methods to index the national wage floor: a choice among alternatives

Methods to Index the National Wage Floor: A Choice Among Alternatives

BRIGITTE SELLEKAERTS AND WILLY SELLEKAERTS*

I. Minimum Wage Indexation Sets a Real Wage Floor

The present system of legis latedamendments to the Fair Labor Standards Act (FLSA) that sets the minimum wage for several years in the future, is not capable of guaranteeing the main-

tenance of the purchasing power of a given minimum wage level. The minimum wage, de- flated by either consumer prices or aggregate hourly wages, shows that the purchasing power of minimum wage workers seriously eroded in the 1970's, a decade occasionally plagued

with double-digit inflation (Figure I). In the previous two decades, when inflation ran at lower and more predictable rates of 1.6 percent and 2.3 percent, respectively, sizeable real minimum wage increases took place.

Minimum wage indexat ion is a policy tool to maintain a real floor to wages, a goal of economic policy that is implied by the FLSA. 1

*Central Michigan University. An earlier version of this paper was funded in part by the Minimum Wage Study Commission, under Contracts J-9-M-0073, J-9-M-1-0044, and J-9-M-0-0050. Research assistance was provided by P. Cheung, G. Gajewski, A. Hengle and T. Nguyen. Only the authors are responsible for remaining errors.

I

In the economic policy framework, wage indexation in general, and minimum wage indexation in particular, is an instrument that facilitates the attainment of one or more policy goals, notably, price stability, low unemployment, external balance, stable growth rates of gross national product near the poten- tial rate, and a fair distribution of income. According- ly, a full assessment of the usefulness of minimum wage indexation for the simultaneous attainment of all economic policy goals belongs in the realm of optimum policy, i.e., the maximization of a social welfare function subject to all relevant economic constraints. However, the maximization of a social welfare function with several interrelated arguments carrying different and maybe even flexible weights, subject to an intricate set of nonlinear and dynamic constraints-in the form of an econometric model representing the working of the economy-is a highly cumbersome process that would not easily permit a comparison of various minimum wage indexation methods.

Labor as a group and employers will benefit from minimum wage indexation if it boosts the real wage bill, leaves profits intact and does not exacerbate unemployment . The measurement of the impact of minimum wage indexa-

tion on these macroeconomic variables is the subject of this paper.

Selection o f a Desirable Minimum Wage In- dexation Method. The mechanism by which the minimum wage is adjusted with respect to an increase in a trigger price or wage can be based on ex-ante indexation or on ex-post indexation (sliding wage scales). A plethora of wages, prices, cost-of-living indexes and poverty income indicators can serve as the trigger for minimum wage escalation.

In the ex-ante indexation method, new wage negotiations are slated whenever increases in consumer prices exceed a given threshold. This form of wage escalator clauses is in use in several West European countries (Switzerland, the

Netherlands, France and Great Britain)? Ex- ante indexation is inappropriate for minimum wage adjustments, for three reasons. First, it is

a method requiring a collective bargaining framework. Second, wage increases are scheduled in advance on the basis of a forecast of consumer prices, which may not be accurate. While in one period, inflationary expectations may dictate wage adjustments that are exces- sively high when the economy's underlying inflation rate is receding, in another, scheduled

wage adjustments may be too low when unanticipated exogenous factors boost inflation in consumer prices above its forecast value. Third, it is beneficial for employers to raise prices of their products immediately after a new wage agreement is molded. This enhances profitabil- ity and thus the ability to pay higher wages,

2 A concise survey of escalator clauses in various countries is provided in A. Ahnefeld and K. H. Frank [1974].

2 ATLANTIC ECONOMIC JOURNAL

and adds immediately to inflation. Therefore, union members will experience reduced satis- faction from the new contract, leading to lower productivity gains and strong pent-up demand for future wage advances. Accordingly, a strong inflationary bias is inherent in the ex-ante wage indexation mechanism. For these three reasons, ex-ante methods to index the minimum wage are rejected a priori in this study.

