Minimum wage and employment: Escaping the parametric straitjacket

Cabras, Stefano; Fidrmuc, Jan; de Dios Tena Horrillo, Juan Working Paper Minimum wage and employment: Escaping the parametric straitjacket Economics Discussion Papers, No. 2016-17 Provided in Cooperation with: Kiel Institute for the World Economy – Leibniz Center for Research on Global Economic Challenges Suggested Citation: Cabras, Stefano; Fidrmuc, Jan; de Dios Tena Horrillo, Juan (2016) : Minimum wage and employment: Escaping the parametric straitjacket, Economics Discussion Papers, No. 2016-17, Kiel Institute for the World Economy (IfW), Kiel This Version is available at: https://hdl.handle.net/10419/130748 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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Licensed under the Creative Commons License - Attribution 4.0 International (CC BY 4.0) Discussion Paper No. 2016-17 | April 26, 2016 | http://www.economics-ejournal.org/economics/discussionpapers/2016-17 Minimum Wage and Employment: Escaping the Parametric Straitjacket Stefano Cabras, Jan Fidrmuc, and Juan de Dios Tena Abstract Parametric regression models are often not flexible enough to capture the true relationships as they tend to rely on arbitrary identification assumptions. Using the UK Labor Force Survey, the authors estimate the causal effect of national minimum wage (NMW) increases on the probability of job entry and job exit by means of a non-parametric Bayesian modelling approach known as Bayesian Additive Regression Trees (BART). The application of this methodology has the important advantage that it does not require ad-hoc assumptions about model fitting, number of covariates and how they interact. They find that the NMW exerts a positive and significant impact on both the probability of job entry and job exit. Although the magnitude of the effect on job entry is higher, the overall effect of NMW is ambiguous as there are many more employed workers. The causal effect of NMW is higher for young workers and in periods of high unemployment and they have a stronger impact on job entry decisions. No significant interactions were found with gender and qualifications. JEL C23 C11 C14 J3 J4 Keywords BART; causal inference; regression approach; matching regression Authors Stefano Cabras, Universidad Carlos III and Università di Cagliari Jan Fidrmuc, Brunel University; Charles University; and CESifo Munich, [email protected] Juan de Dios Tena, University of Liverpool; Università di Sassari; CRENoS; and Instituto Flores de Lemus We received helpful comments and suggestions from Brendan McCabe, Andy Tremayne and David Forrest, as well as seminar/conference participants at the University of Liverpool and “The German Minimum Wage – First Evidence and Experiences from Other Countries” conference at the Institute for Employment Research (IAB) in Nuremberg. Citation Stefano Cabras, Jan Fidrmuc, and Juan de Dios Tena (2016). Minimum Wage and Employment: Escaping the Parametric Straitjacket. Economics Discussion Papers, No 2016-17, Kiel Institute for the World Economy. http:// www.economics-ejournal.org/economics/discussionpapers/2016-17 2 1 Introduction The most characteristic feature of the literature on the causal impact of the minimum wage on employment is the general lack of consensus. Neumark and Washer (2007) compile an extensive survey of previous research and conclude that the minimum wage exerts an adverse impact on employment of low-skilled workers and a non significant impact on total employment. However, other surveys on this issue, a meta-analysis by Card and Krueger (1995) and the subsequent extension by Doucouliagos and Stanley (2008), find that there is a wide range of results in the previous research, and that once the publication selection bias is accounted for the mean estimate is consistent with a non-significant impact of the minimum wage on employment. A possible reason for the wide range of findings is the fact that the results hinge dramatically on ad hoc assumptions about the parametric specification of the empirical model and on the definition of the control group in the analysis. This is corroborated in the highly insightful and interesting discussion in a series of papers by Allegretto et al. (2011, 2013), Dube et al. (2010), and Neumark et al. (2014) in a state-level panel analysis for the US. Dube et al. (2010) and Allegretto et al. (2011) suggest that it is essential to control for spatial heterogeneity in order to estimate the impact of the minimum wage in a panel data setting. In particular, they propose to include two types of local controls consisting of: (1) jurisdiction-specific linear time trends; and (2) interactions between time dummy variables for sets of neighboring states or neighboring counties so they could be used as controls to determine the impact of the minimum wages. Subsequently, Neumark et al. (2014) and Sabia et