The Minimum Wage Fantasy

by on September 20, 2006 at 7:16 am in Economics | Permalink

MaxSpeak is pushing a letter from economists, already signed by notables Alan Blinder, Clive Granger, Rebecca Blank and others, to raise the minimum wage.  Don’t worry, I won’t bore you with the usual story about unemployment.  A small increase in the minimum wage will have only a small unemployment effect, nuff said.  Nevertheless, parts of the letter strikes me as absurd.  The letter says, for example, that "The minimum wage is also an important tool in fighting poverty."  Rubbish.  But don’t take my word for it. 

The minimum wage is a blunt instrument for reducing overall poverty, however, because many minimum-wage earners are not in poverty and because many of those in poverty are not connected to the labor market.  We calculate that the 90-cent increase in the minimum wage between 1989 and 1991 transferred roughly $5.5 billion to low-wage workers…. an amount that is smaller than most other federal antipoverty programs, and that can have only limited effects on the overall income distribution.

The source? Card and Krueger in Myth and Measurement (p.3).

The letter also states that most of the people earning the minimum wage are adults.  Most workers are adults so this is hardly surprising.  What is more surprising is that 25% of the workers earning the minimum wage are teenagers, even though teenagers are a much smaller percent of the workforce.  In addition, over half the workers earning the minimum wage are younger than 25.  The letter can spin things how it wants but it would be more informative to say that most of the workers earning the minimum wage are young workers who with a little age and experience would have their wages increased in anycase.

That brings me to a second strange statement, the idea that "the minimum wage helps to equalize the imbalance in bargaining power that
low-wage workers face in the labor market."  One wonders how bargaining power is defined.  Do these economists really believe that the fat cats are getting rich slurping up surplus from the low-wage workers?  If you measure bargaining power as a difference between wages and marginal productivity it is surely high wage workers who lack bargaining power.

The real rebuke, however, to the bargaining power idea is this: a lot of people earning the minimum wage are teenagers but more than 90 percent of working teenagers earn more than the minimum wage.  Either most teenagers are very good bargainers or wages depend less on "bargaining power" than on productivity.  Either way the letter is confused.

The debate over the minimum wage is more about rhetoric than reality. 

Tom Grey - Liberty Dad September 20, 2006 at 7:35 am

Of that $5.5 billion transferred to low-wage workers, how much of it came from higher prices paid by buyers of products made from those workers?

I think if a Big Mac costs 10 cents more, in order to pay McDonald’s workers higher wages, a big portion will come from low wage earners who buy such Big Macs.

Drew September 20, 2006 at 7:57 am

“If you measure bargaining power as a difference between wages and marginal productivity it is surely high wage workers who lack bargaining power.”

Alex will you explain/clarify this? It seems the opposite is true (as intuition would suggest).

Productivity is hard to measure and it is especially hard to measure in higher paying jobs. One way to think about this is there is uncertainty/variance in how productive a potential employee will be.

Another effect of this is that higher-productivity laborers are more likely to be overcompensated (to help cope with the greater monitoring costs of their jobs).

Is there a model/data that suggests bargaining power is a function of uncertainty in productivity? This seems to make sense to me, and to capture much of the intuitions that are expressed with regards to this debate.

Finally, it may be that lower-wage earners are equally savvy bargainers (or even assume they are less sophisticated bargainers), but they may bargain in ways that are we don’t like (for instance rational teenagers face choice between drug dealing and working at McDonald’s), we may prefer a queue at McDonald’s to an efficient market (after-all Crack-dealers earn less than minimum wage, right).

All in all, there is substance behind the rhetoric.

Mike September 20, 2006 at 8:16 am

They are only asking for a “modest” increase in the minimum wage.

What I am surprised to see is that my dissertation advisor’s name is tacked onto the letter at MaxSpeak’s page. I have enormous respect for the man, he has done wonders for my career. However, here is a quote from his labor economics class I took with him:

“Does the Minimum Wage fight Poverty
Economists have been preoccupied with studying whether increases in the minimum wage due lead to a decline in employment. Evidence is mixed. Perhaps the best estimate is that a 10% increase in the minimum would reduce youth employment by 1 to 3 %. Given such small employment losses, is the raising the minimum an effective way of reducing poverty. No. Most minimum wage workers are teenagers and other part time workers. Poverty is primarily a problem of lack of full-time employment and raising the minimum wage does little for this.†

I mean, we even talked about the same things Alex points out in his post above.