Ex-post indexation, or the sliding wage scale principle, gears wage rate adjustments to recent actual rates of inflation in consumer prices. Generally, wage adjustments are granted when inflation exceeds a specified rate. Wage escalator clauses of this type-sometimes coupled with productivity adjustments-are common in many three-year collective bargaining agree- ments in the United States and are also generally applied in Denmark, Italy, Belgium, Fin- land, Norway and the United Kingdom [Ahne- feld and Frank, 1974, p. 19].

Ex-post indexation has several advantages, rendering it ideally suited as a method to adjust the minimum wage. This method does not re- quire a forecast of inflation and lends itself for legislative action, because wage adjustment rules can be set up in advance and may have to be changed only infrequently. Because sliding wage scales permit wage increases only with a lag after price increases have already taken place, they are not inflationary by design, and they can be accepted as equitable by the majority of voters. They provide an additional cushion against price inflation, not only because wages are adjusted with a lag, but also because the wage adjustment need not amount to 100 percent of the price increase in every time period and for every sector of the economy. Moreover, they offer policymakers the flexibility to change relative wages in the economy by varying the degree of adjustment of wages to overall inflation in different sectors of the economy.

Minimum Wage Indexants (MWI) are aggregate indexes chosen to measure inflation, that can be incorporated in an ex-post adjustment mechanism in an effort to preserve a real wage floor. Four alternative indexes can assume the

role of MWI: the all-items consumer price index (CPI); the "true" cost-of-living index (COL); the implicit deflator for personal consumer expenditures (PC); and average hourly earnings (AHE).

The Consumer Price Index (CPI) is a Las- peyres index with base period weights that measures price increases of a fixed basket of 250 consumer goods in a base period. Since several federal social programs are already indexed with respect to the official CPI, its use as a minimum wage indexant does not deter work incentives of marginal labor market par- ticipants faced with the choice between wage- and non-wage income. Moreover, because minimum wage earnings hover near the sub- sistence level, use of the CPI assures that the indexed minimum wage earnings suffice to purchase at least the basket of commodities of the representative base year. Suppose that in period one an exogenous shock has drastically increased the price of beef. Since the demand for beef is price-elastic, consumers will shift purchases away from beef towards less ex- pensive protein sources.

If, in period two, the consumer's purchasing power is restored on the basis of his current consumption basket-which now contains a smaller share of beef -by means of either a cost-of-living index or the implicit deflator for consumption, he may be penalized for his frugality and forced to permanently switch his consumption away from beef because his

3

true purchasing power is reduced. If, on the contrary, the price increase used to restore the consumer's buying power in period two is measured on the basis of the basket of goods purchased in period one, he can again select beef as a source of protein, buy the same bundle of goods and maintain the same level of well- being as in period one.

A few criticisms of the use of the CPI as a MWI do not relate to the weighing system but to inaccuracies in its computation. They comprise its failure to incorporate the user cost of

i

3The problem of delineation of an appropriate basket of consumption is also inherent in poverty income indexes.

SELLEKAERTS: NATIONAL WAGE FLOOR 3

durables rather than their price, 4 and inaccuracies in its housing componentJ Changes in the quality of the commodities constituting the basket are ignored in the CPI as in most other price indexes.

The Cost-of-Living Index (COL) is a Paasche index with current-period weights. In the utility sense, a " true" cost-of-living index is defined as as the money cost of purchasing an additional unit of utility. Indexation on the basis of this " true" cost-of-living index in the face of relative price changes leaves the consumer on the same indifferenc curve, thus keeping his psychic income constant. True cost-of-living indexes cannot be computed, simply because the shape of the average consumer's indifference con- tours let alone the shape o f indifference con- tours of subgroups of consumers-is not known. While efforts have been made to estimate cost- of-living indexes from the linear expenditures sys tem-the simplest linear demand system that is consistent with a hypothetical underlying utility function that has basic desirable properties-there is no guarantee that utility functions in the real world actually display these underlying characteristics.

