Tuesday, December 10, 2013

Minimum Wage, Demographics, Emergency Unemployment Insurance, and Unemployment from 2007-2011

So, after reviewing the historical evidence on increases in the national minimum wage, I have some method for estimating each of these factors on employment in the latest downturn.

Edit:  After looking some more at the relationship between the MW and the proportion of workers at or below MW, I noticed a non-linearity at the low end of the range, where MW levels were in 2007.  The first hike in 2007 hardly budged the proportion of workers at MW.  This was likely because the legislated MW had fallen below the typical voluntary MW.  I have updated the graphs and numbers below to reflect that deviation from the trend.

Minimum Wage:
This is based on the forecast described in the previous few posts, based on the relationship between the change in the minimum wage as a proportion of average wages, and the change in employment, during episodes of minimum wage increases from 1956 to 2004.  For total employment, during two-year periods following an initial MW hike, the null is rejected at the 10% level.  For follow-up MW hikes in episodes with more than one increase, the null is rejected at the .001% level if we include all periods of time, and is rejected at the 10% level for the 1956-2004 period.
The null hypothesis could not be rejected when tested in terms of unemployment instead of employment for the period ending in 2004.  But, the employment forecast gives us the more important number, in terms of expected jobs lost.  The unemployment forecast simply helps parse that out between workers who leave the labor force and workers who are categorized as unemployed.  With that caveat, I have used the forecast from those tests for the estimated unemployment due to MW hikes.

This estimate is based on a pattern I touched on here.  Unemployment duration tends to grow with age, and education.  I think this tendency can basically be thought of as labor market friction.  Older workers may have greater skill specialization, which creates searching costs.  They may also have more back-up resources, and a greater ability for consumption smoothing.  All of these factors may lead to greater cyclicality in the unemployment rate during times when there are more older workers.  This estimate is based on simple relative average unemployment durations for each age group, with unemployment increasing in proportion to average duration.
This is one of the earliest effects of the baby boomer aging process.  This effect is already diminishing because as older workers enter the oldest age categories, their labor force participation and general level of unemployment decline enough to counteract this effect on unemployment.

Emergency Unemployment Insurance:
I touched on this issue in this post.  Here is a graph of the relationship between unemployment durations of less than 26 weeks and durations of 26 weeks or more, going back to 1960.  Short term unemployment durations and long term unemployment durations moved with some uniformity through many different business cycles over that time, until the implementation of 99 week EUI.  David Grubb from the OECD explains how the level of EUI support was vastly longer than in any previous period.

My estimate for how much this policy affected the unemployment level treats this, much as in the demographic effect, as a labor market friction.  I compared the proportional level of durations over 26 weeks to the typical level we have seen in business cycles over the past 3 decades, and attributed that difference to the EUI policy.  One might be able to argue that there are some other factors involved here, but decades-long pattern of this relationship suggests that those other factors have been dwarfed.  Further, my measure ignores any influence EUI might have had in increasing the average unemployment duration of workers unemployed for less than 26 weeks.  This is clearly a conservative assumption.  On net, until I figure out how to sensibly estimate EUI influence on durations under 26 weeks, this estimate will probably be somewhat conservative.

Here are the unemployment estimates:
graph before update

This chart covers the time period until July 2011.  This is the period where I have a monthly model for minimum wage related employment changes.  These estimates suggest that if we did not have these demographic and policy issues, this would have been a typical unemployment cycle.  (The pale blue line is where I estimate we would be without these policies.)

Here is the graph extended to June 2013.  We are getting far enough away from the MW hikes that the recovery in low-wage employment is mostly dependent on broader economic recovery, Fed policy, etc..  As the earlier posts on MW showed, MW episodes that were small enough would eventually see catch-up employment growth as the economy naturally outgrew the wage-price floor.

graph before update
We may be near a normal labor market, if not for these issues.  These issues might continue to inflate the unemployment rate for a few years, but they shouldn't be permanent.  The Fed hasn't been too loose up to this point, but if they start to err on the side of being stimulative in the face of an unemployment rate that stays stubbornly above 6%, the hidden core of the labor market which may already be back to recovery levels, might create unexpected inflation.  The scale of the recent MW hikes was large enough that there may be low wage workers who continue to be priced out of the market if we don't experience some inflationary adjustments.  There may also be some frictions for long-term unemployed who want to go back to work.  So, unemployment declines might slow down at a higher range than has been the recent experience.  But, it is possible that if federal policies allow these issues to decrease in importance, that could help to reaccelerate the decline in unemployment.

Next up, Labor Force Participation.


