Why A Higher Minimum Wage Will Result In Higher Unemployment When the Economy is Out of Recession
And What Can Be Done about Low Wages and Poverty Despite This
In this post I will demonstrate four things 1) labor markets are subject to fundamentally the same pressures and limitations as other markets, 2) There is strong theoretical and observational evidence from research in economics that a higher minimum wage will result in a higher unemployment rate during a healthy economy, 3) that this change will have an adverse impact on many of the workers that minimum wage policies are written to help, and 4) that it is possible and necessary to create programs that help the poor without these adverse impacts of minimum wages. The first point is important as it weakens arguments that hinge on whether workers are earning a income that they can live on. I am not saying that it is irrelevant if workers are living in poverty or not, just that policy should be evaluated in terms of the real-world economic impact of the lives of these workers. How the economically optimal wage makes you feel is irrelevant. If minimum wage policies are not having the desired impact, then you may want to reconsider other policy options. The second point is the core of my argument in this post. Basic economic theory suggests that increases in the minimum wage increase the unemployment rate when the economy is near full employment. When the economy is far from full employment, however, there may be a temporary decrease in unemployment due to the consumer demand created by the wage increases, but at full employment that extra demand will just go into inflation. The third point is the corollary of the second point. The individuals facing the increased risk of unemployment will be many of the adult, poor, individuals that need help the most. The fourth point is key. Getting rid of poverty is something that needs to be done. However, we don’t need minimum wages to alleviate poverty, and they have been quite ineffective at it. I will propose two measures that will do a better job at eliminating poverty. In particular I will argue for a basic income policy that will give all adult citizens an unconditional payment that would be sufficient to take them out of poverty. I also believe that a nation wide jobs program — possibly one similar to the Great Depression era Works Progress Administration, but also possibly one created by subsidising private employers — should be created with the task of guaranteeing a job at a reasonable wage to all willing and able to work. This type of jobs program would serve a similar role to a minimum wage, but it would not increase unemployment because the workers that would wind up unemployed under a higher minimum wage would instead wind up on the government payroll. The combination of the two programs would serve to eliminate poverty, and would give all individuals a chance to earn a good income.I will close the post by discussing why minimum wages are popular, despite the lack of evidence of their effectiveness.
Labor is Just Another Market
All throughout the political discourse, you will see the opinion that wages and labor are separate from the pressures that affect all other things in the economy. In a normal market prices are subject to the usual situation of supply and demand. And the prices fluctuate according to how many people want to supply a good, and how many people want to buy the good. However, many, such as the author of a front page article on Daily Kos don’t think this happens with labor markets.
I guess how Don Thompson [the McDonald’s CEO]tries to be a really great employer is to pay his workers so little that they get an estimated $1.2 billion in public assistance. And by providing workers with budget advice suggesting they get a second job and don’t spend anything on heat. And by offering an employee “McResources” helpline that told a worker with 10 years of experience at McDonald’s to apply for food stamps. Plus, for all Thompson’s talk of opportunity, there are few opportunities for advancement in the fast food industry, which has a low percentage of managerial jobs and pays its first-line supervisors a median of just $13.06.
The only way this is competitive is if the competition is to keep workers poor.
Lets unpack this a bit.Heres one thing that neither conservatives or liberals will tell you about wages — but that economic theory does. It doesn't matter how hard someone works, or how valuable their work is to the world, or how much the person needs the money, or how great and upstanding the worker is. The only thing your wage depends on is how many people are willing to do the job you do, and how many people want to buy what you make. The employees at McD’s probably work hard and need the money — but in the end a lot of people can do what they do. Therefore, their wages are bound to be low. Same with the likes of immigrant farm workers. Hard work, would’nt want to do it. But lots of people have that skillset. So, wages are going to be low. Lets look at a highly paid market. Say, computer programmers. You will hear some in the tech industry wax poetic about how hard startup founders work. Not really. If you think that, just talk to some of those farm workers. However, the thing is, there are relatively few people with the skillset needed for the tech industry, when compared to the number of people who want to consume tech products (and if you doubt that “consume” is the right word, just try working on tech support for some really dumb lusers — they consume their computers pretty rapidly). Supply and demand applies everywhere, and is a callous bastard that doesn't care about how much you need money or if not having it will push you on welfare. But we keep markets around because they are so efficient — or at least more efficient that the alternatives. And to an extent, supply and demand provides that for some people wages will never be able to reach a level where they can meet their needs just by the income they earn. So, maybe a better alternative to the McD way of “ providing workers with budget advice suggesting they get a second job and don't spend anything on heat”, would be to expand government antipoverty programs, so that they have enough money to afford heat without a second job. The often heard claim that welfare programs subsidize low wage employers is a bit dubious on economic grounds, but that is another blog post.
Supply and demand isn't the only market force that also applies to labor. A business will only hire someone if it sees a profit from that action. But at some point there is only a certain amount of income that a worker can generate for a business. If the wages required to hire a worker exceed the level where it is profitable to hire then the worker won’t be hired. Oh. And there are substitutes to hiring workers. A lot of low-wage workers in retail can be substituted by computer kiosks — if it becomes profitable to make the substitution. Labor markets cannot avoid being exposed to the forces that other markets are, but a lot of arguments for the minimum wage require suspending disbelief on this matter. Later I will show that these market forces mean that minimum wage policies will be counter productive.
The Theoretical Argument For Why Minimum Wages Increase Unemployment
The core of the argument for why minimum wages increase unemployment comes from the basics of supply and demand. Supply and demand can be easily modeled. There is a rule that can model the effect that price has on the demand for a product called the law of demand. It states that the demand for a product should tend to decline as its price goes up. Similarly, the level of a product supplied in a market can be modeled by the law of supply, which states that a higher price means a greater supply of products in a market.
