Puerto Rico's minimum wage: Revisiting a price floor with bite

The employment effect, or lack thereof, of the minimum wage remains a contentious issue in empirical economics, but a significant amount of progress on the issue has been made since the dueling studies of Card and Krueger (1993) and Neumark and Wascher (1995). Modern research on the minimum wage generally finds an employment response that is negative, small, and mostly localized to groups such as teenagers (Wolfson and Belman (2019), Neumark and Shirley (2021)). However, most studies use variation in state and local minimum wages to identify the effect of the minimum, and states and localities in the United States have generally chosen minimum wages that are modest relative to their median wages. In Cengiz et al.'s (2019) comprehensive study of state level minimum wage changes, for example, the highest relative minimum wage was 59% of the median wage.

With current proposals to dramatically increase the federal minimum wage to $15/h being considered by policymakers, the current literature on the employment effects of the minimum wage may be ill-equipped to forecast the effects of much larger minimum wage increases. A federal minimum wage of $15/h would be 95% of the median wage in Mississippi and 87% of the median wage in West Virginia if implemented immediately, for example. Such an increase is far beyond those studied by the majority of the minimum wage literature. The employment effects of such a high minimum may be better gauged by looking to the US territory of Puerto Rico, which has been bound by the Federal Minimum wage since 1983. While Puerto Rico is wealthier than other Caribbean countries, with Gross Domestic Product (GDP) per capita in 2020 equal to roughly $31,000, compared to $9,000 in Jamaica, $18,000 in the Dominican Republic, and $25,000 in St. Kitts and Nevis, it is simultaneously poorer than the U.S. states with which it shares Federal Laws. GDP per capita for all states was $65,281, nearly double Puerto Rico's, and even the poorest states like Mississippi ($40,000) and West Virginia ($43,000) are still much wealthier than Puerto Rico. Average hourly earnings in Puerto Rico were equal to $12.21 in 2010, compared to $21.92 for the mainland United States, $17.74 for Mississippi, and $17.65 in West Virginia. This results in Puerto Rico having a relative minimum wage that is much higher than any other state. Most recently, in 2007, the Federal Minimum Wage was increased from $5.15/h, which was 59% of Puerto Rico's median wage at the time, to $7.25/h, 76% of the median wage. Estimating the effect of this increase on Puerto Rican employment might provide insight into whether the minimum wage has a modest disemployment effect even at higher relative levels.

This paper revisits the question of the minimum wage in Puerto Rico using the most recent increase in the federal minimum wage as a case study. Since there is no a priori sensible control group to use for Puerto Rico, such as a neighboring state with a higher minimum wage, I utilize Abadie et al.'s (2010) synthetic control method, constructing a plausible counterfactual for the path of Puerto Rican employment without the minimum wage increase using the labor markets of other nations, Puerto Rican industries less affected by the minimum wage increase, and cities on the mainland United States. Identification is threatened by the Great Recession of the late 2000s, which coincided with the minimum wage increase and was particularly pronounced in Puerto Rico. To combat this potential source of bias, I use triple differences strategies comparing the estimated employment effects of groups with differential exposure to the wage floor and find that groups with lower wage levels and thus more exposure to the minimum experienced proportionally larger relative decreases in employment. I also construct a synthetic Puerto Rico matching on fluctuations in pre- and post-treatment GDP per capita, rather than just pre-treatment employment, creating a counterfactual which experienced similar macroeconomic fluctuations during the post-treatment period. I find that the increase in the minimum wage lead to substantial reductions in Puerto Rican employment across all specifications. On average, my results suggest an own-wage elasticity of employment of −0.68, larger than estimates from previous studies of the minimum wage in the United States, which are generally in the −0.3 to −0.5 range. I discuss several reasons why the employment response to the minimum wage may have a non-constant elasticity. Alternative avenues by which employers may choose to adjust, such as cuts to hours or fringe benefits, have a limited capacity to absorb higher labor costs, leaving cuts to employment as the only remaining option at higher relative minimum wages. A higher minimum wage is also more likely to bind in the tradable goods sector, where employment is demonstrated to be much more sensitive to minimum wage increases due to more elastic product demand.

