Ruminations, November 9, 2014
Pros and cons of the minimum wage
An increase in the minimum wage seems to be pretty popular these days and highly political. Maybe we should try to look at it objectively and determine if we should support it.
Last increase. The last time the minimum wage increased was in 2009 when it became $7.25 per hour. Since that time, inflation has reduced the purchasing power of the minimum wage to $6.53 per hour, a reduction of about 10 percent. Normally, the minimum wage retains its value for seven or eight years but it is not unheard of to increase it sooner – especially in times of high inflation.
Obamanomics. President Obama, in promoting a higher minimum wage, recently offered this simple explanation: “…what happens if workers got a little more money in their pockets? They spend a little more money, which means that suddenly businesses have more customers, which means they make more profits, which means they can hire more workers, which means you get a virtuous cycle — It’s common sense — that’s what I’m trying to say.”
The President did describe a business cycle with one element missing. Where did the “little more money” come from? It obviously came from the employer. And, if the employer has to pay a little more to get the same amount of output, isn’t that like a tax on employers? (We’ll say more on this later.)
Economists of the minimum wage. Economists David Card and Alan Kruger documented their study in their 1997 book, Myth and Measurement: The New Economics of the Minimum Wage. Studying the job market in New Jersey and Pennsylvania after the implementation of minimum wage programs, they found that employment actually increased, albeit marginally. This study was cited by many proponents of minimum wage increases. Critics noted that there are many facts that go into employment figures and although Card’s and Kruger’s study is accurate, it is not conclusive.
The critics have a point. When the economy is booming, as it was in the mid-1990s, an increase in the minimum wage may occur simultaneously with an increase in employment, while during an economic down turn, unemployment will increase regardless of minimum wage.
Suffice it to say that since the Card and Kruger book, the great majority of economists have been critics of it. Economist Robert J. Samuelson calls the thesis that no jobs will be lost due to a higher minimum wage, “fairy tale economics.”
It is generally the opinion of economists that a higher minimum wage will add pressure to increase unemployment. It is a simple model: If the government causes the cost of labor to increase, employers will buy less of it – and it prices marginal workers out of the labor market entirely. How much less is a guess. Obama’s proposed increase to $10.10 by 2016 is the largest increase in the minimum wage ever proposed – 40 percent, hence there are no models for this experience. And, of course, there can be countervailing factors to offset the pressure not to buy more labor – too many unknowns.
Krugmanonmics. No debate on economics would be complete without some discussion of Economist Paul Krugman. Krugman is a Nobel winning economist who writes a weekly column for the New York Times. He is clearly an accomplished writer who writes for his audiences. He tailors his writing so well that one might say that there are two Paul Krugmans.
The Economist Paul Krugman won a Nobel Prize for advancing the theory on how consumers make choices. He also, with his wife, writes economic textbooks. His audience for textbooks and his work on consumers is clearly economists or those who have some knowledge about economics. Here’s what economist Krugman says about the minimum wage: “when the minimum wage is above the equilibrium wage rate, some people who are willing to work — that is, sell labor — cannot find buyers — that is, employers — willing to give them jobs.” So, in other words, if we create an artificially high minimum wage, then there will be fewer employers willing to pay the higher wages and unemployment will go up.
In his review of an economic treatise in 1998, Krugman said, “So what are the effects of increasing minimum wages? Any Econ 101 student can tell you the answer: The higher wage reduces the quantity of labor demanded, and hence leads to unemployment.”
Now let’s look at what Columnist Paul Krugman writes for his New York Times audience (i.e., mostly liberal non-economists): “The answer is that we have a lot of evidence on what happens when you raise the minimum wage. And the evidence is overwhelmingly positive: hiking the minimum wage has little or no adverse effect on employment, while significantly increasing workers’ earnings. … When it comes to the minimum wage, however, we have a number of cases in which a state raised its own minimum wage while a neighboring state did not. If there were anything to the notion that minimum wage increases have big negative effects on employment, that result should show up in state-to-state comparisons. It doesn’t.”
In the last part of his quoted column, it sounds as if columnist Paul Krugman is referring to the Card and Kruger study for support. Let’s go back and see what Economist Paul Krugman wrote about Card and Kruger at the time the book was published: “What is remarkable…is how this [Card and Kruger’s study] rather iffy result has been seized upon by some liberals as a rationale for making large minimum wage increases a core component of the liberal agenda…. Clearly these advocates very much want to believe that the price of labor — unlike that of gasoline, or Manhattan apartments — can be set based on considerations of justice, not supply and demand, without unpleasant side effects.”
Which Krugman should you believe? Well, you reads your Krugmans and you takes your choice.