al. (2013) criticize these measures on the grounds that there are other non-linear ways of controlling for unobserved trends and that this approach excludes other potential controls apart from those for the neighboring regions. Crucially, the parametric form of the model appears to be the critical determinant of whether a significant or insignificant impact of minimum wage on state employment is obtained. Another potential problem of the minimum-wage literature mentioned above is the aggregation bias. This is because aggregate data might mask the real effect of minimum wage at the 3 individual level. Moreover, the analyses based on aggregate data could be affected by endogeneity as mimimum wage movements could be caused by regional or national macroeconomic variables (Baskaya and Rubinstein, 2011; Sabia, 2014). In this paper, we use the UK Labor Force Survey to estimate the causal impact of the UK national minimum wage (NMW) on employment using a non-parametric Bayesian modelling approach known as the Bayesian Additive Regression Trees (BART henceforth) that was originally developed by Chipman et al. (2010) and applied to the analysis of causal inference by Hill (2011). This procedure shares some similarities with standard matching estimation strategies, see for example Abadie and Imbens (2006), as it compares unemployment-toemployment and employment-to-unemployment transitions of individuals affected by the NMW with a similar individuals whose salary are not affected but are sufficiently close to those in the treatment group. However, this procedure has important advantages over other more traditional parametric specifications. Among them, it does not require any type of hypotheses or priors over the covariates to be included in the model, it can consider a large number of regressors, and it can estimate any type of interactive effects between the treatment variable and any other variable. Thus, under the BART model, the definition of the closest untreated individual for each treated individual and the interactions between the different clusters of individuals and time or and any other relevant covariate is not constrained to follow any specific (and potentially ad-hoc) parametric function. Furthermore, and more importantly, it need not be specified a priori. Our paper is closely related to at least two previous works that estimate the impact of the UK NMW on employment at the individual level using micro-data: Stewart (2004) and Dickens and Draca (2005). Stewart (2004) analyzes how the introduction of the UK NMW in 1999 and its subsequent changes in 2000 and 2001 affected the employment-to-employment transition. Dickens and Draca (2005) follow a similar approach for the NMW increases in October 2003 but they extend the analysis to consider the separate effect of the NMW on job entry and job exit decisions. Both study the impact of the NMW by applying the difference-in-difference 4 technique to the UK Labor Force Survey data, and find both that the NMW does not have a significant adverse effect on employment. Unlike these papers, we do not consider a specific year’s increase in the minimum wage but take into account all NMW changes since its introduction in 1999. Finally, our approach allows us to identify the interactions of the NMW effect with other relevant variables such as gender, age, qualifications and business cycle without the necessity of proposing a parametric specification. The contribution of our paper is twofold. First, we shed some new light on the relationship between the minimum wage and employment. In particular, we find that the NMW exerts a positive and significant impact on both the probability job entry and job exit. Although the magnitude of the effect on job entry is larger, the overall effect of NMW is ambiguous as there are a lot of more employed workers than the number of the unemployed. This could explain the insignificant effect found in the previous work based on aggregate macroeconomic estimations. We find also that the effect is stronger for younger workers and in high unemployment periods. On the other hand, gender and qualifications play little role in shaping the minimum wage effect. Second, we demonstrate the applicability of the BART approach to analyses of economic outcomes without imposing a specific parametric form a priori. While we chose the minimum wage effect on employment, this method could be applied to a broad range of other contexts equally well. In the next section, we present the data used. Sections 3 and 4 discuss methodological approaches used for analyzing the labor-market impact of the minimum wage and explain the main features of the BART model, respectively. Empirical results are shown and discussed in Section 5. The final section summarizes our findings and offers some conclusions. 