Minimum wage is great for machines

The Institute of Economic Affairs blogs on a study into the minimum wage:

One limitation of the great majority of these studies is that they focus on employment in the first few months, or at most a few years, after a minimum wage hike – we label this time frame as the “short run”.

The supply of and demand for both products and factors of production such as labour and capital might well be more elastic in the long run than in the short run. This means that the effect of changes in wages on the number people employed might be greater in the long run. Indeed, we can think of a process by which firms change the way they produce their goods in reaction to higher labour costs is slow.[1]  In some cases, for example, this process might require firms which operate a large low-skill labour force to shut down in the face of higher costs and these firms may be replaced by firms that operate with fewer workers and more capital. This is a process that takes time. The long-run loss of jobs in response to the minimum wage hike might be bigger than the short-run effect often estimated in the literature.

Our recent research presents new evidence on how the restaurant industry, the largest US employer of low-wage labour, responds to minimum wage hikes. We document three new findings:

·         Fast food restaurants are more likely to shut down (exit) and open up (enter) after a minimum wage hike.

·         The rise in entry is higher among chains, which use less labour.

·         There is no change in employment among existing fast food restaurants that continue to operate – the fall in employment arises as a result of more labour-intensive restaurants being replaced with less labour-intensive restaurants.

This is very interesting. Basically they find that there is no fall in employment in the businesses that stay open. They just increase prices I guess. But that some businesses go under and they get replaced with businesses that are less labour intensive.

To interpret these findings, we develop a model where new restaurants can choose how mechanised their production will be. However, once they open, they cannot change the way they make their products. Economists call such a technology ”putty-clay”: the initial choice of how to operate is flexible like “putty”, but once the firm is open, the production process hardens into “clay” and cannot change. For instance, some restaurants might choose to have customers order their meal from a worker, while others might set-up a computerised ordering system. But, once the systems are established, they do not tend to change. This does reflect the reality of how businesses operate – of course old establishments can change how they use technology but, in this industry, it is new entrants that tend to bring about changes.  

This model predicts that when the minimum wage increases, labour-intensive restaurants are more likely to shut-down, whereas capital-intensive restaurants are less impacted by the minimum wage and may even open new restaurants to replace labour-intensive competitors that exit.

In this model, the employment loss due to the minimum wage grows over time because labour-intensive restaurants are slowly replaced with more capital-intensive restaurants. This process is slow, since it is costly to shut down a restaurant and open a new one in its place. The results of this research suggest that a typical minimum wage hike causes an older fast food restaurant to shut down one year earlier than it otherwise would have done.

So minimum wage hikes are great for robots, but not so great for the humans who lose their jobs. But it may lead to a more productive sector of the economy?

Previous work has shown that all the higher labour costs of the minimum wage are pushed on to consumers in the form of higher prices. But, what about the level of job losses? How big are the potential effects? These are difficult to measure precisely, although our estimates suggest that a 10 per cent increase in the minimum wage reduces restaurant employment by less than 1 per cent one year after the hike. Our model, which matches this very small short-run effect, as well as the facts on restaurant entry and exit rates, predicts a 4 per cent reduction in restaurant employment in the long run.

This is only for restaurants, but it may hold true for other sectors. They key thing is that the short-term loss in jobs may be a lot less than the long-term loss.