THE BLOG
08/14/2013 10:42 pm ET | Updated Oct 14, 2013

If Increasing the Minimum Wage Doesn't Cost Jobs, How Does It Get Absorbed?

As I stressed in a recent post, the economic arguments against moderate increases in the minimum wage lack robust empirical support. Most importantly, the majority of studies looking for the job-loss effects that opponents assert will be large enough to offset the benefits to low-wage workers come up short. Such "disemployment" effects hover about zero, as shown in Figure 1 from economist John Schmitt's recent reviewof the literature.

This fact raises another question: if not through job loss, how is the mandated wage increase absorbed? It's got to come out somewhere. Have economists identified the absorption channels?

We have, though there's more evidence for some absorption channels than others. Here's a quick primer on what we know and what we suspect.

First, as alluded to at the end of my earlier post, the initial question you want to ask is what share of the workforce is in the affected range and just how "affected" are they? A small increase, particularly one that's come after many years of inaction, will affect few workers and in such cases there's just not that much absorption that needs to take place.

Moreover, once a worker is in the "sweep" of the higher minimum (i.e., their hourly wage is between the old and new wage), there's the issue of where they are in the sweep. If their wage puts them a few pennies below the new minimum, we'd expect less of an impact than if it will take $1 to bring them up to the new floor.

Schmitt examines this question from various angles in the context of recent minimum wage increases (see his table 1). Starting in the late 1980s, he finds 6 percent or less of the workforce has been in the sweep, with the average hourly wage increase ranging from around thirty to fifty cents. Is this a lot or a little?

History suggests that it's a small enough impact that the wage increase tends to be absorbed not by job loss but by the various mechanisms discussed next. Let's start with the three p's: profits, productivity, and prices. Increased labor costs can be offset by:

-Shaving profit margins: This is an attractive alternative right now, as the profit share of national income is at an all-time high while the compensation share is at a 50-year low. As James Surowiecki points out, this mechanism is limited by the fact that profit margins are thinner at retail and fast food companies than at tech firms and investment banks. Still, the fact is that Walmart, for example, is a highly profitable enterprise with low-labor costs as a key part of their model.

There's little evidence for this mechanism, though a recent study from the UK finds a significant effect. You ask me, the fact that the affected lobbies fight so hard against higher minimum wages is pretty strong circumstantial evidence that this channel is at work.

A related mechanism emphasized by Schmitt is wage compression, i.e., along with some redistribution from profits to wage, there's some empirical support for "... the possibility that employers may compensate for higher wage costs at the bottom by cutting wages of workers who nearer to the top."

-Higher productivity: One of the inefficiencies that low-wage firms face is high rates of turnover and vacancies. Raising the wage floors can help offset such costs by making easier to recruit, train, and hold onto workers. Schmitt cites numerous studies as this process at work, as labor turnover has been found to decrease substantially following an increase in the wage floor.

-Higher prices: This one has been carefully studied, and the results show that part of the cost of the wage increase is passed through to higher prices. The literature finds small overall effects on the price level: a 10 percent increase in the minimum is associated with less than half a percent increase in the overall price level, though larger increases are found in low-wage labor intensive industries (around 1-4 percent).

Schmitt ticks through other possible absorption sources but there's either little research on them or what there is doesn't find much impact, including reduced hours, lower non-wage benefits, less spending on training, or greater product demand by recipients of the now-higher paychecks.

So there are lots of ways in which firms and economies absorb minimum wage increases. Not all are benign -- higher prices, lower profits -- though the fact that some of increase is absorbed by squeezing inefficiencies out of the low-wage labor market seems like an unequivocal plus. But at the end of the day, what's most important here is that the research supports the contention that the benefits of the increase in the wage floor to low-wage workers significantly outweigh the costs.

That's why you see such workers and their advocates pressing hard for the increase. And to the lobbyists who say they're really just trying to protect these benighted workers from the unintended consequences of the increase, I'm quite certain they'd say, "thanks, but no thanks... we got this."

This post originally appeared at Jared Bernstein's On The Economy blog.