2 Data Our analysis is based on the UK Labor Force Survey (LFS). The LFS is a quarterly nationallyrepresentative survey of households across the UK. Each quarter, approximately 60 thousand 5 households and over 100 thousand individuals aged 16 and above are surveyed. Each household is retained in the survey for five consecutive quarters, with one-fifth of households replaced in each wave. The survey contains detailed demographic and socio-economic information on the respondents, including, importantly, their labor-market outcomes. Since the NMW was introduced in April 1999, we use all quarterly datasets available from April-June 1999 to October-December 2011, pooling all available LFS waves during this period. In order to have a sufficient number of observations, we include all individuals aged between 16 and 40. The UK NMW features three different age-dependent rates: the 16-17 years old rate, the youth rate (applying to those aged 18-21 1 ), and the adult rate. 2 Historically, the youth rate has remained some 35% higher than the 16-17 rate while the adult rate has exceeded the youth rate by around 20%. The LFS reports the date of birth of every respondent and also the date the survey was carried out. By comparing these two dates, we can determine the precise age of each respondent on the day of the survey. 3 We therefore know whether a particular individual is below or above the age threshold at which they become eligible for a different (higher) NMW rate. 3 Methodological Considerations We analyze the effect of the NMW increases on employment by going beyond standard regression and matching estimation methodologies traditionally used for this purpose. Regardless of the methodology, the analysis involves comparing the changes in labor-market outcomes (such as employment) after a NMW change for the treatment and control groups. 4 1 The upper limit for the youth rate has been lowered to 20 from October 2010. Where relevant, our analysis takes this change into account. 2 A fourth rate, for apprentice workers, was introduced in October 2010 (we do not consider those subject to this rate in our analysis). No minimum wage applies to those who belong to one of the few exemptions such as members of the armed forces, volunteers, students on work placements, workers living in the employers’ households, and (until 2010) apprentices. 3 The precise date of birth is not available in the publicly released LFS datasets. We are grateful to the Office for National Statistics for making the restricted release of the LFS available to us. 4 Note that our approach is similar in spirit to the difference-in-difference approach in Stewart (2004) and Dickens and Draca (2005) who compare the average change in the employment status before and after the introduction of a very specific minimum wage policy. Given that we consider a whole sample of minimum wage changes through thirteen years, our analysis is based on the estimation of the effect on the 6 Consider the impact of NMW on the probability of job loss. The treatment group comprises workers whose wages have to go up in the wake of an annual NMW increase because the new NMW rate is higher than their current wage. The wages of those in the control group should be close to but just above the new rate so as not to have to change. More specifically, the treatment group can be defined as the individuals whose wages meet the following condition: nmwt< wit < nmwt+1 (1) where nmwt is the (age-dependent) NMW rate in effect at time t while wit is the worker i’s wage. The control group is defined as the workers whose wage before the increase is greater than the new NMW rate but lower than some upper bound to ensure that we only consider workers earning just above the minimum wage, so that are likely to possess similar characteristics as those earning the minimum wage. If we set the upper bound as c above the new rate, the control group comprises workers meeting the following condition: nmwt+1 ≤ wit < nmwt+1 ∗(1 + c) (2) We can then estimate the following equation 𝑃(𝑒𝑡+1 = 0|𝑒𝑡= 1)= Φ(𝛼 ∗ 𝐷𝑖+ 𝛾 ∗ 𝑋𝑖𝑡) (3) where the dependent variable is the probability that individual i is unemployed conditional on being employed in the preceding quarter, Φ(.) is the standard normal cumulative distribution function, Di is a dummy variable denoting individuals belonging to the treatment group, included on its own and in interaction with the gap between individual i’s wage and the new NMW rate, and Xit collects all remaining covariates (individual socio-economic characteristics and time effects). An analogous equation can be estimated for the probability of remaining employed conditional on employment in the previous quarter. In line with the standard practice, change in employment status, before and after the policy application, for the treatment and control groups. 