Since a genuine cost-of-living index is not published by the Bureau of Labor Statistics or by other official data gathering agencies, the impact of its use as an indexant cannot be measured empirically. Therefore, it is not further addressed in this study.

The Personal Consumption Deflator (PC) is published by the Bureau of Economic Analysis as part of the National Income and Product Accounts and is available in three forms: a current-weighted (Paasche) index, a chain-price index and a constant-Weighted (Laspeyres) index The deflator chosen for analysis in this paper is

i i

4 The same measurement problem plagues the computation of various components of aggregate spending in the National Income Accounts.

s A detailed discussion of the home ownership issue is provided in Blinder [1980, pp. 552ff].

the Paasche version. ~ While a PC-based minimum wage index maintains a form of real purchasing power-as PC is derived on the basis of the actual basket of goods consumed in each per iod- i t does not guarantee that the minimum wage worker can continue to buy the original basket of commodities.

It may be feared that, in an inflationary en- vironment, indexes of price advances computed on the basis of an up-to-date basket of goods (i.e., the COL or the PC) display smaller incre- ments than a consumer price index, computed on the basis of a consumption basket that may reflect outdated spending habits. However, Blinder [1980] has demonstrated that the dif- ference in inflation measured by the CPt and a variable-weight price index otherwise equivalent to the CPI was minor in recent years.

Average Hourly Earnings (AHE) indexes are published in many different forms. Since the subject of this paper relates to the national minimum wage, the aggregate measure of AHE, computed for the private nonfarm business sector, is the most appropriate MWI. Be- cause AHE are largely the outcome of collective bargaining and tend to catch up with cost- of-living increases as well as productivity increases, their use as a MWI ensures that minimum wage workers share in average productivity advances.

Economists have observed that historical minimum wage levels have often hovered near 50 percent of hourly earnings in the manufac- turing sector (Figure I, Part B) and have sug- gested indexing the minimum wage on the basis of this relationship. However, the national minimum wage cannot simply be indexed on the

6 To derive the CPI from the PC,it is necessary to (1) subtract the contribution of shifting weights in PC, (2) subtract the contribution of differences in weights of comparable PC and CPI expenditure components (this step leads to the PC chain index), (3) subtract the contribution of PC expenditure components that are not comparable with CPI components, (4) add the contribution of CPI expenditure components not comparable with PC components and (5) subtract the contribution of differences in seasonal adjustment. A table listing the relative importance of these conciliatory items during recent quarters is provided in the Survey of Current Business [1980, Table 3, P. 31.


II0

Figure I

A. Purchasing Power Of The Minimum Wage Relative To Consumer Prices; 1960 - 1981

( 1 9 6 7 : 100 )

105

" ~ 100

95,

"~ 913-

85-

8~o A ~o A 8~ 815 Time

B. Purchasing Power Of The Minimum Wage Relative To Average Hourly Earnings (1960-81)

(1967 : 100)

I05 / t ~ ! t _ . . . . . . . . . . . . . . . . . . .

7t0 7'5 810 815 Time

basis of AHE in a SIC category that is conve- niently selected because of an apparent historical relationship. If wages are to form the basis for minimum wage indexation, economy-wide average hourly earnings are superior to average hourly earnings in any particular sector.

II. A Model to Analyze the Economic Impact of Minimum Wage Indexation

Owing to its highly restrictive assumptions,

log

ca

w

ca 95

9C N

6 0 615

C. Purchasing Power Of The Minimum Wage

Relative To Average Hourly Compensation;

1 9 6 0 - 1 9 8 0 ( 1 9 6 7 : 1 0 0 )

fOo . . . . . . . . . . . . . . . . . . . .