The remainder of the paper is organized as follows. Part II gives a brief summary of the state of the literature on the employment effects of minimum wages and previous investigations into Puerto Rico more specifically. Part III provides background on the minimum wage in Puerto Rico and provides evidence that the 2007 increase in the minimum lead to a large increase in hourly wage. Part IV explains the synthetic control method, and Part V presents my results. Finally, Part VI concludes.

Research on the employment effects of the minimum wage is as voluminous as it is controversial. As Neumark and Shirley (2021) summarize: depending on what one reads about how economists summarize the evidence, one might conclude that: (1) it is not well-established that higher minimum wages do not reduce employment, (2) the evidence is very mixed with effects centered on zero with no basis for a strong conclusion one way or the other, or (3) most evidence points to adverse employment effects (p. 2). In general, however, the evidence seems to be synthesized into supporting an employment effect of the minimum wage that is negative, small, and localized within subgroups such as teens and high school dropouts. In their meta-analysis summarizing the past 15 years of research on the employment effects of the minimum wage, Wolfson and Belman (2019) summarize the consensus range of elasticities of teen employment to the minimum wage as being −0.13 to −0.07, implying that a 10% increase in the minimum wage decreases employment among teenagers by between 1.3% and 0.7%. Neumark and Shirley's (2021) meta-analysis reaches similar conclusions, with a median elasticity of −0.11. The majority of this research relies on evidence from the United States, where cross-state differentials in the minimum wage generate natural experiments useful for identifying the employment effect. The average US minimum is 39% of the median wage and the largest minima are just above 50% of the median (Cengiz et al., 2019).

The idea of using Puerto Rico to examine the effects of a high relative minimum wage is not a new one. Santiago (1986) sought to examine the employment and unemployment effects of the minimum wage in Puerto Rico soon after the gap between the continental and Puerto Rican minima closed around 1983. Using multivariate time series techniques and transfer functions, Santiago concluded that the empirical findings suggest that both disemployment and unemployment effects resulted from the post-1974 minimum wage policy … consistent with theoretical hypothesis (p. 308). Soon after the revival in interest in minimum wage research in the 1990s, Castillo-Freeman and Freeman (1991) published research on the minimum wage's effect in Puerto Rico, primarily utilizing time-series data for their analysis. The authors found significant impacts on employment, concluding that—

Imposing the U.S.-level minimum reduced total island employment by 8–10% compared to the level that would have prevailed had the minimum been the same proportion of average wages as in the United States. In addition, it reallocated labor across industries, greatly reducing jobs in low-wage sectors that had to raise minima substantially to reach federal levels

Castillo-Freeman and Freeman's average estimate of the elasticity of employment to the minimum wage was −0.41. Two years later, Alan Krueger reexamined the impacts of the minimum wage in Puerto Rico, and reached different conclusions from Castillo-Freeman and Freeman, stating—

The strongest evidence that the minimum wage had a negative effect on employment in Puerto Rico comes from an aggregate time series analysis. The weakest evidence comes from cross-industry analyses. In general, however, I think one would have to consider the evidence surprisingly fragile … perhaps the conclusion that one should reach from the review of evidence is that the jury is still out on Puerto Rico's experience

In the 14 years since then, statistical techniques for casual inference have come a long way, but the evidence from Puerto Rico still lies unexamined with a fresh set of statistical eyes. Dube and Zipperer (2015) only cite the Freeman and Krueger papers in a 2015 report on Puerto Rico, and David Neumark noted in 2018 that “surprisingly, to the best of my knowledge the evidence from Puerto Rico has not been revisited” (p. 9).

Beyond Puerto Rico, Gregory and Zierahn (2020) study another instance of a high relative minimum wage. In 2006, Germany's minimum wage for roofers increased, leading to a statutory minimum wage that was equal to or even exceeded the median wage in low-wage areas in eastern Germany. The authors conclude that the minimum wage caused the wages of low-skilled East Germans to increase by 5–6%, but also caused employment among that group to decline by 3.5%, suggesting an own-wage elasticity of −0.58 to −0.70.

