Minimum Wages in the 21st Century – They have had limited direct employment effects

Minimum wage policies have evolved from their initial introduction, and have become an important tool used by many countries to address various economic and social challenges. The debate and perspectives on minimum wages have also evolved considerably, influenced by both changing economic theories and empirical research. Although economists were highly skeptical about the benefits of the policy throughout much of the previous century, that view was seriously challenged beginning in the 1990s. Today, in the 21st century, there is widespread interest in making greater use of minimum wages (Manning, 2021). Countries around the world are introducing or raising their minimum wages at an unprecedented rate. Major international organizations such as the OECD, the IMF, and the World Bank have advocated for the policy as a means to alleviate inequality and even boost employment (ILO et al., 2012).

In the research community, there has been a proliferation of empirical studies that develop new techniques, take advantage of new data sources, and consider new aspects of the policy. The literature has also expanded from primarily based on evidence from the United States to examining the impact of the policy worldwide. Meanwhile, there have been significant theoretical advances in understanding how labor markets operate and how those models can be applied to better understand the impact of wage floors.

This chapter surveys the literature on the impact of minimum wages on low-wage labor markets. We describe and critically review the empirical methods in the new minimum wage literature, particularly those leveraging quasi-experimental variation. We provide a quantitative overview of the most recent evidence on the employment and wage effects of the policy, while also exploring emerging research on its impact on other margins, including amenities, other inputs (such as capital and high-skilled workers), firm entry and exit, output prices and demand, profits, and productivity. This approach allows us to present a comprehensive picture of how minimum wage policies affect firms, workers, and labor markets. We also review the evidence on the policy’s impact on wage inequality and income distribution. Finally, we discuss how these effects can vary depending on the economic context and the level of a country’s development.

We reviewed the most important evidence on how minimum wages shape the labor market and other downstream outcomes, focusing on contributions made since the beginning of the 21st century. During this period, a substantial body of empirical evidence has accumulated regarding the employment effects of the policy and its broader economic and social impacts. While the evidence is not unanimous, a reasonable conclusion from the existing literature is that minimum wage policies have had limited direct employment effects while significantly increasing the earnings of low-wage workers—at least at certain levels and in particular economic contexts. We see this as suggesting that minimum wages can be beneficial in many situations and should be considered a key economic tool for intervening in low-wage labor markets and improving economic outcomes.

However, the fact that minimum wages are effective at certain levels and in certain contexts does not imply they always work. Research in the 21st century should focus on determining the appropriate levels of the minimum wage, rather than debating the existence of the policy itself. Nonetheless, answering this question presents a number of challenges that researchers will need to overcome to make progress.

First, we need a better understanding of the heterogeneous impact of the policy across different economic contexts. Identifying turning points where the minimum wage begins to significantly affect employment dynamics is an essential next step. A common theme throughout our chapter is the difficulty in characterizing heterogeneous effects. Estimating the average causal response to minimum wages is challenging enough, and sometimes requires strong assumptions for identification. Obtaining reliable estimates by subgroups (such as different types of workers or policy levels) typically require even stronger assumptions and may lack statistical power. Additionally, due to publication bias towards statistically significant results, the search for heterogeneous treatment effects may be more prone to false discovery. Therefore, research on heterogeneity requires careful and transparent analyses, and a variety of econometric and data challenges need to be addressed.

Second, a particularly important recent advance in the minimum wage literature is the use of a more transparent event study design rather than the relatively opaque TWFE panel regression. Future work should rely on event study designs to provide more precise estimates for each major minimum wage event. Accumulating knowledge about these events will be crucial for properly understand the nature of heterogeneity in minimum wage effects. The literature can also advance by providing more details about the treated and potential control units and how they were selected.

Third, to determine the appropriate levels of the minimum wage, we need to improve our models of low-wage labor markets. The standard competitive model often fails to capture the complexity of real-world labor dynamics, suggesting a need for more nuanced economic frameworks. Building such models requires a better understanding of the various margins of adjustments, especially in areas with relatively thin literature, as identified in Section 4. These economic models should account for consumers’ demand responses and the productivity-enhancing effects of the policy, along with incorporating labor market imperfections. However, it is important to avoid past mistakes. Models should be designed to match the best available evidence, instead of primarily being used for extrapolation. At a fundamental level, core theories of the labor market should be falsifiable, and we should not dismiss empirical findings that are difficult to reconcile with existing models.

Lastly, to set the optimal level of the minimum wage, it is crucial to define what “appropriate” means. This is a complex question, as many of the welfare consequences of the policy may depend on its interactions with other policy instruments and the political feasibility of changing them. Future research should better incorporate the interaction of minimum wages with key taxes, benefits, and government policies into the analysis.

In conclusion, while the study of minimum wage policies has made significant strides, there remains ample room for further research to refine our understanding of their economic impacts. By addressing the areas outlined and advancing methodological approaches, researchers can contribute to more informed policy decisions that balance wage fairness with economic efficiency.

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