95

8O

60 45 7o 7s so B5 T i m e

the simple neoclassical model cannot serve as a tool to measure the impact of eventual minimum wage indexation on the U.S. economy, even if refinements to account for imperfect knowledge and the existence of two labor skill classes are introduced. Therefore, a more detailed and realistic model was relied upon to compute the impact of various indexation schemes.

The Simple Neoclassical Model relied upon in the indexation literature focuses on aggregate economic phenomena during a given contract period (e.g., three yea r s ) / In the labor market, both demand and supply are generally stipulated to react to real wage rates and to random shocks during the contract period. Since workers are assumed to be paid their marginal product, no separate wage determination relationship is included. There can be no unemployment during the contract period in this framework, because employment is determined by firms while labor supply is determined by workers at aparticular level, given the real wage rate pre- vailing at the beginning of the contract period, as long as a mechanism exists to preserve the market-clearing value of the real wage rate in the face of rising prices and exogenous shocks.

7 See, for example, the models used by Blanchard [1979] and Gray [1976 and 1978].


If two classes of labor are introduced by authors attempting to capture minimum wage impacts, in the form of a "covered" versus "noncovered" labor sector, workers disem- ployed via minimum wage impacts are pushed to the noncovered sector, so that aggregate unemployment still does not take place and the spirit of the simple model remains unchanged. ~

Proponents of the simple neoclassical model generally attempt to measure how a specific degree of indexation changes the outcome of the impact of nominal disturbances on real variables. 9 They view indexation as a scheme designed to provide protection to economic agents, possessing the same degree of knowledge, from unanticipated movements in prices and generally abstract from anticipated shocks. I° However, this study requires the assessment of the effect of anticipated shocks.

The simple neoclassical model's answers to the indexation issue are immediately obvious. In the event of a monetary disturbance 11 -e.g., one caused by monetary policy-the absence of indexation of wages leads to a change in real wages, and real effects take place in both labor and output markets. At the other end of the spectrum, if full indexation of wages is present in labor contracts,the 0quilibrium real wage rate remains unchanged and the monetary disturbance has no impact on the real sector. Accord- ingly, the optimum degree of indexation in the economy where only monetary shocks occur equals unity. ~

If only real shocks occur, the corresponding change in real output induces a change in the real wage in the absence of indexation and the labor market finds a new equilibrium. I f indexing is present at a rate of unity, the same real shock causes a greater real disturbance, because

8 This is the approach taken by Boschen and Gross- man [1981].

9See, for example, Gray [1976]. ~* It would be unrealistic to assume, however, that

the minimum wage worker can find employment in the non-covered sector, and that he possesses the same degree of knowledge about anticipated shocks as large corporations.

~lThe random disturbance in the output equation is either zero or averages zero during the contract period.

~2 This is equivalent to a full and immediate adjustment of wages to prices in the classical model.

the labor market no longer clears. This asymme- try has led the indexationists l~ to conclude that full indexing protects the real sector from eventual monetary shocks but may exacerbate the effect of real shocks. Moreover, since the neoclassical economy produces only one commod- ity, fluctuations in relativeprices and quantities are excluded by design.

If both real and monetary shocks occur during the contract period, economists relying on the simple neoclassical model find that the optimum degree of indexation lies between zero and unity. Full indexation then no longer washes away the effects of monetary variability.

The Model Used For This Study. Relaxation of the simplifying assumptions of the neoclassical model is equivalent to the specification and estimation of a more disaggregated and inter- active econometric model. Although the most recent [1978] version of the MIT-PENN-SSRC (MPS) Econometric Model of the U.S. Econ- omy contains 200 equations with a high degree of endogenous interactions, it needed to be modified extensively to render it capable of capturing the general equilibrium effects of modifications in the pattern of minimum wage adjustment on behavior of various economic units. Accordingly, a new labor sector and wage/price determination sector were specified and estimated, and incorporated with the remaining equations of the existing model. The new equations are summarized in Table 1. The behavioral equations for labor productivity and labor force participation are presented in the appendix.

