June 22, 2016

The Minimum Wage is the Triumph of Expediency Over Economics



Conservative and libertarian critics of the minimum wage have the weight of theory and evidence on their side. Let’s recap:

  • Minimum wages reduce employment among low skill workers and young people. Source: one, two, three.
  • Minimum wages can price out low skill immigrant labor altogether. Source: one, two.
  • Minimum wages encourage black and grey market activity. Source: one, two.
  • Minimum wages raise consumer prices in ways that tend to be regressive, lowering the purchasing power of the poor. Source: one, two, three.
  • Minimum wages increase wage and price stickiness, hampering labor market adjustment in the event of a recession. Source: one, two, three.
  • Minimum wages distort demand for labor substitutes, leading to inefficiently early adoption of labor saving technology. Source: one, two.
  • Minimum wages distort labor markets geographically by binding on rural and low productivity regions to a greater extent than urban and high productivity regions. Source: one, two, three.

These are just some of the costs of minimum wages. They could, of course, be outweighed by even larger benefits, but this does not appear to be the case. Minimum wages are weak and poorly targeted tools for supporting the poor. And while it’s possible that, in some industries, firms respond to minimum wage hikes by investing in worker productivity, there are better ways to do that than wage controls.

If this is all well known, why have elements on the left become increasingly vocal about the need for higher minimum wages?

Firstly, the last few years has seen a widespread disinformation campaign to downplay the negative effects of minimum wages. This is in part a political calculation. Indeed, the reason minimum wages are rarely ever indexed to inflation is because it creates a perennial cause célèbre for politicians to campaign around.

But it is also in part a good-faith misunderstanding, especially among civilians. The econometric evidence on minimum wages is simply too mixed and difficult to interpret for the average person on the street, making it very easy for opponents and proponents alike to cherry-pick the studies that confirm their biases.  

This is worth emphasizing: Measuring the effects of minimum wage hikes is hard because empirical social science is hard, not because there are no effects. This is especially true of the research on the minimum wage. Minimum wage increases tend to be incremental and anticipated by firms which make adjustments in advance, adjustments which can occur along many different margins.

Hiring or firing workers is an adjustment along the extensive margin, but some firms may choose to adjust along the intensive margin by working their employees harder. Wage increases can also be offset by reducing non-wage benefits, worker hours, by canceling future projects, or by phasing in higher skilled labor. Ormore than likelysome complex mix of all of the above.

Minimum wage opponents are often belittled as naive subscribers to Econ-101. Ironically, it’s minimum wage supporters who appear to be mostly satisfied by studies that look only at the first order effects on the extensive margin and (predictably) find little to report. It’s true that the labor market looks very different compared to classic competitive markets, like commodities, for a host of institutional and psychological factors. But that’s all the more reason to suspect the problem of “the seen and unseen” is at play in the empirical literature, and that the true cost of minimum wages is underestimated, and shifted onto margins that are much harder to detect.

A simple example might help. Suppose, all things being equal, a minimum wage increase would lead to staff reductions at a fast food restaurant. But all things are not equal. Simultaneously, the higher minimum wage leads to increased prices at sit-down restaurants, which, rather than reducing wait staff, have their waiters work harder. Higher sit-down restaurant prices then cause some low income consumers to substitute to fast food restaurants, increasing the demand for fast-food workers in a way that offsets the original staff reduction.

In this two good, two firm economy, an econometric event study would find no impact from minimum wages on employment and an ambiguous impact on real incomes. Statistical aggregates like the employment level simply can’t capture how over-worked wait staff are, or how much real incomes for consumers who continue to eat at the sit-down restaurant have been reduced, or to what extent the well-being of the consumers who are forced to make the switch to the inferior fast-food option has been lowered.

Many conservatives understand this, but aren’t willing to embrace the obvious alternative: subsidizing people’s wages. If a “living wage” imposed via price controls has a lot of unseen, although off-budget costs, wage subsidies have the exact opposite problem. They are salient, cut directly into the government’s budgetary resources, and to the extent that they are distortive (by incidentally subsidizing firms that hire lower skilled workers) the distortion is easy to measure, observe and complain about.

Nonetheless, wage subsidies are still an unequivocally better option than minimum wages. Unlike minimum wages, the Earned Income Tax Credit (EITC), a kind of wage subsidy, has been shown to reduce poverty substantially, and without increasing labor market rigidity, pricing out immigrant labor, or the rest. In fact, on every bullet point from the list above, the EITC is either neutral or helps.

And yet, in the recent report released by the Republican Task Force on “Poverty, Opportunity, and Upward Mobility,” the EITC is mainly referenced as an example of a program fraught with “waste, fraud and abuse.” Yes, the IRS improperly pays out the EITC at a high rate. But more to the point, the resultant budgetary cost of improper payments are highly visible.

The costs of minimum wages, on the other hand, are perniciously hidden from view. That makes them easier to push for politically, but political expediency is pointless if it’s toward the end of an ineffectual, if not outright harmful public policy.

Note: TMBG is completely unaffiliated with the Niskanen Center; I just like their song. More policy briefs should have theme music.