Do legal minimum wages create rents? A re-examination of the evidence.

• Author: Sicilian, Paul

1. Introduction

   The effects of minimum wage laws have interested economists for many years. While much of the research regarding minimum wage laws has focused on its employment effects, several economists have been concerned with the laws' effects on the non-pecuniary aspects of jobs. There is disagreement in the literature as to whether minimum wage legislation creates rents in those jobs for which the law is a constraint. Several researchers have argued that firms will offset any rent created by the minimum wage by reducing the non-wage aspects of the job [4; 7; 14; 15]. In a recent paper Holzer, Katz, and Krueger [5] present evidence suggesting that employers do not completely offset the minimum wage. They use information on application rates for job openings found in the Employment Opportunities Pilot Project data set (EOPP) to test for the existence of rents on minimum wage jobs. Minimum wage jobs are found to have longer queues of applicants than other jobs, ceteris paribus, which suggests the existence of rents.

   This paper presents additional tests of the existence of rents. Using the EOPP data, we find that workers who received starting wages equal to the minimum wage have a significantly higher probability of quitting than workers paid either less than or more than the minimum wage. This result seems to contradict the findings of Holzer, Katz, and Krueger regarding minimum wage jobs. As we see it, our findings support Wessels' [15] contention that since wages are more visible than non-pecuniary aspects of compensation, low wage workers mistakenly queue for minimum wage jobs, thinking them more attractive than they are, but then quit when reality sets in.

   The paper is organized as follows. Section II discusses the existing theoretical and empirical research regarding minimum wages, section III presents our empirical procedures, section IV discusses the EOPP data set and in section V we discuss our results. Finally, in section VI we draw some tentative conclusions and discuss future research.

2. Literature Review

   The textbook treatment of minimum wage legislation ignores the laws' effects on non-wage aspects of jobs. According to this analysis, when employers are forced to raise their wage offers due to minimum wage legislation, they simply move up along their demand curves for labor, reducing employment. Thus, while minimum wages create disemployment, those workers who remain employed in jobs covered by the minimum wage benefit. The theory has clear implications for labor market dynamics. Namely, those individuals covered by the law will be less likely to quit because the expected net return to search is reduced. Those not covered will queue for minimum wage jobs [9].

   Others have suggested that employers will be able to offset the minimum wage by reducing the non-wage aspects of jobs. This hypothesis has been tested by Leighton and Mincer [7] and Hashimoto [4] who both found evidence of reduced on-the-job training in response to minimum wage legislation. Others have found that legal minimum wages may reduce fringe benefits such as paid vacation, sick leave, shift premiums and severance pay [14; 15; 1].

   Holzer, Katz, and Krueger, question whether the firm fully offsets the minimum wage. They employ an efficiency wage model to demonstrate that the employer may not want to completely offset the minimum wage. Previous research, while finding evidence of at least some offset, has not been able to determine whether the offset is complete. To get at this issue Holzer, Katz, and Krueger consider application rates for jobs paying the minimum wage. They find that these jobs have a significantly larger number of applications than jobs paying either below the minimum wage or jobs paying above the minimum wage. They conclude that "overall, these results suggest that employers do not fully offset rents from the minimum wage by reducing fringe benefits or eroding working conditions" [5, 754]. Holzer, Katz, and Krueger note that researchers have used turnover rates to test for the existence of rents in high wage industries and large firms. They contend, however, that employee turnover is more appropriate for measuring ex post rents but that application rates will better measure ex ante rents.

   These researchers conclude that minimum wage jobs offer economic rents because workers perceive rents, ex ante. Implicit in this conclusion is the assumption that the worker is fully informed about the non-wage aspects of the job prior to working since only in this case will the perceived ex ante rent accurately reflect a true rent. If, ex ante, the typical worker is misinformed about characteristics of the job, then a queue could form even if the job does not provide a rent. The literature on job search has long recognized that workers will not be fully informed about jobs until they are actually working on those jobs. This imperfect information results in "job-shopping" on the part of workers [6]. Wilde [16] for example, develops a model of equilibrium job-quitting in which jobs have both "general" characteristics - which are observed prior to starting a job -...