In addition to the inverse of the unemployment rate, productivity, and price expectations, the wage equation incorporates a minimum wage variable that is fully adjusted for changes in coverage by industry. Despite serious multi- collinearity between the lagged minimum wage and the price expectations variable, their separate effect was well captured by relying on a two-step estimation procedure. Because changes in contributions for unemployment insurance and social security often become ef- fective in the same quarter as a minimum wage

~3Term introduced by E. S. Phelps [1977].


Dependent Variables

TABLE 1

Estimated Equations

Explanatory Variables I

Average Hourly Compensation (/~2 = .965;D14] = 1.704)

Producer Prices (/~2 = .998;DW = .918)

Consumer Prices (R 2 = .960;DW = 1.758)

Implicit Deflators

Productivity (output per worker hour) and Labor Demand (number of workers) (R 2 = .988;DW = 1.705)

Labor Supply (/~2 = .941 ; D W = 1.533)

Unemployment Rate (aggregate and prime-age)

Unemployment rate* Productivity* Coverage-adjusted minimum wage Inflationary expectations* Contribution rates for UI and OASDHI

Unit labor costs* Unit domestic materials costs* Unit capital costs* Unit imported materials costs* Unutilized capacity* Price controls

Wholesale prices* Price controls

Wholesale* or consumer* prices

Capital/labor ratio* Anticipated minimum wage Unutilized capacity* Employment share in Federal spending Rate of change in nonfarm business output*

Demographic variables Changes in military draft practices Minimum wage anticipations Unemployment rate (actual relative to trend)*

Labor demand* Labor supply*

1Explanatory variables (or their components) that are themselves explained endogenously elsewhere in the econometric model are designated by an asterisk (*). Each explanatory variable in the estimated equations was significant at 5 percent or better. The behavioral equations for average hourly compensation, producer prices and consumer prices are presented in Setlekaerts [1982].

increase, their impact was captured by separate additional explanatory variables. Moreover, in- clusion of cyclical dummy variables permitted the estimated elasticities to vary from one business cycle to the next.

With the exception of one of the implicit deflators, the MPS Model does not contain behavioral price equations. Accordingly, a price determination sector was specified in which changes in producer prices are rendered a function of changes in various components of ex-

pected unit production costs, unutilized capacity and various price controls. Consumer prices and all implicit deflators were explained endogenously on the basis of producer prices and appropriate exogenous variables.

The specification of the equation for productivity in the private nonfarm business sector derives from the underlying aggregate production function (hence, the presence of the capital/output ratio) and is augmented with variables capturing the effect of changes in the unem-


TABLE 2

Comparison of Root Mean Square Errors (RMSE) and Number of Interations in Adapted and Original Version of MPS Model 1 (Dynamic Simulation from 1973:1 - 1979:2)

Adapted Model Used Basic MPS Model in this Study

RMSE of Selected Variables:

Real GNP 14.713 42.563 Real Consumption 8.838 17.784 Income of Households 0.969 1.645 Consumer Prices (%) 2.919 3.342 Unemployment Rate 0.662 1.475 Total Manhours 1.592 5.200 GNP Deflator 1.303 3.160

Average Number of Iterations Required to Attain a Solution 13 15

The original model is the 1978 version of the MPS Model of the U.S. Economy.

ployment share in the federal government sector and the effect of changes in the anticipated minimum wage (MWa), computed as the average of the annual minimum wage increases legislated to go into effect in future years.14 A rise in MW a boosts productivity, indicating that, under the present system of periodic FLSA amendments, businesses tend to raise output per worker in advance on the basis of the minimum wage increases that are scheduled to go into effect in future years.Underaregime of indexation, however, MW a would become the same as the legislated minimum wage.

