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Krueger Appointment Does Not Bode Well For Industry’s Employment Concerns

Jim Prevor’s Perishable Pundit, September 12, 2011

Alan Krueger is the Bendheim Professor of Economics at Princeton University, having done his undergraduate work at Cornell’s famed School of Industrial and Labor Relations. He went on to get his PhD in economics at Harvard and is well known as a labor economist.

Now President Obama, focusing on jobs, has selected him to chair the White House Council of Economic Advisers.

It is rare that a nominee to the Council of Economic Advisers has any particular interaction with the food industry, but this selection has turned more than a few heads in the foodservice sector as Professor Krueger is famous as a result of a deeply flawed paper he wrote with Professor David Card now with U.C. Berkeley.

The paper, titled Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania, published in the American Economic Review, was wildly controversial because it was counterintuitive and it countervened the conventional economic understanding of demand curves.

One would assume that when you raise the price of something – say strawberries or labor — demand for the thing would go down. In contrast, if you reduce the cost of something — say grapes or labor — the demand for that item will go up. Professors Kruger and Card, however, compared labor use at fast food restaurants in New Jersey — which had just raised the minimum wage — to eastern Pennsylvania — which had not — and the professors claimed exactly the opposite. The emphasis is added:

On April 1, 1992 New Jersey's minimum wage increased from $4.25 to $5.05 per hour. To evaluate the impact of the law, we surveyed 410 fast food restaurants in New Jersey and Pennsylvania before and after the rise in the minimum. Comparisons of the changes in wages, employment, and prices at stores in New Jersey relative to stores in Pennsylvania (where the minimum wage remained fixed at $4.25 per hour) yield simple estimates of the effect of the higher minimum wage. Our empirical findings challenge the prediction that a rise in the minimum reduces employment. Relative to stores in Pennsylvania, fast food restaurants in New Jersey increased employment by 13 percent.

It is hard to overstate what an extraordinary finding this was. Nobel Prize winning economist Milton Friedman once wrote a book expressing a classical economic principle and titled it, There’s No Such Thing as a Free Lunch but here, Professors Krueger and Card claim to have found the proverbial free lunch. After all, if the cost of labor could be increased while simultaneously increasing the demand for labor, why stop with a 13% increase in employment? We could raise the minimum wage more and eliminate unemployment!

The claim was so divergent from classical economic theory, business experience and, dare we say it, common sense, that one would have expected two rigorous academics to double check their methodology before publishing.

Perhaps ideology got the professors excited or maybe they saw in such an audacious claim a ticket to fame and fortune; whatever the motivation, the professors published and, very quickly, were shown to have made a serious mistake.

The research the professors did was based on a telephone survey of the managers and assistant managers of fast food restaurants. But, of course survey responses may or may not reflect what actually happens, and in this case, the actual payroll records told a different story than what the telephone surveys indicated.

The Employment Policies Institute issued a study titled The Crippling Flaws in the New Jersey Fast Food Study. which summarized its findings in three points:

The New Jersey fast food study has been re-estimated using payroll records rather than the badly flawed telephone surveys used in the original study. The results, compiled by independent economists, are not surprising: there was significant job loss stemming from New Jersey’s decision to increase the state’s minimum wage in 1992.

Since the release of the first edition of this report (April 1995), additional problems have been identified in the Card-Krueger data set — particularly in their attempts to measure price fluctuations as a response to increases in labor costs.

The data base used in the New Jersey fast food study is so bad that no credible conclusions can be drawn from the report.

David Neumark, a Professor of Economics at UC Irvine and a research associate at the National Bureau of Economic Research, and William Wascher, senior associate director, division of research and statistics for the Board of Governors of the Federal Reserve System, published, a piece — also in the American Economic Review — titled The Effect of New Jersey’s Minimum Wage Increase on Fast-Food Employment: A Re-Evaluation Using Payroll Records and its findings were quite different, once again we add the emphasis:

We re-evaluate the evidence from Card and Krueger's (1994) New Jersey-Pennsylvania minimum wage experiment, using new data based on actual payroll records from 230 Burger King, KFC, Wendy's, and Roy Rogers restaurants in New Jersey and Pennsylvania. We compare results using these payroll data to those using CK's data, which were collected by telephone surveys. We have two findings to report.

First, the data collected by CK appear to indicate greater employment variation over the eight-month period between their surveys than do the payroll data. For example, in the full sample the standard deviation of employment change in CK's data is three times as large as that in the payroll data. Second, estimates of the employment effect of the New Jersey minimum wage increase from the payroll data lead to the opposite conclusion from that reached by CK. For comparable sets of restaurants, differences-in-differences estimates using CK's data imply that the New Jersey minimum wage increase (of 18.8 percent) resulted in an employment increase of 17.6 percent relative to the Pennsylvania control group, an elasticity of 0.93. In contrast, estimates based on the payroll data suggest that the New Jersey minimum wage increase led to a 4.6 percent decrease in employment in New Jersey relative to the Pennsylvania control group. This decrease is statistically significant at the five-percent level and implies an elasticity of employment with respect to the minimum wage of -0.24.

Krueger’s work was so uninformed because he never consulted with anyone who actually knew anything about the business. Had he done so, the following problems in his methodology would have become instantly evident:

1)   Managers or assistant managers in fast food restaurants are typically on the floor, often actively helping customers or cooking. The notion that they are able to somehow give accurate payroll statistics over the phone is a fantasy.

2)   The question that was asked about employment, which simply was how many full time and how many part timers are there, is not the right question. Very often firms can reduce payroll by cutting hours, not the number of staff. The relevant question in a fast food restaurant is how many hours are being worked over a set period.

3)   The full time/part time distinction is not always clear and there was no definition given. The data cannot be consistent.

4)   Cash payment per hour may go up and employers compensate by, for example, reducing the number of hours worked or by requiring employees to launder their own uniforms, etc. The study was not comprehensive enough.

5)   The study was too narrow. The issue of whether fast food chains hired more or fewer people is not important. What if these chains did hire more people because their capital-intensive facilities and limited menus enabled them to compete more effectively with Mom & Pop coffee shops that thus went out of business? One would expect an increase in the minimum wage to lead to more use of self-serve gas stations as opposed to full serve gas stations, so studying one specialized sector just doesn’t tell us very much.

6)   Many reductions in labor use could occur over long periods as restaurants get redesigned and automation becomes more cost effective. 

The President’s appointment of Professor Krueger is a very bad sign. The man in this job is exactly the man who has to tell the President that his actions, on health care, taxes, the environment and various regulatory issues, will increase the cost of employment and thus reduce the number of jobs created.

Unfortunately Kruger has both shown a willingness to believe the implausible and a willingness to issue a pronouncement without really talking to the people who know.

That the restaurant industry can speak first hand is saying that this appointment will not reassure business leaders and not encourage job creation.

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