When the United States created its first national minimum wage through the Fair Labor Standards Act of 1938, Puerto Rico was exempted from the wage floor of $0.35 for fear that the resultant disemployment effects would devastate the island's economy (Castillo-Freeman and Freeman, 1991, p. 178). Instead, the law established committees to set separate minimum wages for various Puerto Rican industries and occupations. In the 1970s, however, the industry committee method of setting the island's minimum wage was gradually replaced until, by 1983, Puerto Rico was essentially covered by the federal minimum wage. The most recent increase in Puerto Rico's minimum wage occurred with the Fair Minimum Wage Act of 2007, which was introduced by Representative George Miller in January 2007 and signed into law in May of the same year. The act increased the federal minimum wage of $5.15/h RST to $5.85/h in July of 2007, then to $6.55/h in July of 2008, and then finally to $7.25/h 1 year later. Table 1 contains summary statistics for Puerto Rico and the United States in both – 2006, prior to the phase-in of the $7.25/h minimum wage, and 2010, after its completion.

It's possible that, although the statutory minimum wage for Puerto Rico is high, it's actual effect on workers’ wages was mitigated by noncompliance on the part of employers. Perhaps workers shift into more informal work arrangements were the minimum wage is not in effect in reaction to the higher price floor. If this were the case, then Puerto Rico may actually be an inappropriate case study for examining the employment effect of the minimum wage. One way to test this possibility is to compare the distribution of hourly wages in Puerto Rico just before and just after the minimum wage increase. If the increase really did result in higher wages, then we should expect to see a dramatic decrease in the number of workers earning below the new minimum of $7.25 and a corresponding increase in workers earning $7.25. Using microdata from the 2000, 2006, and 2010 Puerto Rico Community Surveys (PRCS), I constructed the distribution of hourly wages on the island before the minimum wage increase in 2006 and after the completion of the phase-in in 2010. Comparing the wage distributions before and after the minimum wage increase, spikes are evident at the area of the minimum both before and after the increase, suggesting that a great number of Puerto Rican jobs were shifted into compliance with the new $7.25 minimum wage (Figure 1). I also examine the difference between the 2000 and 2006 distributions in a placebo test, where the minimum wage was fixed at $5.15 for both years. If the difference in the wage distributions between these 2 years is similarly dramatic, then we may be cautious in interpreting the difference between the 2006 and 2010 distributions as a result of the minimum wage increase. The difference between the 2000 and 2006 distributions in Figure 2 are comparatively small, with both exhibiting a spike at the contemporary minimum of $5.15. These results imply that the Fair Minimum Wage Act of 2007 was a major determinant of the actual wages that Puerto Ricans were paid. For another comparison, Figure 3 displays the change in the wage distribution in US states affected that are bound by the minimum wage increase. There is a clear decline in jobs below the new minimum with a corresponding increase in jobs paying the new minimum, but the effect is significantly less dramatic than the one seen in Puerto Rico.

Figure 1

Figure 2

Figure 3

The unique difficulty of addressing the impacts of any policy on Puerto Rico is the absence of an a priori sensible control group. When examining the impact of state minimum wage increases on the continental United States, previous research most commonly utilized neighboring states which did not increase their minimum wage as a control group (Dube et al., 2010, Cengiz et al., 2019). This strategy is inappropriate for Puerto Rico due to both the island's unique geographic position and relatively low level of economic development relative to the mainland United States. With this in mind, I chose to use a method of policy analysis unavailable to either Castillo-Freeman and Freeman or Krueger in the 1990s: the synthetic control methodology first introduced by Abadie et al. (2010). The intuition behind synthetic control methods are simple: by constructing a synthetic version of the treated united consisting of a weighted average of donor units which minimizes the pre-treatment root mean squared error (RMSE) in the dependent variable and other predictor variables, the post-treatment behavior of the synthetic unit can analyzed as the counterfactual of the treated united had the treatment not taken place. Thus the effect of the treatment on treated unit 1 in post treatment period t on dependent variable δ be written as: α^1t=δ1at−δ1st\hat \alpha 1t = \delta 1at - \delta 1st where δ_at and δ_st are the levels of the dependent variable in the actual and synthetic treated unit at time t.