Changes in labor force participation are determined by corresponding changes in demographic variables and military draft laws, by the discouraged worker effect, and by the anticipated changes in the minimum wage, as defined above. Employment of workers is linked by a bridge equation to the number of hours worked, while the unemployment rates

t

14Contrary to the custom of computing expectations variables as a distributed lag~ over past values of the corresponding variables. MW- is a true expectations variable, since it is computed on the basis of announced and therefore known future values of the minimum wage.

for the prime and the total work force are derived by a set of definitions to close the labor sector.

The predictive performance of the complete econometric model is considerably greater than that of the 1978 MPS Model itself. Table 2 shows that the Root-Mean-Square Errors (RMSE) for crucial endogenous variables are considerably smaller and the average number of iterations required to attain a solution is reduced from 15 to t3. This enhanced predictive power results not so much from the incorporation of the minimum wage but from the incorporation of a price sector, the labor demand and supply equations and the derivation of the economy's unemployment rate via definitions related to labor demand and supply rather than by Okun's Law. The dynamic model performance is further enhanced by using a "tracking" solution rather than a standard control solution.

Ill. Impact of Alternative Ex-Post Indexation Schemes

The macroeconomic impact of minimum wage indexation~ both in the long run and in the short run, was assessed by replacing the minimum wage increases legislated by the 1966 and successive amendments to the FLSA by an


indexed minimum wage, and simulating the differences in the endogenous variables of the model outlined in Section II above. The impact of a given indexed minimum wage increase is not identical to that resulting from the same size increase under a system of legislated increases, because the announced minimum wage increases affect labor force participation as well as productivity. Therefore, the empirical results are not striclty comparable to those derived in Settekaerts [ t982].

Since ex-ante indexation was rejected on a priori grounds earlier in this paper, only the impact of selected ex-post indexation methods was analyzed. Implementation of a given minimum wage indexation method requires determination of the indexant, the fre- quency and time of the adjustment, and the size of the adjustment coefficient. Three published aggregate data series emerge as feasible wage-floor indexants: the all-items, all urban consumer price index; the index of average hourly earnings in the private nonfarm business sector; and the implicit deflator for personal consumption.

Five alternative adjustment patterns were derived with respect to each of the three indexants. The first four permit the minimum wage to be adjusted quarterly on the basis of the corresponding quarterly percent changes (com- pound annual rates) in the indexant, They are, in particular, the average of the previous four quarters' changes in the indexant, with a one- quarter lag; the same average, with a two-quarter adjustment lag; the average of three quarters' changes in the indexant, with a one-quarter adjustment lag; and, finally, the previous quarter's change in the indexant. The fifth mechanism permits the minimum wage to be adjusted only in the first quarter of each year, on the basis of the percent change in the corresponding indexant in the previous calendar year. ~

ii i i i i i

~s Since the minimum wage changes resulting from the replacement of the historic minimum wage levels by their indexed counterparts affect inflation somewhat, price and wage patterns would have differed from their historic patterns under a regime of indexa- lion. Therefore, the indexed minimum wage levels were derived endogenously in the econometric model, by means of successive approximation.

The adjustment coefficient for each of the fif- teen indexation methods was maintained at 100 percent.

Historically, the minimum wage was raised t4 percent, to $1.60, in 1968 and remained unchanged throughout the first quarter of 1974. It is not surprising that all 15 minimum wage indexation schemes display a more gradual pattern of increases, falling below the legislated minimum wage in 1967 and until the turn of the decade, while rising above it in the first half of the seventies. Although each indexation scheme considered reflects this common pattern, the indexed minimum wage would have risen relatively slowest with the personal consumption deflator, and relatively fastest with average hourly earnings as the indexant. However, even in the latter case, the minimum wage would have barely surpassed the $2.90 legislated level in 1979.

