How the Minimum Wage Reduces Inequality
After years of rallies and lobbying, the $15 national minimum wage is in sight, although it took a heavy procedural blow from the Senate parliamentarian yesterday. I’ve written about the minimum wage debate before—it takes up half of a chapter of Economism, and that half was excerpted by The Atlantic—so I won’t repeat myself too much. Last week I did an interview on the topic with Julie Rose for Top of Mind, which triggered a few more thoughts.
To recap for those who haven’t read the book: The minimum wage, like the top marginal tax rate, is one of those issues that attracts a certain type of argument that goes something like this:
You may think you’re helping poor people, but basic supply and demand dictate that a floor under the price of labor generates a surplus in the market, which is unemployment, and it is low-wage workers who will lose their jobs. It’s just Economics 101!
This is an attractive argument because it is elegant, it is contrarian, and it invokes the authority of economics, the dominant explanatory discipline of our time, at least among policy-minded people. It is also what you might believe if you dropped out of Economics 101 after the first month or so. People who actually do research in labor economics know that the world is much less clear than the first-semester supply-and-demand model would have you believe.
It is so much less clear that there is a long-running empirical debate involving several dozen sophisticated research papers trying to quantify the relationship between the minimum wage and employment. Most U.S. labor economists would probably acknowledge Arin Dube to be the leading expert on empirical research on the minimum wage, so you might as well just read what he has to say about it in The Washington Post. Here’s his summary of the overall body of research:
When I focused on studies that looked at overall low-wage workforce, the evidence on job losses were minute: In those cases, the job loss from the same 10 percent increase in average wage of affected workers amounts to maybe 0.5 percent. At that level of job loss, the wage gains far offset the losses: The low-wage workforce as a whole is better off from the policy.
Still, the problem is that economism is an ideology, meaning that it benefits a particular interest group—in this case, businesses that like having cheap labor. And there are enough papers out there that one can do what the Congressional Budget Office did in its report last year: cherry-pick studies and overweight the ones you like to get a biased result. (See Dube’s article for the details.)
Some people profess to be baffled at how the minimum wage could not increase unemployment. They took Economics 101. If the price of labor goes up, of course companies will buy less of it! However, there are many explanations of why companies might adapt to a higher minimum wage without cutting jobs (higher prices for customers, lower turnover, higher productivity, etc.). Here I just want to suggest one other way to look at this question.
The same model that says the minimum wage must increase unemployment also says that companies cannot make economic profits. The explanation goes like this. Let’s say some company is selling its products for $5 above their cost. Then some competitor will come along and sell its products for $4 above cost and take the entire market. But then another company will sell its products for $3 above cost, and so on. This continues until every company is making just enough profit to cover its cost of capital.
But this is obviously not true. There are plenty of companies that are making excess profits beyond their cost of capital. There’s a big one named after a river in South America (and it has a $15 internal minimum wage, even though it operates in lots of low-wage locations). At any given moment, most companies are making economic profits.
For those companies, the division of profits between capital (shareholders) and labor (workers) is a pure negotiation. To use round numbers, let’s say the company is paying $10 per hour, but it could pay up to $20 per hour and still cover its cost of capital. In that case, a $15 minimum wage is a simple reallocation from capital to labor. The company would choose to pay $15 rather than lay people off because it will still make $5 in profit per hour of labor.
(Someone will object that, if the workers’ labor really is worth $20, then they can get jobs at some other company that will pay $11 instead of $10. In practice, however, when some big company opens a new warehouse in an economically depressed area, it gets to set the wage however it wants. Unlike companies, which can locate their operations more or less wherever they want, most workers cannot simultaneously search for jobs everywhere in the world at once.)
In a world where the vast majority of corporate equity is owned by the very rich (that’s what makes them very rich), the minimum wage is essentially a distributional issue. Companies create value, as consultants like to say. The minimum wage places a limit on how much of that value shareholders can appropriate to themselves. That’s what opponents don’t want you to think about.