7 equation (3), and in particular the coefficient estimate of the first term, is interpreted as capturing the differentiated effect of the minimum-wage increase on the probability of becoming unemployed for the treated individuals relative to those in the control group. A similar approach can be used to estimate the impact of NMW on the probability of job entry. In this case the equation to estimate is 𝑃(𝑒𝑡+1 = 1|𝑒𝑡= 0)= Φ(𝛼 ∗ 𝐷𝑖+ 𝛾 ∗ 𝑋) (4) A particular problem presents itself here in the fact that we do not have any previous wage information for those who enter employment only after the NMW increase. In other words, we do not know whether those entering into employment after the increase would have earned more or less than the minimum wage before the increase. Dickens and Draca (2005) resolve this by defining the treatment group as those whose earnings are less than or equal to the (age-relevant) new NMW rate and the control group as those who earn up to c percent above the NMW: Treatment group: 𝑤𝑡+1 ≤ 𝑛𝑚𝑤𝑡+1 (5) Control group: 𝑛𝑚𝑤𝑡+1 < 𝑤𝑡+1 < 𝑛𝑚𝑤𝑡+1 ∗(1 + 𝑐) (6) A somewhat uncomfortable implication of this specification is that the treatment group now includes also those who earn less than the NMW (there are specific cases when this is allowed, for example for apprentices or for those who receive employer-provided accommodation or other in-kind payments). An alternative specification would entail constructing the treatment group as including only those who earn the minimum wage after the NMW increase. Using that specification yields very similar results. Note that our analysis could suffer from a potential endogeneity problem as in a nonexperimental sample, such as the Labor Force Survey, workers earning less than the new NMW rate are more likely to lose their jobs even if NMW does not change because they are likely to 8 be less productive than workers earning higher wages. 5 Therefore, it is the characteristics associated with their lower wages (and not the minimum wage itself) that determine their higher probability of job loss compared to other individuals with above-NMW wages. In other words, if wages are not allocated randomly, the allocation of individuals into treatment and control groups is not random either but depends on their characteristics. In order to assume that the outcome is independent of the treatment, it is necessary to account for all possible conditioning factors by including a broad range of covariates, 𝑋. More specifically, the strong ignorability hypothesis with respect to the allocation of treatment states that 𝑌 is conditionally independent of D given 𝑋 and that the probability of treatment allocation is always positive regardless of the specific value of 𝑋. Under this hypothesis, the estimation of the marginal effects associated to the treatment variable can be considered in general as a consistent and unbiased estimation of the causal effect of NMW on the probability of job exit and job entry: including a relevant set of covariates in equations (3) and (4) is a sufficient condition to ensure an unbiased estimation. However, as argued by Morgan and Winship (2007), the regression approach can be subject to two important drawbacks. The first relates to the fact that the causal effect of NMW is not constant across individuals. In this case, the estimated causal effect represent a conditional variance weighted estimate of causal effects of individuals and the causal estimation is only unbiased and consistent for this particularly weighted average that is not usually the parameter of interest. The second problem relates to the fact that the strong ignorability condition does not necessarily imply that treatment is uncorrelated with the error term net of adjustment for 𝑋 as this error term depends on the specification of covariates, 𝑋. Therefore, in order to interpret the estimation of a regression strategy as a reliable causal effect, we require a fully flexible parameterization of 𝑋. An alternative approach that overcomes the drawbacks mentioned above is matching: comparing the labor outcomes of the treated individuals with those of similar individuals, with similarity determined based on the set of variables X. Let 𝑌𝑖 be the response, that is 𝑌𝑖= 1 if job 5 Note however that in expressions (2) and (6), small values of c would imply that the salary of the treated and control groups could be deemed to be very similar. 