The law of demand is pretty damming for the minimum wage. It means that, when everything else is equal, an increase in the wage will mean less demand for the labor of workers. This loss of demand for labor means a increase in unemployment. And it is the law of demand that incorporates the previously made observation that if the wages required to hire a worker exceed the level where it is profitable to hire then the worker won’t be hired into economic models. Because the productivity of workers is at the core of how the workers will be affected, the least skilled workers will be the ones hit the worst. The law of supply also creates problems for the minimum wage. The increased price that labor can fetch can be expected to increase the number of people who want jobs. In fact we can say that in general a price control that sets a minimum price for a good creates a surplus of the good, while a price ceiling creates a shortage of the good. This simple model does break down when the economy is depressed, as during a depressed economy the increased consumer demand due to the wage increase can reduce unemployment. However, this consumer demand increase has little to no effect in a healthy economy. This is because wages are spent on a wide range of industries and how workers spend their wages is rarely targeted towards the industries where there is the most unemployment.
However, this theoretical discussion is not entirely conclusive. Many have argued that due to the vastly asymmetrical bargaining power between workers, the effect of a minimum wage is primarily to even out this difference. Other effects that alleviate the negative impact of minimum wage policies on unemployment have been proposed. The only way to conclusively rule these out is through empirical study. Which brings us to my next section.
The Empirical Evidence
The minimum wage debate has been one of the most widely studied issues in economics, and a glut of research has been produced to resolve the debate. Most of this empirical data is favorable to the conclusion that increases in the minimum wage increase unemployment. In discussing this research I will take a broad view of the research in this area, focusing on that the broad opinion of the research community, rather than a few specific studies. With science of all fields, including economics, reproducibility is key. You know a result is good, not when one team has come up with a given result, but when many separate teams come to a result. There is another reason why it is dangerous to over rely on a single study; there is error in data collection and it is possible to come to an erroneous result just by bad luck. Also bias and poor study design can also make a study come out to a wrong result. Therefore, it is necessary to take into account the design of the studies, and to make sure that the authors are really measuring what they think they are measuring. For the previously mentioned reasons we can create a hierarchy of research quality. At the top is a well done research review. A research review is a study that compiles results from other researchers and seeks out the general trends in this research. The next rung is the controlled study — something that is effectively impossible to do in researching the minimum wage. The third rung is the observational study. These are studies that attempt to systematically observe the impacts of a change in multiple distinct locations and that use statistical methods to analyse the observations. The lowest rung consists of non-systematic observations and case studies. These provide very weak evidence, but unfortunately have a large role in public dialogue. For these reasons I will primarily look at literature reviews.
David Neumark and William Wascher conducted a literature review of the topic in 2006, focusing on recent (at the time) research. They found that the studies conducted tend to indicate that the minimum wage increases unemployment. In their words “A sizable majority of the studies surveyed in this monograph give a relatively consistent (although not always statistically significant) indication of negative employment effects of minimum wages … we see very few — if any — studies that provide convincing evidence of positive employment effects of minimum wages”. Additionally, they found that the studies that show that a minimum wage increase does not increase unemployment often have methodological flaws that reduce their credibility. When these flawed studies are filtered out, “among the papers we view as providing the most credible evidence, almost all point to negative employment effects”. The authors then looked at the question of who is harmed by minimum wage increases and found that “the studies that focus on the least-skilled groups provide relatively overwhelming evidence of stronger disemployment effects for these groups.” This paper also contains a discussion of the history of the research and discussion of the issue that is worth a read. It is worth noting that Neumark and Wascher conducted a previous observational study where they found that minimum wage increases depressed employment by a substantial margin.
A literature review by Charles Brown, Curtis Gilroy, and Andrew Kohen looked at the effect of minimum wage changes on youth unemployment. They give an overview of the theoretical models of the issue and then they look at studies of the empirical evidence. They found that most studies suggest small increases in unemployment in response to an increase in the minimum wage, and substantial numbers of youth will drop out of the labor force all together. The data is ambiguous on the issue of whether whites or minorities will be affected more.
How to Fight Poverty Without the Minimum Wage
Despite my opinions about the minimum wage I still believe that it is necessary to fight poverty. There is sufficient wealth in the United States to eliminate poverty. We have taken the path of inaction when all Western European and Scandinavian nations have for decades tried to eliminate and alleviate the suffering of the poor. They have made great strides in doing so, while still keeping strong economies. But the U.S. has stood still, letting poverty deprive millions of access to basic rights such as food, shelter, health care, and a chance for a productive life.
It is possible to fight poverty without the possible negative impacts of minimum wage policies. To fix poverty in the U.S , I would recommend a basic income program. Every family would receive a sum of money from the federal government to make their income above the poverty line level. Because everyone would get to keep the income they earned by working, without effecting the lump sum paid to them, someone is always better off working. Also an income level just barely above the poverty line isn't enough to take away someone’s motivation to work, since isn’t very much money and wouldn’t provide for many or any extras or luxuries. To help people earn more than this basic income government jobs program, and/or wage subsidies should be enacted.
References
A discussion of the relevance of the supply/demand model and minimum wages can be found in most economics textbook.The following website sums up the issue in a neutral way.
http://economics.about.com/od/labormarketminimumwage/Labor_Markets_and_the_Minimum_Wage.htm
Neumark, David, and William Wascher. Minimum wages and employment: A review of evidence from the new minimum wage research. No. w12663. National Bureau of Economic Research, 2006.
Brown, Charles C., Curtis Gilroy, and Andrew I. Kohen. “The effect of the minimum wage on employment and unemployment: a survey.” (1982).
