Legal minimum wages and employment duration.

• Author: Grossberg, Adam J.

1. Introduction

   The effect of a legal minimum wage on employee turnover is an important consideration when evaluating the effectiveness of a minimum wage policy. If an increase in the minimum wage results in greater turnover, then firms' hiring costs are increased, and the direct benefit to workers who are paid the minimum wage may be lessened. A reduction in turnover, on the other hand, would mean more stability for employers and workers, though access to minimum wage jobs may be reduced for job seekers. Despite the recent proliferation of studies on the effects of legal minimum wages, their impact on turnover has received relatively little attention from economists. This may be due to the fact that much of the literature focuses on the "teen labor market" where there is more churning than in the "adult labor market" (Gardecki and Neumark 1998). The fact remains, however, that a significant proportion of workers hired at the minimum wage are adults, and the effects of the minimum wage on the turnover hazard are understudied. (1)

   Standard economic theory suggests that a price floor such as a minimum wage results in fewer transactions and in rents for those suppliers who manage to sell. In the context of the labor market, this means workers in minimum wage jobs may be expected to receive rents and, therefore, may be less likely to quit. Another possible consequence of a minimum wage arises from imperfect information in the labor market combined with heterogeneity among workers and jobs. Prior to the start of an employment relationship, the worker does not know all the relevant aspects of the job and the employer does not know all the important characteristics of the worker. As a result, in the absence of a mandated minimum wage, job applicants may use wage offers to infer information about the nonpecuniary aspects of jobs, thereby facilitating the matching process. A binding minimum wage compresses the wage distribution so that a single wage is associated with a larger array of jobs. (2) This means that the wage offer becomes a poor indicator of a job's nonwage characteristics, which leads to a higher proportion of poor matches and, consequently, more turnover.

   This paper uses data on young men and women in the 1988-1994 rounds of the National Longitudinal Survey of Youth (NLSY) to estimate the relationship between the minimum wage and the turnover hazard. The extent to which the minimum wage binds varies across states both because of differences in state laws and because of differences in wage levels across states. We exploit this variation to estimate turnover hazards as a function of the ratio of the nominal minimum wage to the state median wage. This variable measures the extent to which the minimum wage binds.

   We find some evidence that in states where the minimum wage is low relative to the state's median wage, men hired at the minimum wage have lower employee-initiated separation hazards than other low-wage workers. As the minimum wage rises relative to the prevailing median wage--that is, as the minimum wage becomes more binding--men hired at the minimum wage are increasingly likely to leave their jobs at any given duration. When the minimum wage is high relative to the median wage we find that men hired at the minimum wage have significantly higher employee-initiated separation hazards than other low-wage workers. We interpret these findings as evidence that while rents may accrue to minimum wage workers, the job matching process is undermined when the minimum wage binds. Our results apply to the men in our sample, but not to the women. Indeed, for women we find no connection between employment duration and the starting wage rate, though we do uncover some evidence that for women in low-wage jobs, employment duration is more elastic with respect to the presence of family-friendly fringe benefits than it is for men.

   The paper proceeds as follows. The next section explores the possible reasons minimum wages would affect turnover and discusses the existing empirical and theoretical research on this topic. Section 3 presents the theoretical framework we use to guide our estimation procedures and our interpretation of the empirical results. Section 4 describes our data and presents some descriptive evidence on the relationship between turnover and minimum wages. We present our econometric model and discuss our estimates in section 5. The conclusion discusses the implications of our findings.

2. Research on Minimum Wages and Turnover

   The standard model of competitive labor markets predicts an increase in employer-initiated terminations when the minimum wage increases and employers move up along their labor demand curves. Economists have long suspected, however, that the relationship between turnover and a legal minimum wage is more complex. Mixon (1978), for example, argues that minimum wages reduce employee-initiated quits for two reasons. First, the net benefits of turnover are reduced because of the reduction in the difference between a worker's current wage and the expected wage on a new job. Second, since firms are likely to be more selective when hiring into minimum wage jobs, the costs to the worker of searching for a new job are expected to be higher. Using quarterly industry data from 1959-1975 he finds evidence that increases in the ratio of the minimum wage to the industry average wage reduces the monthly industry quit rate.