Again, the small increase will likely do very little (although one piece of data I’d liek to see is what share of minimum wage workers are employed at small mom and pop businesses) – but I still am totally floored that my advisor’s name is on this letter.

jon September 20, 2006 at 9:23 am

Don’t teenagers have a lot of bargaining power? They can walk away from a job much easier than an adult employee. They generally don’t have to provide for their own necessities. They generally don’t have to worry about healthcare. They don’t have to worry about how quitting a job will look on their resume. They are less constrained in what jobs they can take, frequently having parent provided transportation that a poor employee may lack and no need for child care which many low income adults need. The employer also has to compete with extra curricular activities which by improving the teenager’s chances of getting into a good college could have significant value.

In the context of a low skill job, it seems to me that a teenage employee has more bargaining power than an adult relying on the job for their sole means of support.

Alex Tabarrok September 20, 2006 at 10:04 am

Drew here are a few reasons to think that MP>W is more likely for high-wage workers. there are fewer high wages workers than low wage workers, markets are thinner, there is less competition and more two-sided bargaining. eg. Movie directors can basically only work in LA and only for a handful of firms – low wage workers can work anywhere in the United States and have many potential employers. A movie director doesn’t have a wage, he bargains and his effective wage will differ greatly depending on the movie, the producer, the firm etc. (See jon’s comments about teenagers also.) High wage workers are also much more likely to generate externalities that they cannot capture, e.g. intellectual property, improvements in the productivity of others, increases in social capital etc.

Best

Alex

Anderson September 20, 2006 at 10:24 am

I would think the EITC is a better tool than the minimum wage.

Swimmy September 20, 2006 at 11:17 am

Eclectecon: Don’t be so quick to concede! The minimum wage may not be common where you live–it’s certainly not where I live–but I’m from a small town in Tennessee with only a handful of major employers that would be quite harmed. The minimum wage gives producers in high cost-of-living areas an advantage over those in more rural areas. A national minimum wage hike could be very harmful given that wages in our nation are not uniform.

JohnDewey September 20, 2006 at 11:32 am

joan: “What I don’t know is what interest group is opposing it on the conservative side. ”

Certainly my group – small business owners in Southern states – oppose raising the minimum wage. But I don’t think we’re a powerful interest group.

Here’s what I don’t understand, Joan. Suppose I offer a job in my bookstore to a college student at $5.30 an hour. Suppose that college student takes that job instead of the $7.00 an hour job at the supermarket next door. What business is that of yours or anyone else’s? Both the employer and the employee are happy with the arrangement.

eriks September 20, 2006 at 12:23 pm

I was wondering if conservative and libertarian economists support the EITC. If so, why not start a campaign to increase the EITC (which liberal economists will surely join) if you find the minimum wage proposals so repugnant?

JohnDewey September 20, 2006 at 12:51 pm

eriks: “why not start a campaign to increase the EITC (which liberal economists will surely join) if you find the minimum wage proposals so repugnant?”

I’m not an economist, but I do have an opinion. I find government welfare assistance to be just as repugnant as governmet interference in private wage agreements.

Why are either minimum wage increases or EITC increases needed? No one in the U.S. is going without food. No one is being denied medical care. Every child receives an education. The only people who remain homeless are the addicts and the mentally ill.

If individuals wish to provide more than simple, basic needs, they can do so directly or through charities. How can anyone justify confiscating the hard-earned income of those who do not wish to do so?

joan September 20, 2006 at 1:08 pm

jim: “This article makes the argument convincingly and straight forwardly that the minimum wage makes both workers in the relevant markets and firms worse off.”

Since 1980 studies on the actual effect of minimun wage changes found them to be much smaller than expected. By your definition if you take the new informaion into account you are showing “left-leaning academics biases”.

If I use the theory of gravitation I can make the argument convincingly and straight forwardly that steel ball and feathers fall at the same rate. I could even argue that you are not breathing because all the air molecules are lying on the ground.

georgist September 20, 2006 at 3:06 pm

“How can anyone justify confiscating the hard-earned income of those who do not wish to do so?”

Hear, hear. We ought to tax the _unearned_ income of landowners and other economic rents, rather than burdening productive activity by taxing profits or wages.

