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Disentangling the Minimum Wage Puzzle: An Analysis of Worker Accessions and Separations from a Longitudinal Matched Employer-Employee Data Set', Journal of the European Economic Association, 4 (5), September, 988-1013

In this study the dynamics of employment at the firm level following a sharp increase in the minimum wage is analyzed. Several novel aspects are introduced in the empirical analysis of the topic. First, the change in the legislation under analysis provides remarkably good conditions for economic analysis, since the increase in the mandatory minimum wage was large, unpredictable, and it affected only a very specific group of workers.
Indeed, in 1987 the minimum wage for workers aged 17 increased in Portugal by 50 percent, due strictly to changes in the legislation, and for workers aged 18 or19 it was raised from 75 percent to the full minimum wage rate, therefore increasing by 33 percent. Second, the analysis relies on a panel of linked employer-employee data, covering in each year nearly all of the wage earners in the private sector (over two million workers), an outstanding data set. Every firm with wage-earners is legally obliged to reply to this inquiry by the Ministry of Employment, and the response rate is thus extremely high.
Third, the study handles issues that have not previously been explored in the literature. By explaining employer behavior regarding both accessions and separations, and focusing not just on firms remaining in business, but also on new firms and those closing down, this study adds to the previous literature that has explained net job flows at the firm level (Card and Krueger 1994, Katz and Krueger 1992, Pereira 2002).1 We can therefore address the minimum wage puzzle, by identifying exactly where and how the minimum wage bites: do employers dismiss mainly youngsters, following a rise in the youth minimum wage? Or do youngsters become under-represented among the newly hired workers? Do firms that are about to be set up, which are free to choose their labor force from the available pool of workers, hire relatively fewer youngsters than comparable firms did before the minimum wage was raised? Does a rising minimum wage place unbearable constraints on firms, contributing to firm closure? Identification of the precise source for changing employment levels can reconcile some of the evidence that has previously been presented in the literature as contradictory.
We will also rely on micro data on workers to follow a line of analysis previously used by Abowd et al. (2000), Zavodny (2000) and Currie and Fallick (1996). At the individual level, we can provide a direct answer to the question: are the workers directly affected by a rise in the minimum wage less likely to keep their jobs? Therefore, in the current study, two types of constraints traditionally faced by labor economists in the empirical analysis of the minimum wage are relaxed. First, the impact of the minimum wage is usually hard to isolate from that of other economic forces. Ideally, the conditions for quasi-experiments should be met, in which case changes in the minimum wage would affect strictly a specific group of workers, subject to conditions otherwise similar to other workers, a situation that very rarely occurs in economics.
The studies by Card and Krueger (1994, 1995) and Katz and Krueger (1992) have become well-known examples of that methodology, as their work generated an intense debate.2 Second, even when changes in the minimum wage provide good conditions for economic analysis, the study to be undertaken still depends crucially on the data available, in particular its quality and detail.3 On both of these fronts, our study relies on unusually favorable conditions, enabling the analysis to progress into directions left unexplored by previous studies. Section 2 describes the institutional framework in Portugal and the major changes that have taken place with respect to the mandatory minimum wage. Sections 3 and 4 provide an aggregate perspective on changes in the wage distribution and in employment, showing a high degree of compliance with the new legislation and a positive impact of rising minimum wages on employment. Section 5.1 models job accessions and job separations in continuing firms, whereas section 5.2 performs a similar exercise for new firms and for firms closing down.
Worker turnover is the subject of section 6. An extension of the theoretical model of Burdett and Mortensen (1998) is highlighted in section 7, as it provides very clear predictions that fit well the empirical evidence disclosed for Portugal. The last part of the paper presents concluding comments.


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