What happened when Puerto Rico raised its minimum wage

WASHINGTON - Over the past few years, demands for a minimum-wage increase have jumped from around $9 an hour - which seemed ambitious at the time - to $15 an hour. Change has been rapid: The $15 minimum will eventually be law in a couple of cities, and it's headed for the ballot box in a few more. And on the federal level, legislators have bumped their proposal from the White House's initial bid of $10.10 an hour to $12 an hour nationwide.

That might work fine in places like New York City, where labor costs tend to be higher and consumers have a greater willingness to pay. But what about the lower-wage places, where the Senate Democrats' plan would mean a hike of 65 percent? Couldn't that hurt minimum-wage workers, if the higher cost of labor prompts firms to hire fewer people, or drives firms out of business?

Possibly. Certainly there is some wage level above which companies have to cut payrolls, and there's lots of research on both sides to fuel arguments about how much. But evidence from one historical example - Puerto Rico - suggests the effects might not be as bad as one might expect.

Here's the scenario. Back in 1977, Congress required Puerto Rico to increase its minimum wages - which had been set industry by industry at levels below the federal floor - to match the mainland, over a period of several years. In 1976, the minimum was $2.03 in Puerto Rico and $2.30 in the United States. By 1987, it had reached $3.35 in both places, making Puerto Rico's minimum wage a much higher percentage of its average wage than it was in the U.S. proper.

Several years later, Alida Castillo-Freeman of the National Bureau of Economic Research and Richard Freeman of Harvard University took a look at what happened during that time. The results were clear: Wages had risen and clustered around the new $3.35 minimum. Employment had dropped by about 9 percent, compared to what it would have been if Puerto Rico's minimum wage-to-average wage ratio had stayed the same as it was on the mainland. Most of those jobs came from low-paying manufacturing companies that might have been on the margin anyway.

In retrospect, Freeman says, the island lost nowhere near as many jobs as he expected. "What we found was that there were a couple industries that really got bopped - places that were already going downhill," he says, reasoning that the lost jobs, while painful for the affected employees, might have been inevitable. "If you're so unproductive that you can't pay a little bit more, than maybe you don't belong in a modern economy."

Why weren't the employment effects greater? Earlier research, summarized in a paper by Alan Kreuger, had found that many firms responded by increasing their productivity and simply making less in what were already outsized profits, which allowed them to retain workers. In Puerto Rico's case, an unemployment crisis was averted as thousands of lower-skilled people emigrated to cities with greater opportunities, such as Miami and New York.

Based on that experience, Freeman thinks a few things might happen if the federal minimum goes up to $12. First, some companies might find ways to work around it, either by having their employees work off the clock or by turning them into independent contractors. That's not ideal, but it at least allows people to keep collecting some paycheck.

"There are many ways that firms and workers will make sure that people don't lose their jobs," Freeman says. "If you say that 90 percent of the people get higher wages, and that's what you want to have happen, and then 10 percent find ways to wiggle around so they keep their jobs, that's a pretty good outcome."

Second, if jobs do disappear, Freeman figures that people will move to areas of greater opportunity. "Minimum-wage workers tend to be young people, so they're reasonably mobile," he says. "Mississippi is the lowest-wage state in the country. If it tips you to move to Georgia, which has higher wages, that's a reasonable response."

Opponents of the minimum wage increase, like the restaurant industry-backed Employment Policies Institute, argue that higher minimum wages can adversely affect employment in cities too. An EPI report released in April found that some small businesses in Oakland, Calif., anticipated they might have to close, or at least lay people off, when the minimum wage there goes up to $12.25 per hour.

And in retrospect, although the island faces many different challenges, it doesn't appear that the higher minimum wage did Puerto Rico's economy much good. Productivity has lagged, and unemployment is still high, particularly among youth, leading the New York Fed to recommend in 2012 that a subminimum wage be instituted for people under the age of 25 - and potentially for the whole population.

But overall, Freeman argues, the evidence from minimum wage hikes in other places - such as Britain and Australia - shows only moderate effects on employment, if any, because governments tend to give businesses time to adjust.

"Put a zero after your wage and mine, and we know that the employer's going to get rid of us," Freeman says. "But they never seem to push the minimum really into that dangerous territory. Twelve dollars in three years is not going to incredibly shake up Mississippi."