Who directly benefits from a minimum wage increase? Today, 5 percent of American hourly workers are paid the minimum wage. Most are 25 or younger and 69 percent of them work part-time. The typical minimum-wage earner is not the family’s sole or most important breadwinner.
The majority of benefits often go to middle-class teenagers. And the reduction of jobs (as well as the higher costs that are often imposed to make up for the increased payroll costs) are borne by those who need the jobs the most.
Who indirectly benefits from a minimum wage increase? Some estimates are that twice as many workers would benefit from an increase in the minimum wage as are paid the wage. The truth is that we don’t know how many will benefit and here’s why: Let’s say you run a fast food restaurant and pay (in round figures) some employees a minimum wage of $7 an hour and more experienced employees, $8, $9,,$10, $11 and $12. If the minimum wage goes to $10, won’t you need to maintain the wage differentiation between all employees and give everyone a $3 raise? That means that your hourly payroll goes from $57 an hour to $75 an hour and you will need to get $18 an hour more productivity (75 – 57), raise prices enough to cover the additional $18, take the $18 out of profits or eliminate jobs.
Labor unions in particular favor minimum-wage hikes because it increases the price of labor among non-union workers who compete with their members (who already earn wages far above the minimum) for jobs and can lead to pressure for more wage increases (on the low end) for union members.
In addition, unions supporting “living wage” laws have encouraged laws with a loophole that exempts wages in collective-bargaining agreements from the minimum wage. They then convince employers to use the loophole to avoid paying a “living wage,” which may sound good to management, but once unions are established, they can exert pressure for higher wages with threats of strikes and work actions.
A better alternative – The Earned Income Tax Credit. The Earned Income Tax Credit (EITC) was established in 1975 and has been increased several times since then. It directs additional money to working adults (not part-time teenagers or middle income folks working for extra income) and can direct them more money than would a minimum wage increase. An added plus is that it doesn’t affect the employer a smidgen – hence no lost jobs. Former Obama Chair of the Council of Economic Advisors Christina Romer concluded that an expansion in the earned income tax credit would be a lot better than an increase in the minimum wage. She said that that view is common among economists.
The difficulty with the EITC is that it is an “on budget” item. That is to say, it is a direct payment by the government and must be financed by more deficit spending or more taxes. Either way, it puts pressure on law and budget makers that they would rather not have. On the other hand, although the minimum wage doesn’t serve the poor nearly as well, it is an “off budget” item and absolves legislators of all kinds of complications – but it does serve as a sort of hidden tax on employers.
What to do? Let’s take a look at what Economist Paul Krugman says about what the minimum wage really does: “What the living [minimum] wage is really about is not living standards, or even economics, but morality. Its advocates are basically opposed to the idea that wages are a market price—determined by supply and demand, the same as the price of apples or coal. And it is for that reason, rather than the practical details, that the broader political movement of which the demand for a living wage is the leading edge is ultimately doomed to failure: For the amorality of the market economy is part of its essence, and cannot be legislated away.”
But Columnist Krugman says that, especially in the fast-food industry, the minimum wage will not have a deleterious effect on jobs; after all, you can’t outsource fast-food workers and it would be very difficult to automate the process. Really?
Last month, Don Thompson, CEO of MacDonald’s, contemplating a higher minimum wage, said that, in less than a year, MacDonald’s will “make it easier for customers to order and pay for food digitally and to give people the ability to customize their orders.” That sounds like MacDonald’s is automating the folks who take orders and make change: fewer jobs.
Given the groundswell for increases in the minimum wage, it seems that – good or bad — this is coming. And there will probably be some movement by members of Congress to abrogate their responsibilities and index the minimum wage to inflation (“I have no control over it so don’t blame me if it is too high or too low”). Also, the indexing would probably dampen jobs by telling employers that, not only is the minimum wage rising this year, it will rise every year.
Is a minimum wage good or bad? And if it is good, what’s the best timing for it to have a minimum effect on jobs (a tight job market?) and a maximum effect on workers?
What a difference 40 years makes
Forty years ago, we were extracting ourselves from a war in Vietnam in which 58,000 American and one million Vietnamese soldiers were killed. This spring, Pew Research conducted a survey to see how different Asian nations viewed others.
In Vietnam, 76 percent have a favorable view of the United States – more favorable than their view of any other nation in the survey except Japan (77 percent). And a plurality (30 percent) think that the United States is their greatest ally.
Time changes a lot.
Quote without Comment
Economist Robert J. Samuelson, writing in the Washington Post, on February 23: ”But the EITC [Earned Income Tax Credit] lacks the minimum wage’s political charms. The minimum wage is liberals’ symbol for showing how much they care for the poor — and how much they despise inequality — while demonstrating conservatives’ callousness. Congress gets to dispense pay increases to millions of workers, using private dollars. By contrast, expanding the EITC would require scarce on-budget dollars.”