After constructing the treatment effects using the synthetic control for the treated units, statistical significance can be determined by running placebo tests. By estimating the same model on each untreated donor unit, while disallowing the treated unit to be used as a donor, one can generate a distribution of effect sizes for the placebo unit. If the size of the treatment effect for the treated unit is much larger than those generated for the untreated units, than it is unlikely that the estimated effect was the result of chance. If the distribution of placebo effects at time t is α^1tPL={α^jt:j≠1}\hat \alpha _{1t}^{PL} = \left\{{{{\hat \alpha}_{jt}}:j \ne 1} \right\} , then the two-sided and one-sided p-values for period t are: p−values2s=Prob(|α^1tPL|≥|α^1t|)\matrix{{p - {values}_{2s} = Prob\left({\left| {\hat \alpha _{1t}^{PL}} \right| \ge \left| {{{\hat \alpha}_{1t}}} \right|} \right)} \hfill \cr}p−value1s=Prob(|α^≥α^1t)\matrix{{p - {value}_{1s} = Prob\left({\left| {\hat \alpha \ge {{\hat \alpha}_{1t}}} \right.} \right)} \hfill \cr}

If some placebo units have poor matches than the p-values may be too conservative. Galiani and Quistor (2017) recommend two methods for adjusting p-values for the quality of pre-treatment t. The first of these is that donor units which exceed a certain pre-treatment RMSE can be dropped from the distribution α^1tPL\hat \alpha _{1t}^{PL} for the calculation of the p-values; alternatively, all effects can be divided by the pre-treatment t to generate pre-treatment adjusted p-values.

One final test for significance is the placebo date test, where a model for the treated unit is estimated with the same parameters except for the treatment period. If the effects seen during the initial estimation are causally related to the treatment, then one should expect small and insignificant differences between the actual and synthetic unit following the placebo date.

Estimates of the elasticity of teen/young adult employment to the minimum wage in Puerto Rico, summarized in Table 13, vary in magnitude and significance, but remain negative and at least modest in size. The average of all elasticities is −0.47, nearly equal to Castillo-Freeman's estimate of −0.41. Estimates of elasticity of accommodation and food employment to the minimum wage differ by method, with cross-industry comparisons yielding a higher elasticity than using US cities as donors. For comparison, Wolfson and Belman (2019) report the consensus range in the literature for the elasticity of teen employment to the minimum wage in the United States to be −0.13 to −0.07. Harasztosi and Lindner (2019) report that 25% of teens in 2012 were directly affected by the minimum wage, so the consensus range of own-wage elasticities is −0.28 to −0.52 for the continental United States. Across all groups, the average own-wage elasticity of employment was −0.68, ranging from −0.22 to −1.65. The increase in the Federal Minimum wage from $5.15 to $7.25 appears to have depressed employment among affected workers in Puerto Rico to a greater degree than among affected workers in the continental United States.

