The public debate around labour market institutions in the US is currently focused on the minimum wage.
President Barack Obama has repeatedly proposed a raise in the minimum wage (now at $7.25/hour) at federal level from the beginning of his second term, but no wide consensus has been reached upon this burning issue. A quick review of labour economics basic principles could be useful to get a more comprehensive understanding of the controversy and avoid common ideological drifts in the analysis of the problem.
Traditional labour economics models, the ones which assume the labour market to be perfect, suggest that an increase in the minimum wage would most likely cause an increase in unemployment at the equilibrium, driven both by lower employment and higher participation rate.
However, evidence confirms that labour markets are far from being perfect. There are particular cases in which a raise of the minimum wage in a labour market subject to imperfections (matching frictions and externalities related to job search) may have beneficial effects on employment. Specifically, this happens when the wage level is not the market clearing one, that is when the employer has some particular power over employees in the wage setting process. This kind of power is technically defined as monopsony power and we can think of it as the power that employers exert over low-skilled workers in negotiating their wage level. In this case, the effects of the introduction of a minimum wage or a raise in its level on employment are ambiguous: depending on the level established, they can be either positive or negative.
Numerous empirical studies have been conducted to investigate the effects of a raise in the minimum wage on employment levels. Card and Krueger studied the effects on employment of the raise in the minimum wage implemented in New Jersey in 1992. The fast-food industry was used as a reference to evaluate the change in employment rate, since this industry is characterised by low-productivity jobs and workers in this sector are more likely to be subject to monopsony power of employers.
As in a real scientific experiment, New Jersey was taken as a treatment group and Pennsylvania as a control group, since the labour markets of the two states shared similar characteristics. The minimum wage level was the same in both states before 1992 ($4.25/hour) and was raised to $5.05/hour in New Jersey. Through a difference-in-difference approach that took into consideration employment levels in New Jersey and Pennsylvania before and after the treatment, Card and Krueger observed a 2.7% net increase in the employment rate in New Jersey fast-food industry.
As modern labour economics theory suggests, the public debate around minimum wage should be concentrated on its level rather than on its existence. From a purely economic point of view, the efficiency maximising policy would probably be to keep the minimum wage at relatively low levels, avoiding the risk of harming employment.
Overall, a moderate raise in the minimum wage level in the US could have positive effects on employment, as the empirical case of New Jersey examined before shows. Moreover, if this raise were implemented at a federal level, positive side effects would follow. First, it would constitute a binding floor for wages, thus limiting the effects of extreme competition among states. Second, the strength of the enforcement regime would be higher than in the case of a minimum wage established at state level.
In conclusion, it is necessary to deny a common fallacy related to the public discussion around minimum wage: numerous politicians and union leaders argue that high levels for minimum wage would help contrast inequality. This is true to the extent that these levels do not harm employment. However, a high level of minimum wage will most likely have the only effect of pushing an increasing share of workers out of employment, thus increasing inequality.