JohnDewey September 20, 2006 at 3:19 pm

Joan: “Since 1980 studies on the actual effect of minimun wage changes found them to be much smaller than expected.†

Here’s a few recent studies that show a strong negative impact from minimum wage increases:

Minimum Wage Reduces Jobs for Low-Wage Workers in France and U.S. (NBER, Jul1997)

http://www.nber.org/digest/apr98/w6111.html

Each mandated hike in the minimum wage hurts unskilled workers (Employment Policies Institute , Jan1998)

http://www.ncpa.org/hotlines/min/jan98c.html

Expect the loss of 145,000 to 436,000 teenage jobs from raising the minimum wage (FRBSF, Feb1999)

http://www.frbsf.org/econrsrch/wklyltr/wklyltr99/el99-06.html

Workers initially earning near the minimum wage are adversely affected by minimum wage increases (NBER Feb2000)

http://www.nber.org/papers/w7519

Job loss following minimum wage hikes is economic reality (University of Georgia, May-2006)

http://www.epionline.org/news_detail.cfm?rid=72

There have been more. Please don’t argue that recent research is conclusive and ignore studies such as the above.

Why should labor disobey the laws of supply and demand that are obeyed by any other good?

Will Johnson September 20, 2006 at 3:38 pm

I believe that people that are making more than minimum wage are worried way to much about what they think low wage workers should make. The minimum wage is of no concern to many who are considered low wage workers, in many parts of the country the jobs viewed as low wage pay more that the minimum wage. So the title low wage job should be amended to say jobs that pay minimum wage, and not include jobs that have gratuity and tips that make the wage total more than the understood minimum wage. Minimum wage is a very relative statement depending on where you are at in the US. For instance in rural NC a minimum wage of lets say $6 is worth more than the same wage in lets say New York City where the costs of living are higher. So for this reason why not make the minimum wage a dynamic figure that is based on the minimum cost of living in the area of employment. Therefore it will be a higher rate in New York City than in rural NC. This could help solve some of the problems.

JohnDewey September 20, 2006 at 3:56 pm

will johnson: ” So for this reason why not make the minimum wage a dynamic figure that is based on the minimum cost of living in the area of employment. ”

I agree that a national minimum wage makes no sense. But why not just let the market decide what to pay? There are some workers who are just not worth $6.00 an hour. Some are mentally challenged, some are teenagers, some have severe physical disabilities. Rather than have these folks be priced out of any work, why not allow them to earn something?

eriks September 20, 2006 at 5:14 pm

JohnDewey,

It’s hard to discuss an issue if you guffaw at the statistics without offering alternate measures. Further, to suggest that these people are without food because of drug habits is either disingenuous or cruel.

You’re right that we don’t see the extreme nutritional and calorie deficiencies as there are in Third World countries, but again, it doesn’t mean that the poor in America aren’t badly off. Do you disagree that much of poverty is systemic and many of those impoverished have very little opportunity to improve their situation? Many poor people eat foods that are terrible for them because of ignorance and limited funds. Phil Gramm’s anecdote about fat people is more a condemnation of our education system and food industry than it is of anti-poverty programs.

Your use of the term welfare is confusing. Do you mean programs that improve well-being? Or do you mean “free money”? Because the EITC is designed to provide funds to those who work–encouraging work force participation and self-sufficiency. If you agree that children should be helped to escape poverty than surely a program such as the EITC–which encourages a strong work ethic–is a good start, right?

JohnDewey September 20, 2006 at 5:43 pm

eriks: “Do you disagree that much of poverty is systemic and many of those impoverished have very little opportunity to improve their situation?”

Oh, I definitely disagree. I’ve known and read about too many individuals and families who worked their way out of extreme poverty. America is still a land of opportunity for everyone. That’s why so many illegal immigrants risk their lives to get here.

eriks: “Or do you mean “free money”? Because the EITC is designed to provide funds to those who work–encouraging work force participation and self-sufficiency.”

I’m well aware of EITC’s purpose and it’s restrictions. But it’s still free money – transferred from taxpayers to non-taxpayers. It was necessary only becasue of all the other free money that was available.

eriks: “surely a program such as the EITC–which encourages a strong work ethic–is a good start, right?”

It’s still free money. It allows unmotivated workers the luxury of not improving skills. Is it better than free money without restrictions? Yes. But not much better. If we’re going to give away my money to someone else, I want to know that it’s going to someone who needs it. I am positive that many who receive EITC do not need it.

jim September 20, 2006 at 5:56 pm

joan:

You wrote:”Since 1980 studies on the actual effect of minimun wage changes found them to be much smaller than expected. By your definition if you take the new informaion into account you are showing “left-leaning academics biases”.”

