Whither The Wage Floor? Better That It Wither: Part III

The Wrong Remains the Same

            Part I (here) argued against raising the minimum wage because an income floor restrains individual freedom and eliminates low-paying jobs. Part II (here) argued against a raise because a wage floor is better imposed by individual states rather than by the federal government.

These points are largely ignored; the argument is usually whether the benefits of higher pay outweigh the countervailing costs of worker layoffs. But over the past twenty years this question has steadily moved toward obsolescence based on academic findings that a wage floor doesn’t adversely affect jobs. President Obama, a minimum-wage advocate, thinks the debate is settled, “[T]ime and again,” the arguments against an increase “have been proven wrong.” 

The struggle of ideas is over. Good triumphed. And without any legitimate opposition to a wage floor, all that’s left is a simple moral imperative. “[N]o one who works full-time should ever have to raise a family in poverty.” That’s how President Obama defines it.

So, says the President, “It’s time to give America a raise.”

            Maybe. But not by increasing the minimum wage. Not today. Not tomorrow. Not ever.

This third of three posts about the minimum wage reviews the fundamental economics of the issue and the seemingly contradictory empirical evidence. The post next assesses this research and concludes that (a) the costs are real and harmful and (b) the benefits are dubious and not very helpful. For these reasons and those discussed in the first two posts, the minimum wage shouldn’t be raised.

The Basic Theory

According to economic theory, a rise in wages causes an increase in labor supply and a decrease in labor demand. If effective, a minimum wage is a market distortion that fixes pay above a competitive rate, which results in higher wages for some and unemployment for others. Economist Russ Roberts explains (here), “When the government requires that wages be higher than what they would otherwise be, that creates an increase in the number of people who would like to work and reduces the number of opportunities available,” which “creates a reserve army of the unemployed.”

Nobel laureate Paul Krugman puts it this way (here): “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, hence leads to unemployment.”  

Differences about the minimum wage had long manifested choosing between the benefits of higher pay and avoiding the costs of job layoffs. But minimum-wage proponents now suggest that this model is no longer applicable.

            The Basic Theory, A Makeover   

Research beginning in about the early 1990s challenged the notion that raising wages causes layoffs. Economists David Card and Alan Krueger studied (here) fast-food restaurants in contiguous counties in New Jersey and Pennsylvania, seeking to answer the following question: “How do employers respond to an increase in the minimum wage?” Their answer excluded job loss: “[W]e find no evidence that the rise in New Jersey's minimum wage reduced employment at fast-food restaurants in the state.” Card and Krueger explained that their findings were “[c]ontrary to the central prediction of the textbook model of the minimum wage.” This important study, published in 1994, represents a paradigm shift in the economics of the minimum wage.

In February 2013 John Schmitt of the Center for Economic and Policy Research surveyed (here) the state of the art in minimum-wage research since Card and Krueger. Focusing primarily on work beginning in about 2000, Schmitt concluded that “[t]he weight of [the evidence] points to little or no employment response to modest increases in the minimum wage.”

Earlier this year in a letter to Congress urging a $10.10 minimum wage, 600 economists expressed their opinion (here) that a wage-floor increase has “little or no negative effect on the employment of minimum-wage workers.” Krugman in one of his columns (here) observed that “hiking the minimum wage has little or no adverse effect on employment, while significantly increasing workers’ earnings.”

The new scholarship is far from monolithic. There is at least equal if not more evidence of layoffs. Economists David Neumark and William Wascher, for example, in a 2006 survey (here) concluded that “the oft-stated assertion that the new minimum wage research fails to support the traditional view that the minimum wage reduces the employment of low-wage workers is clearly incorrect”; “the preponderance of the evidence points to disemployment effects.” In another study published in 2012 (here), economists Joseph Sabia, Richard Burkhauser, and Benjamin Hansen found that raising New York’s minimum wage decreased employment among young, low-educated workers by a staggering 20%. 

But even if Schmitt’s survey is more reliable, Schmitt’s conclusion isn’t that a minimum wage is cost free; rather, Schmitt finds that wage increases, if kept to a certain size, are paid for in ways other than jobs.

The Basic Theory, Made Over

It’s doubtful that Card and Krueger thought they’d disproven the laws of economics upon finding no employee layoffs as a result of New Jersey’s higher minimum wage. As established by their explicit objective, the two economists sought to identify how employers adjust to mandated increases in employee pay. Although Card and Krueger found that employers didn’t eliminate jobs, their study identified several other employer responses.

