes such as real wages, employment, welfare, and labor can be conveniently explored in interactive maps here. Note that we are using a relative minimum wage number because wage levels differ significantly between countries and over time. Using this table from the OECD that reports relative minimum wages for different countries, it is easy to put our relative measure into an international perspective.
Figure 1 – Effects of minimum wage on employment, equity and well-being
Notes: Results are model-based counterfactuals. Employment is the total number of employed workers. Equity is measured as 1-G where G is the Gini coefficient of real wage inequality among all employed workers. Well-being is expected utility. It captures individuals who are active in the labor market and absent from the labor market and takes into account the effects of the minimum wage on employment probabilities, wages, prices of tradable goods, housing rents, displacement and worker-establishment matching qualities.
In a nutshell, our simulations reveal that ambitious federal minimum wages can reduce wage inequality without having a detrimental effect on well-being – a measure of a worker’s expected standard of living that incorporates wages, prices property and housing, travel costs, and the likelihood of being unemployed or satisfied with a job. However, this is not without significant job losses. While employment effects remain small up to about 50% of the national average wage, they accumulate at an increasing rate at higher levels. Therefore, the fact that relatively low minimum wages in the past hardly reduced employment does not mean that higher minimum wages in the future will not create unemployment. We recommend that ambitious minimum wages be implemented in small steps, after careful assessment of short-term employment effects so that potential tipping points can be detected in time.
More generally, our results illustrate how the desirability of any minimum wage will depend on the relative level considered and how one wishes to negotiate the effects on employment, equity and well-being. Depending on the priorities, different minimum wage levels will be optimal. For example, maximizing employment requires setting a relatively low level – in the case of Germany, around 38% of the national average wage (42% of the national median wage or €7.60 per hour in absolute terms). This should generate a small positive effect on employment, but also negligible effects on equity and well-being. Maximizing well-being requires a more ambitious minimum wage of 58% of the national average wage (64% of the national median wage or almost €12 per hour in absolute terms), which will also lead to a greater reduction in inequality nominal wages. Any increase in the minimum wage level within these limits will trade positive equity and welfare effects for negative employment effects. Of course, even higher minimum wage levels can be advocated on the basis of an equity objective. In fact, our simulations suggest that the minimum wage could be set at 70% of the national average wage (77% of the national median wage or €14 per hour) before the welfare effect becomes negative. However, recommending such a high minimum wage level would imply that one cares strictly about the expected real wage – the product of the real wage earned subject to being in employment and the probability of employment – with no aversion to higher rates. higher unemployment.
While these trade-offs may seem politically frustrating, our analysis also reveals more encouraging news. Rather than going down the road of ever-higher federal minimum wages, policymakers have the option of implementing regional minimum wages. We find that regional minimum wages – if set for spatial units no larger than counties – are targeted policy instruments that mitigate the trade-off between negative employment effects and positive welfare effects. To illustrate the potential, the employment-maximizing minimum wage, at 50% of the average municipality wage, could increase welfare by 4% – as much as the welfare-maximizing federal minimum wage. and generate a significant positive effect on employment of 1.1%.
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To note: The post office gives the point of view of its authors, not the position USAPP– American Politics and Policy, nor from the London School of Economics.
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About the authors
Gabriel Ahlfeldt – LSE Geography and Environment
Gabriel Ahlfeldt is Professor of Urban Economics and Spatial Planning in the Department of Geography and Environment at LSE and Associate of the Center for Economic Performance.
Duncan Roth– Employment Research Institute
Duncan Roth is a senior researcher at the Institute for Employment Research (IAB).
Tobias Seidel– University of Duisburg-Essen
Tobias Seidel is professor of economics at the University of Duisburg-Essen.