Under each method considered, the long-run impact [1967-1979] of minimum wage indexation would have been beneficial for the economy as a whole. On the average, for the complete period, real output and employment are vir- tually unchanged and exceed their historical levels by at most 0.5 percent. None of the indexation schemes would have been inflationary. With several of the methods, inflation in consumer prices would have been somewhat lower than in actual history, and no method would have resulted in significantly more inflation. The fear expressed by many that "indexation" is synonymous with "inflation" is, therefore, unfounded. In the majority of schemes considered, corporate profits are enhanced, though by a minor amount, supporting the hypothesis that firms can more readily adjust to gradual and expected advances in unit labor costs than to ad hoc legislated increases.

While in the long run all methods considered exert a very small average impact on the economy, the quarterly pattern of the simulation results shows that the impact is at times sizeable. For example, differences in real GNP relative to its historic level amount to as much as $8.0 billion in some quarters. More impor- tantly, GNP tends to exceed its historic values in recessions and to fall below these values


during periods of peak economic activity. Ac- cordingly, an indexed minimum wage con- tributes to economic stability. This result is fully in line with the predictions of the neoclassical model.

Ex-post indexation of the minimum wage has a persistent favorable impact on the U.S. economy whether indexation is started in an upswing or in a downturn. The favorable impact of ex-post minimum wage indexation does not depend on a particular business cycle. ~

In 1977, inflation in consumer prices had cooled off to 5.74 percent, while average hourly earnings growth was 7.24 percent. The 1977 amendments to the FLSA raised the minimum wage by four successive annual increases of 15.2 percent, 9.4 percent, 6.9 percent, and 8.1 percent over the 1978-1981 span, of which the first provided a real increase no matter what yardstick of aggregate inflation is used, while the remainder did not. Ex-post indexation of the minimum wage from 1978 on would thus have led to a smaller minimum wage increase in 1978 and larger increases in 1979, 1980, and 1981, compared with actual history. The empirical tests conducted over the 1978- 1979 time period indicate that a CPI-indexed minimum wage (with a once-per year adjustment) would have attained $2.45 in 1978 and $2.64 in 1979, rendering wholesale and consumer price inflation somewhat below their historical paths in 1978, while employment would have risen marginally. 17

Had indexation instead been initiated in place of the 1974 amendments, the reverse pattern would have resulted. For example, indexation with respect to average hourly earnings, on the basis of the previous four

, i i l l

16The simulations were performed for the follow- ing sub-periods: 1967:1-1969:3, 1969:3-1973:4, and 1973:4-1979:1, three complete business cycles between peaks; 1973:1-1975:1, the downward phase of a full business cycle, and 1975:1-1979:2, the upward phase of the same business cycle.

7 Consistent with the long-run results, a minimum wage indexed on the basis of the implicit deflator for total personal consumption would have led to minimum wage increases somewhat below those based on hourly earnings or the consumer price index as an indexant.

quarters' changes in that indexant with a one- quarter lag, would have left the minimum wage near $2.20 in 1975, gradually increasing to $2.70 in 1978. It is interesting to note that the minimum wage was legislated at $2.70 for that year, suggesting that policymakers in 1977 may have attempted to introduce a catch-up increase compensating for previous years' losses in purchasing power.

The best indexant is average hourly earnings in the private nonfarm business sector, since it provides minimum wage increases that incorporate both advances in the cost of living and in productivity, without detrimental impact on the economy. Annual adjustments on the basis of the previous year's increaseinthis indexant, with a 100 percent adjustment coefficient, comprise themost practical scheme. Therefore, the recommendation of the Minimum Wage Study Commission [1981] that a new measure of hourly earnings be created by the Bureau of Labor Statistics as a minimum wage indexant, encompassing both earnings of farm and nonfarm workers, creates merely another unneces- sary hurdle in the implementation of minimum wage indexation by Congress.

Conclusion. Ex-post minimum wage indexation has beneficial impacts on the economy as a long-run policy. With average hourly earnings as the indexant, this policy has three major beneficial impacts on minimum wage workers: their buying power is maintained, they share in the gains in average output per worker, and the disemployment effect is negligible. Business and workers in general benefit, as profits and employment are mildly enhanced in the long run and the overall stability of the economy is fostered.

