The beauty of the United States where policy is concerned is that state variations allow for lots of decent analysis. Nowhere is this more clear than on the minimum wage, where a fascinating new empirical paper by Terra McKinnish from the University of Colorado Boulder adds further light as to whether Econ 101 holds in regards to raising statutory pay rates.

Remember, there are (to simplify) two main theoretical stories of the labor market. In an ordinary competitive model, imposing a minimum wage above the equilibrium wage rate leads to an increase in the quantity of labor supplied (more people want to work at the higher wage) and a reduction in the quantity demanded (employers want fewer worker hours at the higher price). The difference between the two is the increase in “unemployment” – i.e. the difference between the worker hours people are willing to work and the demand for worker hours at that wage rate. Raising the minimum wage in a competitive labor market is said to have “disemployment effects.”

In the past decade though, some academics have posited a different theory of the labor market, implying that all or many employers have “monopsony power” - monopoly power but in the purchase of labor. Profit maximization would lead firms to pay less than the value of the marginal product of labor and employ less labor-hours than would be the case in a competitive market. The implication is that when there is a strong element of monopsony in the labor market, the imposition of a higher minimum wage can lead to both an increase in pay per hour and an increase in hours of employment. Workers would gain unequivocally from the minimum wage, while previously exploitative employers would lose.

Let’s put aside for a second that in reality the labor market is complex, dynamic, and there could be elements of both. Empirically, the question is which provides a better explanation of the real labor market we see.

Here’s where McKinnish’s new study comes in. She seeks to exploit the variation in minimum wage rates between states and the compressing effect of the 2009 federal minimum wage increase to analyze whether a relative increase in a minimum wage within a state led to more commuting into that state to work for under 30s or more commuting out of the state to work.

Suppose I’m residing and working in a state whose minimum wage is unchanged and a neighboring state increases its minimum wage relative to the one I am in. A result of more commuting from my state to the neighboring state would be consistent with the monopsony story that a higher minimum wage could support more employment or at least the idea that the disemployment effects of higher minimum wages were small. On the other hand, if the higher minimum wage in the neighboring state resulted in more commuting out of the state then this would signify the disemployment effects of Econ101, and thus the competitive labor market story.

McKinnish employs difference-in-differences techniques to try to find the answer, using commuting records of people earning both low and modest hourly rates to control for other factors which could influence commuting, such as the health of the economy.

Upon doing all this, three key findings arise from her work:

1. Prior to the 2009 federal minimum wage increase, there is no evidence that low-wage workers commuted at higher rates (relative to moderate-wage workers) to neighboring states with a higher minimum wage.
2. After the federal minimum wage increase, low-wage workers modestly increased out-of-state commuting out of states most affected by the federal minimum wage increase.
3. Moderate-wage workers reduced the rate at which they commuted out of states most affected by the federal increase following the rise in the rate (consistent with the idea that increasing minimum wages leads to employers replacing low productivity workers with higher productivity ones).

The implications of this finding are 3-fold. First, it directly refutes the narrative presented by some in the media that people commute towards states with higher minimum wages. Second, it suggests that the real labor market looks much more like the competitive model than the monopsony one. Third, it suggests that studies which seek to examine the effects of minimum wage increases using data based on the residential location of the worker will tend to understate the disemployment effects of the wage rise.

In all, this study is further evidence to support the Econ 101 view of minimum wages. See here and here for more.