Asymmetrical Information - Megan McArdle

02.14.13

How to Think About the Minimum Wage

The president wants to raise it to $9 an hour. But will this help low-wage workers, or throw them out of work?

It’s easy to see why Barack Obama wants to raise the minimum wage.  It’s popular with his base.  It’s popular with unions, who dislike competition with low-wage labor.  And it doesn’t cost the government anything ecept the cost of printing some new posters telling people what the minimum wage is.  

But is it a good policy idea?  

The three main considerations are the same as for any economic policy: who does it help?  Who does it hurt?  And what is the effect on growth?  

It’s obvious who benefits from a higher minimum wage: people who get minimum wage jobs.  In theory, it may also boost the incomes of people who are making near the minimum wage, as employers raise those wages to ensure that these are “better than minimum wage jobs”—though in this labor market, I wouldn’t bet on it.  

But who are the people in minimum wage jobs?  This is primarily being sold as a poverty-fighting tool, so it would help to know how many of the people making it are poor.  

The answer seems to be no; most of the people making the minimum wage are not living in households below the poverty line.  Over half the people earning minimum wage are below the age of 25; for them, this is not likely to be a permanent condition, but a first rung on the income ladder. Many are students or entry level workers who are part of established households with higher earners.  

Older minimum wage workers are probably more likely to be poor, but on average, they're not.  To be sure, they're unlikely to be wealthy--this workforce will be predominantly drawn from near-poor and lower-middle-class households.  Undoubtedly, they have uses for the extra money.  But it will not specifically lift people out of poverty, because most of the people earning minimum wage aren't in poverty now.  

That's who it helps.  Who does it hurt?

Ironically, minimum wage workers.  Or so argue conservatives.  When something becomes more expensive, people tend to use less of it.   Or as economists like to say, "demand curves slope downward". Raise the minimum wage, and some of the people who now have a minimum wage job will be out of work--or see their hours cut back.  

The empirical evidence for this proposition, however, is somewhat mixed.  David Card and Alan Krueger have done some pretty famous work showing no disemployment effects, and since Alan Krueger is now the head of the Council of Economic Advisors, it's not surprising that Obama is embracing a higher minimum.  However, David Neumark and William Wascher have also done some pretty famous work showing that there are disemployment effects.  A recent paper by Jonathan Meer and Jeremy West suggests that the effect may show up, not in firings, but as a reduction in new hiring.

On balance, I think the evidence suggests that minimum wages do reduce employment--in part because I think that when you're arguing that demand curves don't slope downward, you need some extraordinary proof to back up your extraordinary claim.  

Yes, there are all sorts of individual wrinkles; the economy is not a neat textbook model full of perfectly smooth curves.  Businesses have a fair amount of inertia, and a strong reluctance to fire people.  And businesses can make up for some of the loss by cutting worker amenities or forcing them to work harder. Nonetheless, it's hard for me to believe that overall, you can raise the labor costs of low wage firms by 25%, which is what the President is proposing, and see no change in the number of workers they use.  

But I think that the evidence so far also suggests that the effect probably isn't particularly large.  If it were big, there wouldn't be much debate over whether minimum wages reduce employment: the effects would be pretty obvious in the data.

So what about economic growth?  I imagine there's some effect, but I doubt it's large enough to ever tease out of our noisy economic data.  Of course, when growth's anemic, you hate to lose even a hundredth of a percentage point.  But this is hard to argue over, because we'll never know if there is an effect, much less how big it is.  

So the debate boils down to this: should we hurt some unknown number of workers in order to help others?  Right now, I think the answer is no.  

The thing about unemployment is that it's much, much worse than having a crap low-wage job.  It's worse than almost anything.  It's one of those life events that people never really recover from.  Two years after a divorce or being widowed, people have adjusted, and are mostly about as happy as they were before the terrible event.  But after two years of unemployment, people are still miserable.  And even after they get another job, a prolonged spell of unemployment  often has permanent effects on future earning power, and risk for things like depression.  We should weight the losses of the people who are out of work much higher than the gains to the people who get an income boost.

In an ordinary economy, those losses probably aren't that large.  But unemployment is still in the range of 8%, and the unemployment rate for young workers, and low-skilled workers, is considerably worse than that.  

Source: Bureau of Labor Statistics ()

With this much slack in the labor market, I don't think we should do anything that risks raising the unemployment rate. Especially since we are already handing employers a big new labor cost: Obamacare.  

Starting in 2014, employers either have to provide full-time workers with insurance, or pay a penalty for failing to do so.  With the economy weak and this much slack in the labor markets, that means they already have strong incentives to reduce their workforce, or cut more of their workforce back to full time.  I don't want to increase those incentives one iota.

If we think that low-wage workers should make more money, we should increase the Earned Income Tax Credit, not force a potentially job-killing wage boost on employers.  Of course, the Earned Income Tax Credit will get scored by the CBO as costing money, while a higher minimum wage won't.  But the real costs of a minimum wage are potentially much worse.