Although the initial impact of introducing ex-post minimum wage indexation in the economy is not negligible, this cost only occurs once. Ad hoc legislated amendments to the FLSA, on the contrary, impose frequent exogenous shocks on the economy. Moreover, once ex-post indexation is introduced, the economy moves quickly to a long-run beneficial path.


APPENDIX

Productivity Equation (t-statistics in parentheses):

Zog PHEt

XBNFt - [(CSHt + YSEt)/(.OI *PXBNFt)] = 2.310 - .086 log (MW~)

(7.61) (7.93)

_ XBNFt XBNFt.1 - . 9 6 2 * .05 * [ l o g ( ~ ) + (,,-U2-2--~)] (6.75) et/~ct

KPS t + KPD t -1.598 log ( ) + 0.080 (14.13) LEEMt (2.22)

EGFLt Zog(~t)

+ 5 Z ai

i=1 [log (XBNFt_ i ) - log ( XBNFt.i. 1 )]

~ 2 = .9876 DW = 1.705 SER= .009 Sample per iod:1966:4-1979:2

Time Period ai

t-1 - .459 (4.40)

t-2 - .402 (5.22)

t-3 - .034 (4.30)

Time Period ai

t-4 - .184 (2.55)

t-5 - .096 (2.10)

PHE = Hours worked by employees in the nonfarm business sector. XBNF = Nonfarm business product and product of households in 1972 dollars. CSH = Consumption of housing services, in 1972 dollars. YSE = Proprietors ' profits. PXBNF = Implicit price deflator for nonfarm business output . MW a= Average of announced increases in the statutory minimum wage. XBC = Production capacity for business output (computed variable). KPS = Net stock of producers' structures, end of period, in 1972 dollars. KPD = Net stock of producers' durables, end of period, in 1972 dollars. LEEM = Number of persons employed in the nonfarm business sector. EGFL = Compensation of Federal employees, in 1972 dollars. EGF = Federal government expenditures, in 1972 dollars.


Labor Force Participation Equation (t-statistics in parentheses):

L F LA * 100 = 5.078 + 0.063 log (__7777_)

N16 (13.66) N16

N5 + 0.007 JPG - 0.094 log

(2.89) (6.67) (N-i6)

- 0.006 JMIL + 0.024 log (Mie a)

(2.69) (5.32)

NPRJ2 + 0.745 log ( ~ ) - 0.003 (URPRt - URPR~)

(2.68) (6.16)

/~2 = .9411

Die = 1.5331 SER= .003

Sample period: 1966:4-1979:2

L F = Number of persons in the total labor force.

N16 = Population of labor force age. LA = Number of persons in the armed forces.

JPG = Dummy variable for price controls.

N5 = Population aged 5 and less, JMIL = Dummy variable for changes in draft requirements. M W a = Average annualized minimum wage increase mandated by each successive amendment to

the FLSA. N P R J 2 = Male population, aged 20-54.

URPR = Unemployment rate for male prime-aged workers.

With the exception of the minimum wage variables, the source of the data was the MPS Model Databank.

REFERENCES A. Ahnefeld and K. H. Frank, "Scope and Forms

of Escalator Clauses in Various Countries," Appendix to M. Friedman, "Monetary Correction," inEssays on Inflation and Indexation, Washington, D.C.: American Enterprise Institute, 1974, pp. 16-23.

Olivier Jean Blanchard, "Wage Indexing Rules and the Behavior of the Economy," Journal of Political Economy, 87, 1979, pp. 798-815.

Alan S. Blinder, "The Consumer Price Index and the Measurement of Recent Inflation,"~Brookings Papers on Economic Activity, 1980, 2, PP- 534-72.

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methods to index the national wage floor: a choice among alternatives

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