Thoughts on the $15 Minimum Wage

A lot of posts about the campaign for a $15 minimum wage recently. Thought I’d share what the available econometric literature has to say about what might happen if this was implemented and offer a few thoughts on the topic. The impact of large increases in the minimum wage is fairly speculative, there are few data points to study because few large increases have occurred in practice.

However, the impact of modest increases in the minimum wage is one of the most heavily studied topics in econometrics, this research does provide significant insight, and political debates about this still often don’t reflect the available evidence:

Basically, studies have consistently failed to find a notable or even discernible effect on average employment as a result of modest increases in the minimum wage. Studies have tried to find compelling evidence of significant net employment losses for decades because basic microeconomic models do predict that some net job losses would occur and industry groups hate minimum wage laws. Possible reasons why the effects on employment from modest increases in the minimum wage are negligible or nondiscernable:

- Wages and labor markets are 'sticky' - i.e. some changes in employment levels may occur dynamically over time but on average labor contracts, average employment levels, and average wage levels don’t adjust quickly. So for example, rather than causing significant net job losses in the short or medium term, modest minimum wage increases may make automation and other forms of capital investment relatively more attractive relative to labor over time. This by itself isn’t even necessarily a bad thing if it leads to an economy that’s more productive on average over time. Alternatively, modest minimum wage increases could theoretically reduce average rates of job creation but there’s no compelling empirical evidence that this is a major effect in practice.
- Most markets are monopolistically, oligopolistically, or monopsolistically competitive rather than the perfect, friction-less markets assumed by basic microeconomic models. When labor costs increase, employment losses could be negligible or nondiscernable because average profit margins (which BTW, those same basic microeconomic models predict *shouldn’t exist on average* after accounting for risk and the cost of capital) fall modestly and/or modest price increases are passed to consumers. 
- Job losses do occur in some industries but *net* losses don’t occur because job losses in some industries are significantly or virtually completely offset by higher average consumer and investment spending driven by the higher take-home incomes of people that keep their jobs at the new, higher wage rate.

Even an increase in the minimum wage to $15 likely wouldn’t lead to large net job losses (modest net losses are probable) but the evidence is admittedly much spottier about this (again, fewer big increases have occurred so there is less data to review). This is what’s probable based on reasonable assumptions:

- Automation would be relatively much more attractive and investment spending on it would likely increase significantly. However, the industries with high labor intensities (and high non-skilled and semi-skilled labor costs) that would likely see significant job losses from a large increase in the minimum wage are precisely the same industries that would likely see high job losses due to automation during the next recession. This typically occurs at a small background rate during expansions and increases very sharply in the aftermath of recessions. The basic mechanisn is as follows: revenue falls during recessions, job losses occur when revenue falls, and when revenue starts to rise again as the recession ends, many of the old jobs that were lost are replaced by automation during the next expansion. The empirical evidence is pretty compelling that this is exactly what has happened in the U.S. for decades.

So if the impetus for investment spending to cut costs is lower revenue or higher expenses, the result is the same and many or even most of the jobs lost to a higher mimimum wage are probably going to be gone soon anyway. Incentives to move jobs offshore would also increase but again, that’s likely to happen anyway in most cases during the next recession. Modest net job losses are likely but the largest practical impact of increasing the minimum wage is likely to be *accelerating the timing* for losses due to automation that would’ve occurred anyway during the next downturn. It’s also worth noting that with the number of quarters of sustained growth the U.S. has had recently, a recession is very likely sometime in the next 2–4 years. Historically, recessions in the U.S. have occurred every 8–10 years regardless of what government policy is.

- Product prices would rise but in many or even most industries, higher labor costs will just reduce average profitability rather than pass all costs to consumers. In other words, who pays for what when factor input costs rise *is an elasticities argument* and the huge jump in consumer price inflation that some people predict is likely to be very overstated, price increases are likely to be small or modest.

- Modest net job losses are likely on average but the severity of job losses would vary dramatically by region and industry. Small or modest net job losses are likely in major urban agglomeration economies but large or massive job losses may be experienced in some of the poorest and rural areas. This is due primarily to two significant factors. One — rural areas and other poorer areas have relatively fewer high-value-added industries, have relatively more labor intensive industries, and have more industries focused on natural resource extraction, agriculture, and other industries where the primary good of sale is a highly homogeneous commodity subject to global price competiton. In industries selling commodities, prices are indeed much more elastic and efficient on average so increases in factor costs are likely to much more heavily impact output and employment. In other industries like trucking, transportation, fast food, retail, and some parts of the restaurant industry, significant unskilled labor forces perform repetitive or otherwise relatively easily automated tasks. Workers in those industries are inherently more vulnerable to displacement from automation, particularly in cases where labor intensities are high. Two — the average price level for basically *everything* in rural areas and other poorer areas is cheaper. In those areas, a $15 minimum wage is relatively much more expensive for firms and it also buys much more in purchasing power parity terms than the same $15 wage would in a major city.