For example, employers may have absorbed wage increases by higher consumer costs: “[P]rices of fast-food meals increased in New Jersey relative to Pennsylvania, suggesting that much of the burden of the minimum-wage rise was passed on to consumers.” In this way, consumers helped defray higher pay. Card and Krueger also discussed the possibility “that restaurants can offset the effect of the minimum wage by reducing nonwage compensation.” So while employees may obtain a higher hourly pay rate, their overall remuneration could stay level or even decrease.

Schmitt in his survey analyzes “channels of adjustment,” which describe how increases in the minimum wage “change the behavior of firms.” In total, Schmitt enumerated 11 adjustment channels, including the following: (1) the reduction of employees’ hours; (2) the increase of workplace efficiencies; (3) the preference for higher-skilled workers; (4) the increase of consumer goods and services; (5) and a reduction in nonwage compensation.

Of similar importance is Schmitt’s finding that only “modest” increases spare job loss; this caveat preserves the insight that immodest raises adversely affect jobs. The 1994 pioneering study by Card and Krueger measured the effects of a 19% increase of the minimum wage, from $4.25 to $5.05. Schmitt doesn’t define “modest” or provide any insight into when a raise loses its modesty and starts to cause layoffs.  

The academic work that supports raising the minimum wage shows (a) that job loss is never eliminated from the equation but is forestalled only when the wage increase is sufficiently small, and (b) that even then the costs of minimum-wage increases don’t disappear but are absorbed by various adjustment channels.

Persisting Costs

There’s universal agreement that forced increases of employee pay have economic consequences. And as Schmitt’s survey shows, many of the adjustment channels aren’t good. So the claim that a minimum wage doesn’t cause layoffs is misleading because it suggests that avoiding job loss is the same as avoiding costs.

            Consider some of these adjustment channels.

For example, reduction of nonwage compensation is just another way to describe a pay decrease. If an employer adjusts to higher wages by diminishing nonwage compensation, such as health insurance or pension contributions, it is the employee who absorbs his or her own pay raise.

Diminution of employees’ hours, another example, erodes the employee’s expected net gain. Any increase of weekly pay is decreased by a cut in hours worked; thus, depending on the rates, the benefit to the worker is minimized at best and completely evaporates to a pay decrease at worst.

Higher prices of goods and services are particularly problematic because everyone who consumes those goods and services are forced to pay more. Low-wage workers would be forced to pay higher prices to meet their needs; thus, while they may receive more income, they spend more, too. And the nonworking poor who don’t enjoy a boost in income are nonetheless burdened by the higher cost of living that is directly attributable to a minimum-wage raise; their lot worsens without any offsetting good.

There’s also the employers’ preference for workers with higher skills. Although this is good for high-skilled workers, it’s bad for low-skilled ones. And it’s the low skilled that needs entry-level employment to gain experience to move along an upwardly mobile path. With artificially higher wages, employers discriminate against low-skilled workers and disadvantage the very group that the increased pay is supposed to help. The research by Sabia, Burkhauser, and Hansen found that increasing the minimum wage hurt low-skilled workers most.

            These costs constitute the best-case scenario that follows only the most carefully calibrated wage raise of a sufficiently “modest” size. As discussed, according to the most generous work, an imprecise pay increase will cause job loss. In this way, the new minimum-wage research isn’t a refutation of economic theory but an indication that it is the degree of the increase that determines when costs materialize as (a) job loss or (b) adjustment channels.

            None of the research, though, provides guidance on how best to set the size of the raise. And that’s important. As the argument against a raise goes, if $10.10 is good, certainly $20 or $30 would be better. Economists reject that position because, as the research shows, the size of the raise defines the consequences that follow. Krugman opined (here) that “even liberal economists” think that “$20 an hour would create a lot of problems.” In this respect, advocates of a robust wage floor must confront the quandary of fixing prices that are high enough to be effective but low enough to refrain from causing job loss. Of course, even the best engineering doesn’t avoid harm; the harm merely changes form enough to obscure the debate.

But all of these penalties and perils would, arguably, be worthwhile as the consequences of undeniably worthy benefits. Unfortunately, that’s just not so.  

Dissipating Benefits

Schmitt began his survey with the observation that “[t]he employment effect of the minimum wage is one of the most studied topics in all of economics.” Conspicuously absent from most of that research, though, is much work about the good a wage floor is supposed to do. That’s surprising considering that the fundamental justification for a minimum wage is that it confers a benefit on the working poor. What’s more astonishing is that the existing evidence provides little support for such a benefit.