   The standard model has, of course, been extended to recognize that compensation includes both monetary and nonmonetary benefits. Wessels (1980a, b) suggests that employers will respond to a binding minimum wage by reducing nonwage benefits so as to offset the mandated wage increase. If workers are not aware that the "full wage"--wages plus benefits--at other firms has also fallen, the minimum wage may prompt workers to change jobs, with the result that quit hazards are elevated, at least in the short-run, until information improves. He also argues that the impact on quit rates will be larger for workers earning relatively high wages prior to a change in the minimum wage, since it is more likely that these workers' nonwage benefits can be more fully adjusted in response to the minimum wage. Wessels, using industry-level quit rates from 1966, finds evidence supporting this story. Sicilian and Grossberg (1993), using data from the Employment Opportunities Pilot Project (EOPP), also find evidence consistent with this information distortion argument, as they show that workers hired at the minimum wage are significantly more likely to leave their jobs voluntarily than other low-wage workers. Also, several authors argue on theoretical grounds that employers are likely to reduce expenditures on job training when the minimum wage is binding (e.g., Leighton and Mincer 1981; Hashimoto 1982). If this is true, then minimum wage legislation can indirectly increase turnover since on-the-job training reduces turnover hazards (Mincer 1988; Parent 1999; Grossberg 2002). (3)

   On the other hand, employers may be either unable or unwilling to reduce nonpecuniary job benefits so as to fully offset wage increases resulting from minimum wage legislation. In this case, minimum wage jobs offer rents, reducing voluntary turnover. Using data from the EOPP, Holzer, Katz, and Krueger (1991) find significantly longer queues of job applicants in minimum wage jobs than in other low-wage jobs. They take this as evidence of the existence of rents in minimum wage jobs. They do not, however, look at turnover. Similarly, Katz and Krueger (1992) find that a majority of fast-food restaurants in Texas did not report attempts to offset the 1990 minimum wage increase.

3. Rents and Job Matching on Minimum Wage Jobs

   To date, no consensus has emerged on the relationship between minimum wages and turnover. There are theoretical arguments and empirical evidence supporting both the proposition that minimum wages reduce turnover and the proposition that minimum wages increase turnover. In this section we attempt to reconcile these opposing claims and to motivate our own empirical analysis.

   Our point of departure is De Fraja (1999), who uses a model with asymmetric information to show, inter alia, that rents can result from the imposition of a minimum wage. In De Fraja's model each job is characterized by its wage (w) and by the amount of effort required on the job or, more generally, by the nonwage attributes of the job (e). Workers have heterogeneous preferences regarding effort exerted on the job, but employers cannot observe the workers' preferences. As a result, firms offer the same wage-effort package to all workers. One consequence is that, among those hired at the minimum wage, workers with relatively low disutility of effort receive rents. Thus, when the minimum wage is binding, turnover will be reduced due to the creation of rents for some workers.

   De Fraja assumes that information regarding both wage and nonwage benefits is known by prospective employees. Typical search models of turnover, on the other hand, assume that while the wage on a job is readily observable, the job's nonwage attributes are not (e.g., Johnson 1978; Holmlund and Lang 1985). In these models, the labor market is characterized by the joint distribution (w, e) of existing job offers, though a worker must take a job to learn the value of e on any particular job.

   We modify this approach by assuming that while the specific value of e associated with a particular job is not known prior to taking the job, workers know the joint distribution of w and e. As a result, knowledge of the wage offer for a particular job provides information about nonpecuniary characteristics, via knowledge of the conditional distribution (e|w). (4) If this conjecture is correct, and if minimum wage laws distort information by altering the conditional distribution (e|w), the result may be an increased propensity for bad matches to occur in minimum wage jobs and...