There are multiple theoretical reasons why the elasticity of employment to the minimum wage may decrease at higher relative minimum wages. As Clemens (2021) discusses, cuts in employment are only one way in which employers may respond to an increase in the minimum wage, but these alternative margins of adjustment dry up as the relative minimum wage grows higher. For example, while most of the literature on the employment effects of the minimum wage focuses on the extensive margin of employment, hiring and ring, there is emerging evidence that RMS in the United States adjust along the intensive margin by cutting the number of hours each employee works. Jardim et al. (2017) found that the minimum wage led to a reduction of hours worked in Seattle, while also estimating a null effect on restaurant employment. Horton (2017) also found that randomly imposed minimum wages lead to a large reduction in hours worked in an online labor market. An alternative response to cutting hours is to reduce non-cash fringe benefits accorded to workers such as health insurance or paid leave, a response documented by Clemens et al. (2018). Since only 23.6% of Puerto Ricans receive employer-funded health insurance, compared to 49.6% of Americans in general (U.S. Census Bureau, 2019), employers in Puerto Rico were already less flexible in their ability to cut fringe benefits compared to employers in the United States. As the relative minimum wage climbs higher these alternative margins of adjustment become less capable of absorbing employers’ higher labor costs. Hours and fringe benefits can only go so low before employers are faced with the choice of either cutting back employment or shutting down entirely. Another mechanism by which the sensitivity of employment to the minimum wage increases at higher relative minimum wages has to do with the differential employment response across sectors of the economy. Research from Cengiz et al. (2019) and Gopalan et al. (2021) suggests that the employment response is significantly stronger in the tradable sector of the economy relative to the non-tradable sector. This heterogeneous response is likely due to higher product demand elasticity for the tradable sector limiting the ability of tradable RMS to defray costs by raising output prices. In the mainland United States, the vast majority of workers bound by the minimum wage increase were concentrated in the non-tradable sector, where average wages are lower. In Puerto Rico, however, a quarter of manufacturing workers in 2010 earned $7.25/h or less (Table 2), indicating that a greater share of affected workers in Puerto Rico belonged to the tradable sector where prices are less able to absorb the higher wage floor.

This paper contributes to the extensive literature on the employment effects of minimum wages by focusing on the 2007 increase in Puerto Rico's minimum wage, which led to a relative minimum wage for the island nation that was significantly higher than any found in the continental United States and thus affected the wages of a greater number of workers. Results indicate that employment in Puerto Rico fell relative to a data-constructed synthetic counterfactual following the phase-in of the higher minimum wage. Furthermore, employment for more affected subgroups like teens and restaurant workers fell more sharply proportional to their higher minimum wage coverage (Table S11). Estimated elasticities of employment to the minimum wage for groups in Puerto Rico were higher than those found from studies of the mainland US, but elasticities of employment to the own wage were also larger than consensus estimates from the mainland. This may be due to the fact that RMS are less able to adjust along non-employment margins such as hours or fringe benefits at higher relative minimum wages, and that higher relative minimum wages are more likely to bind in the tradable sector of the economy where output prices are less flexible. There still exist limitations to this particular strategy for estimating the effect of the minimum wage on employment in Puerto Rico. Limited availability of hourly wage data makes it difficult to assess the direct effect of the minimum wage on workers’ incomes, and my analysis doesn’t investigate alternative margins for adjustment such as output price increases, reductions in hours, or cuts to non-wage benefits.

The largest limitation of my analysis is my inability to completely rule out the effect of confounding shocks to Puerto Rico's labor market which coincided with the minimum wage increase. For example, between 1996 and 2006, Congress gradually phased out various tax incentives, most notably the possession tax credit under US Code Section 936, conferred to Puerto Rican companies, increasing the tax burden for many Puerto Rican RMS. While this phase-out occurred during the pre-treatment period, it's possible that its effects weren’t fully felt until after the minimum wage increase in 2007. Similarly, as discussed in Part V, Section 1.3, cross country comparisons may fail to isolate the effect of the minimum wage increase from the effects of the Great Recession which hit Puerto Rico especially hard. However, several components of my analysis serve to control for Puerto Rican specific-shocks and still indicate a negative employment effect of the minimum wage. First, some of the comparisons in Part V, Section 2.1 exploit variation in the bite of the minimum wage across Puerto Rican industries, which would all be affected by Puerto Rican specific macroeconomic shocks. Secondly, in the results using international comparisons in Part V, Section 1, I find that the estimated treatment effect of the minimum wage was smaller for all workers than for teenage workers with higher levels of exposure to the minimum. The estimated employment elasticity from the triple differences approach was actually larger than the one obtained through international comparisons alone, which is the opposite of what would be expected if an island specific shock was biasing the results. Finally, even when I create a synthetic Puerto Rico matching entirely on fluctuations in pre- and post-treatment output and growth, which assumes that the minimum wage increase had no effect on GDP levels or growth, I still find evidence of declines in employment.