In a survey published in 2012 (here), economists Joseph Sabia and Robert Nielsen found “little evidence that raising the minimum wage has been effective in reducing poverty or material hardship among all individuals, workers, less-educated individuals, or less-experienced individuals.” Furthermore, Sabia and Nielsen concluded that “alleviating material hardship is unlikely to be substantially advanced by increases in state or federal minimum wage.” They also put it this way, “[T]he evidence is clear that increasing the minimum wage is a poor way to reduce hardship for the targeted employees.”

Joseph Sabia and Richard Burkhauser published a study in 2010 (here) about whether a wage floor helps the working poor. They found “no evidence that minimum wage increases between 2003 and 2007 affected overall state poverty rates.” Sabia and Burkhauser noted that their conclusion was “quite robust across definitions of poverty.”  

Economists Ximing Wu, Jeffrey Perloff, and Amos Golan studied the question and determined that the minimum wage doesn’t accomplish its goal (here): “Although Congress reputedly passed the minimum wage legislation to help the working poor, it fails to do so.” These economists found that certain welfare programs, including a wage floor, actually increases income inequality.

Schmitt’s survey reviews just the costs without assessing the benefits. Arindrajit Dube, a prominent economist who has produced significantly to the evidence disproving job loss, and who coauthored two of the four “key studies” that Schmitt analyzed, published a report in December 2013 (here) on the minimum wage’s effect on poverty. Dube found “robust evidence that minimum wage increases lead to moderate increases in incomes at the lower tail of the family income distribution.” But even Dube criticized the minimum wage as “a blunt tool when it comes to fighting poverty.” To help the poor, Dube prefers “more targeted policies like cash transfers, food stamps, and programs that raise the employment rate for highly disadvantaged groups.” Note that no economist would claim that increasing a wage floor would help raise employment levels, especially for particularly vulnerable groups.

This criticism by Dube of the minimum wage’s effectiveness dovetails nicely with the contrary work and the voluminous research that demonstrates job loss. Both lines of analysis, and Dube’s concerns, recognize that a wage floor doesn’t properly target the groups that policymakers hope to help.

In 2012 approximately 1.56 million people earned minimum wage, representing 2.1% of all hourly workers and about 1.1% of the total workforce (see here and here). The majority is young and works part time (see here). Specifically, 70% are 34 years of age or younger; 55% are 24 years of age or younger. Furthermore, 70% work 39 or fewer hours per week; 51% work 29 or fewer hours per week. Note that these weekly-hours figures are undoubtedly understated by as much as 11.8%.

The minimum-wage worker isn’t consigned to a lifetime of low pay; approximately two-thirds of workers who earn minimum wage receive a pay raise within their first year of employment (see here). And the average income of the family of minimum-wage workers is $53,113 (here), almost equal to the US median household income in 2012.

            Discussion at the debate included whether these figures are misleading because they understate the number of workers who would benefit from a wage raise. David Cooper of the Economic Policy Institute estimates (here) that raising the minimum to $10.10 would boost the pay of approximately 27.8 million people.

            But counting the workers at minimum wage is preferable. First, it’s more precise; estimates like Cooper’s include pay raises that aren’t required but are predicted based on employers’ policy. Second, it’s more consonant with the politics of the debate; the claim that $7.25 is unacceptably low requires examining the statistics at that rate rather than including workers whose pay is far less contentious, like $9 or $10. Third, and finally, it’s more responsive to the topic question; Cooper’s estimates are based on a specific plan rather than whether the wage floor should be lifted at all. This is a substantive not a procedural point because although a higher wage floor captures more workers, it also increases the risk of job loss and thereby reduces the reliability of the estimate.

            In Summation

Supporting the increase of the nation’s lowest wages is easier than opposing it, a fact that’s reflected in a recent poll (here) showing 76% of Americans would vote to raise the federal minimum wage to $9. But that doesn’t mean it’s good policy. As has been shown, it’s decidedly bad.

These are the contorted positions that are necessary to embrace a wage floor: (1) state intervention of individual choice is tolerable, (2) the elimination of low-paying jobs is tolerable, (3) national pricing is better than state and local rate fixing, (4) the research that proves a minimum wage doesn’t cause job loss is better than the scholarship proving the opposite, (5) all costs other than job loss caused by a minimum wage are tolerable, (6) the research that proves a minimum wage is beneficial is better than the scholarship proving the opposite, (7) the minimum wage is useful despite its clumsiness as a tool against poverty, and, finally, (8) the intricate variables that comprise the labor market are decipherable enough to establish a minimum wage that’s high enough to help but low enough to avoid harm.

            That's a rather tall task.

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