Does Minimum Wage Affect Unemployment: Essay

Literature Review:

In January 2015 Germany passed a statutory national minimum wage (NMW). This is the first time Germany has had an economy-wide minimum wage. It was introduced at a level of €8.50 per hour. Previously there were only minimum wages in specific sectors of the German economy. The introduction of a minimum wage has been extensively debated by both economists and policymakers. It was argued that it would have significant negative implications on unemployment because a large proportion were set to receive a wage rise (13.3% of all employees) Seebauer (2018). But those predictions thus far have proven to be inaccurate. It is used as a tool for anti-poverty and to stop the exploitation of workers. International evidence on the impact of an NMW on unemployment does not give a clear result and is inconclusive. There have been several studies in this area providing different results. Either a positive, negative, or no effect.

Standard economic theory would suggest that the impact of imposing an NMW would increase unemployment. Firms faced with higher costs for labor will reduce their demand for it and will aim at improving their productivity and adopting new technology. An alternative view discussed by Card and Krueger (1993) is that a rise in NMW would decrease unemployment. This is if a firm has monopsony power. Whereby a firm faces an upward-sloping labor-supply schedule and since there has been a rise in the minimum wage, workers that would have previously not worked to fill these vacancies decide that the wage is at a level that they will work and the vacancies fill.

Moving on to assess the existing literature. Firstly, looking at the UK. Stewart (2004b) uses the difference in difference estimator to assess the effect of the introduction of an NMW in 1999. This is where you compare the treatment group, a group of employees whose wage is just below the NMW that has been set. The control group is a group of employees whose wages are slightly higher than the NMW introduced. The results showed that there were no adverse employment effects in any of the three data sets used or in the four demographic groups (male, female, adult, and youth). Criticisms of this approach included that there may be measurement errors in wages and the spillover effects of the NMW further up the pay distribution. Potential spillover effects are lower separation and hiring rates (Brochu and Green (2013)). Another approach used to measure the effect of an NMW on employment is to look at specific regions and was first proposed by Card (1992) who looked at US data and found no adverse effect. This method is used because it is recognized that there will be a greater impact in regions where more workers earn closer to the minimum wage. The bite of the minimum wage determines which regions will be most affected. It is the ratio of the minimum wage to median hourly wages and is known as the “Kaitz index” (Dube (2019)). This index in a specific area is then related to the employment rate. Dolton et al (2012) conclude using this approach that there is a statistically significant positive effect of the NMW on employment between 2004 and 2006. In Machin et al (2002) instead of testing for regions in which the NMW would have the largest bite they analyze the effect on the residential care homes industry. In this sector, one-third of workers were paid below the NMW that was set to be introduced. The results showed a rise in unemployment and cuts in hours worked. Caution for reaching conclusions must be taken as a particularly low-wage sector was chosen for analysis.

Now examining the literature that has been written on the NMW impact on unemployment in Germany since 2015. The data available has provided difficulties as there has been non-compliance by firms so greater regulation and enforcement needs to occur to fully determine the effect of Germany adopting an NMW. Testing the effect using the regional comparison approach Caliendo et al (2017) find no significant effect. However, their work is undermined because the minimum wage was not fully binding when carrying out their tests. In addition to this piece of literature, Bonin et al (2019) use this same approach and also find that there has been no significant effect. An interesting argument made for why there has been no real impact is that because of the implementation of the minimum wage, some workers became discouraged from looking for jobs and withdrew from the labor force. This means that these individuals are not taken into account in the calculations of unemployment levels. Boffy and Ramirez (2019) found this to be the case in the United States between 1990 and 2017.

Project Outline:

Research Question: What is the effect of Germany introducing a minimum wage on unemployment in the retail sector?

Motivation:

Given that Germany only passed a national minimum wage in January 2015, there is limited existing literature on the impact of this on unemployment. Especially when compared to the literature on this topic in the United States and the United Kingdom. This paper will use empirical analysis and econometric modeling to help determine the effect of the NMW on unemployment. Looking specifically into the effect in the retail sector.

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This paper will be able to analyze the effect of the NMW over a greater period than previous papers which have only analyzed the impact over the short run (2 years). This will allow for a more robust analysis and allow us to gain a deeper understanding. Furthermore, after the introduction of the NMW, wage changes take time to implement so by analyzing in 2019 the impact will be more visible to see.

In this paper, the retail sector will be analyzed because it is a sector in which a large proportion of the labor force earns around the minimum wage. The potential effect on outcomes is far greater than in sectors in which workers were already paid well above the minimum wage such as in financial services. The disadvantage to specifically analyzing the retail sector is that there will be a greater ‘bite’ and so a larger potential negative effect.

Objective:

To determine both the direction and magnitude of the implementation of the minimum wage in Germany on the level of unemployment in the retail sector. Although this will not be conclusive in determining whether or not Germany adopting a minimum wage was beneficial as other macroeconomic and microeconomic factors have to be considered it will be one way of understanding the impact it has had.

Economic Significance:

The level of unemployment is an important measure in determining the health of an economy. And because minimum wage is introduced to try to reduce poverty and the exploitation of workers. Examining the impact of NMW on unemployment is a highly important and well-debated economic issue. Furthermore, because a large proportion of workers in a sector such as the retail sector will receive a higher wage because of the introduction of an NMW it is important to determine whether this is beneficial to their employment prospects.

Data and Methodology:

To conduct a comprehensive study on the issue requires robust and reliable data. The (German Socio-Economic Panel) GSOEP will be where I will be collecting the data for this paper. It is an annual survey of 16,000 representative households.

This paper will use one of the approaches that was discussed in the literature review. Whereby conducting a difference in difference estimate on unemployment data before and after the NMW introduction in the retail sector (treatment group) and the financial sector (control group). The financial services sector is chosen as the control group as the NMW will have no impact on this sector. The retail sector is the control group as it is the focus of our analysis. The DiD is a quasi-experimental design that will allow us to estimate the effect on a sector that it was specifically meant to benefit. A common approach used in previous literature. Potential issues that need to be considered when analyzing results are first, there may be endogeneity as all exogenous variables will not be able to be considered in the regression of minimum wages on unemployment. The effect of minimum wages may not be all translated into unemployment it could also lead to a reduction of hours worked so this paper will analyze if this has potentially occurred. Furthermore, the DiD approach assumes no spillover effects when in fact there could be.

Contribution to literature:

This paper aims to contribute to the existing literature to gain a further understanding of the impact of the NMW on unemployment in Germany. By looking into the retail sector where there is limited if any literature on the effect this paper can provide insight into the impact of imposing an NMW on a low-wage sector and could be of benefit to other countries considering an NMW.