- Rates of net job creation could fall sharply, but again, this is due primarily to increases in spending on automation that are likely to occur in the near future anyway. Figuring out how to help people displaced by automation is a much different and much more difficult problem that lacks easy or obvious answers. This problem will have to be addressed eventually regardless of what the average wage rate is today.

- Average wage rates would rise for ~ 40% of the labor force. On average, demands on various public services would fall, income inequality would fall, and poverty would fall. But again, regional differences and difference across industries would be stark. In the poorest rural areas, income inequality and poverty could actually increase significantly and demands on public resources could increase sharply in the states least willing and able to pay for them (deep red southern states).

- Incentives to work would go up sharply for a large portion of the population and labor force participation is likely to go up significantly. The stated unemployment rate could also go up sharply in large part *because many more people could be actively looking for work* and would be counted as part of the labor force. A large increase in labor force participation is actually a good thing even if the reasons for the sticker shock of a higher stated unemployment rate aren’t communicated effectively by politicians. The reason why policies like a higher minimum wage or an expanded earned income tax credit make sense on balance as responses to poverty is because *they increase incentives to work* when the alternatives may be larger direct transfers (think direct cash payments and things like food stamps) that are less likely to lead to escape from poverty and/or simply tolerating more severe poverty. It ‘s also worth noting that no matter what the incentives for work are, some of the poorest of the poor still won’t work because they aren’t able to or because jobs aren’t created where they live. These include poor single mothers, people taking care of sick and elderly relatives, and people living in some of the most blighted and/or segregated neighborhoods. Policies aimed at these groups are much different and warrant a separate discussion in later posts.

It’s reasonable for deep red, poor states to oppose a $15 minimum wage without any adjustments or additional assistance because in deep red, poor states it probably will do more harm than good on average, at least in the short to medium term. This is one of the main arguments from some Republicans in favor of alternative policies like the earned income tax credit (EITC) and direct wage subsidies that don’t pass direct wage costs onto firms and it is a strong argument on balance. Both alternatives are also sound, effective policies. The important questions are primarily, as with most things, who pays for what and how much - both alternatives would be funded directly by state and/or federal governments. In any case, accommodating valid Red state concerns about a $15 minimum wage is eminently doable and it’s costs could be reasonable/manageable. For example, a $15 minimum wage could be paired with federal wage subsidies to poorer states with some average percentage of workers X at some X percentage of the federal poverty line. The wage subsidies could even be counter-cyclical — they could go up programmatically during recessions/ downturns (much the same way unemployment benefits kick in as an ‘automatic stabilizer’ during recessions) and go down during expansions. Depending on the level of the subsidies they could theoretically even be *cheaper to the government on average* than paying full unemployment benefits during recessions. Many alternative policy arrangements are possible that would ameliorate deep red state concerns in part or in whole (again, depending on how much the federal government or state governments are willing to pay). For example, a $15 federal minimum wage could be phased in gradually over several years and then indexed to average wage growth (I believe this is the proposal floated by EPI).

But it’s not reasonable for deep red, poor states to oppose *all* policies that will increase mininum wages, which is their real position in practice. A policy to maintain a $15 minimum wage in state-level purchasing power parity terms would face just as much opposition from politicians in those states (and in any case, would still encourage regulatory arbitrage across states). They use the same exact talking points if the level is $5 dollars or $15 dollars and never provide data or hard evidence in support of those talking points. Questions about the severity or distribution of effects or the relative costs/benefits of increasing the minimum wage vs. expanding the EITC or direct wage subsidies seem to never appear in their conversations. I suspect this has as much to do with fear of angering industry groups like the Chamber of Commerce or donors as it does with any severe reservations based on purely economic grounds.

On balance, the $15 minimum wage does make sense. But increases in the minimum wage aren’t costless, they don’t help all of the poor, and it’s not a silver bullet for fighting poverty and income inequality. Large increases in the minimum wage are also likely to be most effective as a tool for fighting poverty and income inequality when they are paired with other effective policies such as an expanded earned income tax credit, an expanded housing choice vouchers program, or with even more unconventional policies such as relocation assistance to help people escape from poor and depressed areas, a modern version of the Homestead Act to help people build equity and reinvigorate blighted neighborhoods, or major reforms to urban zoning laws to lower average housing costs, encourage mixed income development, and encourage affordable housing development (more on all these topics in separate posts). In most cases, people escape poverty and move up the ladder when security is paired with options, flexibility, and mobility so people can still take risks, build capacity, and capitalize on opportunity. For the cases where that isn’t true, again, much different policies are needed.

And on average, a $15 minimum wage is likely to do much more good than harm for the country as a whole and many of the costs associated with the $15 minimum wage are likely to be experienced in the near future anyway, even if labor costs today stay fixed.

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