15 intervals for median, while that with continuous covariates by local polynomial regression smoother (loess) along with their 95% confidence intervals (Cleveland et al., 1992, Chp. 8) . In Figure 2, we interact gender with the effect of NMW increases. Again, the previous finding of a greater effect of NMW increases on job exit than on job entry is reproduced. Although for job entry it is clear that the median values are significantly different, the whole distribution of the two effects are very similar which suggests that gender plays little role. In Figure 3, in turn, we consider the interaction with age (expressed in months rather than years). Here, the pattern is different for job exit and entry. While the causal impact of NMW is decreasing with age in both cases, that decline is much steeper for job entry. This is not surprising, given that young workers are more vulnerable to NMW increases. Besides, the interactive effect is clearly stronger for job entry. In Figure 4, we consider the interaction with the highest attained qualification. Again, although it is possible to observe significantly different mean values associated to the different qualifications, the whole distribution of the estimated causal effect indicates that this variable is not a relevant factor to explain differences in the causal impact of NMW either for job entry or job exit. Finally, Figure 5 presents the interaction with the regional business cycle – measured using the unemployment rate. Interestingly, this interaction effect is very different for the two labor-market flows: the minimum-wage effect on job exit is relatively low and depends little on the regional unemployment rate, whereas that for job entry is higher and positively related to regional unemployment. This implies that the effect of the minimum wage on job entry differs considerably between recessions and booms, whereas the business cycle has little bearing on how the minimum wage shapes job exits. Finally, so far we have been considering the effects of NMW changes for two similar groups, those affected by the change and those who are unaffected but are otherwise similar to the affected individuals both in terms of their wage and in terms of the other covariates used in the analysis. However, to test for the robustness of our results even further, we carry out a falsification experiment whereby we define the treatment and control groups as if the NMW were equal to the actual NMW plus 2£. The results of this experiment, shown in Figure 6, 16 indicate that the causal impact of the (false) NMW increase is significant at the 5% level for job entry but not for job exit. We find similar conclusions for other artificial NMW (results are available from the authors upon request). The fact that the falsification test is significant for job entry decisions could be due to spillover effects of the actual NMW increase: the NMW change can lead to ripple effects even for wage rates above the minimum wage. Importantly, the insignificant falsification test results for job exit give strong support to the finding that the employment of workers earning the minimum wage is adversely affected by NMW increases. 17 Figure 2 NMW Increases, Job Exit/Entry and Gender 18 Figure 3 NMW Increases, Job Exit/Entry and Age Note: Shadow area indicates the 95% confidence interval of the local polynomial regression estimator (loess). 19 Figure 4 NMW Increases, Job Exit/Entry and Qualifications Notes: 1 Degree or equivalent, 2 Higher education, 3 GCE A Level or equivalent, 4 GCSE grades A-C or equivalent, 5 Other qualifications, 6 No qualification, 7 Don’t know 20 Figure 5 NMW Increases, Job Exit/Entry and Business Cycle Notes: The horizontal axis measures the regional unemployment rate. Shadow area indicates the 95% confidence interval of the local polynomial regression estimator (loess). 21 Figure 6 Falsification Test: NMW + £2 Notes: The falsification test simulates the NMW being £2 higher than the actual value. 6 Concluding remarks We estimate the causal impact of the NMW on the probability of job entry and job exit in the UK, applying a novel methodology to this context, the Bayesian Additive Regression Trees (BART). An important advantage of this procedure is that it allows the identification of the most important interactions between the treatment variable and other covariates in the model. We find that the NMW exerts a significantly positive effect both on job entry and job exit, with the impact on job entry being relatively stronger (given that there are fewer unemployed than employed workers, the absolute size of the flows cannot be readily compared). The causal effect of NMW is found to be higher for young workers and in periods of high unemployment; both of these interactions are more prominent for job entry than for job exit. However, no significant interactions were found with gender and worker qualification. Overall, the effect of NMW is stronger for job entry than for job exit. 22 Most importantly, our paper open new lines of research that can be explored in subsequent work. For example, this fully flexible approach could be adapted to deal with some recent issues in the literature about the importance of the econometric specification on estimating the effect of minimum wage using panel data models in US states. Also, it could be used to estimate the possible interactions between the federal minimum wage and the state minimum wages, as done by Baskaya and Rubinstein (2012), without the necessity of estimating two different models. 23 References Abadie, A., and G.W. 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