This is really ignorant, literally: it indicates that you have not bothered to read the article (which provides an explanation for why one should expect the quantity response to be small).

You merely looked at the date of the article and then tossed out a knee-jerk response. I think you are capable of making an intelligent and positive contribution to the argument about the minimum wage, but only if you read about things first before assuming the posture of one who is so smart that she does not need to read them before criticizing them. Your presumption is unmerited.

jim September 20, 2006 at 9:01 pm

joan,

Your honesty more than compensates for your knee-jerk (ignorant)reaction, nevertheless I cannot agree with your assertion that: if the McKenzie article has rarely been cited, then it is deficient. There are counter-examples: in economics we know that some of Ronald Coase’s work was not highly cited for many years following its publication. Beyond economics, there are examples in the history of science like this as well.

And just because you cannot get something at the click of a mouse does not excuse one who want to criticise someone’s work from the intellectual responsibility of going to the library and reading it. Also if you would write Richard McKenzie an email, I’ll bet that he might be able to send you a pdf pronto. Have you tried that, or were you so jacked up by my left-baiting that you couldn’t think straight? If so, perhaps you might want to reassess you objectivity.

joan September 20, 2006 at 10:18 pm

Jim:
I was not critizing the paper I was critizing your post.

mk September 20, 2006 at 11:13 pm

JohnDewey: you are an arrogant idiot who has no idea of what happens in the real world

albatross September 21, 2006 at 10:21 am

Has anyone looked at minimum wage laws as a kind of protectionism for high-wage places, at the expense of low-wage places? In Montgomery County, MD, even the just-arrived Salvadorans don’t work for minimun wage, because that’s below market rates. I wonder how much of the push for raising the federal minimum wage comes from a desire to protect Montgomery County workers from low-wage competition in West Virginia. (I really have no idea how much this matters.)

jim September 21, 2006 at 1:21 pm

joan,

You wrote: “If the article did not get attention it was not just the fault of the left.”

Of course you have a point, but the academe IS dominated by the shrill left: remember what happened to the economist who was president of Havard. Furthermore, even among economists I think that one would find imbalance. Of course the people who are most at “fault” are the scholars who have written about the minimum wage without considering the McKenzie article. Sadly, for example, the Card and Krueger article that was seized upon by the left to undermine the law of demand admitted no knowledge of McKenzie’s paper or ideas. Additionally the editors and referees of the journal that published the C&K article are at “fault.” I continues to amaze me that the law of demand is not taken more seriously by the folks running the top journals in the field; but that, is another story. . .

Is there balance by those controlling top journals in economics? Not according to what I glean from the following article that appeared in EJW:

http://www.econjournalwatch.org/pdf/McEachernCharacterIssuesJanuary2006.pdf

JohnDewey September 21, 2006 at 3:21 pm

cb: “You people are pie in the sky fools if you think any more than a small percentage of EITC is going to the ‘basics’.”

I’m not one of those “pie in the sky fools”, but apparently I’m “an arrogant idiot who has no idea of what happens in the real world”. So take it with a grain of salt when I say I agree with you. My observations of my employees and my relatives who receive EITC checks is that they appreciate the opportunity to buy a new television. But, of course, they would never thank taxpayers like me who pay for their goodies.

jim September 22, 2006 at 11:17 am

Barbar,

Your singular focus on the former president EXAMPLE I gave misses the real point; forget about him completely if you like and just read the EJW article I referenced.

No, my post was not “Blah, blah, blah” that can be dismissed by anyone who is at all serious about the pursuit of knowledge and insight. If you aren’t, why are you reading the Marginal Revolution? If you are interested in a slanted left perspective on a wide array of current events you would probably be happier just listening to the standard drum beat dominating National Public Radio. There was a time I can remember when NPR regularly featured William Allen’s commentary for a bit of balance. But those days are gone and forgotten by the czars running that show these days. Needless to say I no longer make contributions to NPR as I once did.

Johnny Upbeat September 22, 2006 at 9:32 pm

I believe that raising the minimum wage is simplistic. It is useful mainly to politicians who are pandering for the vote. It especially hurts the fixed income retired. The effect of the minimum wage increase is to instantly increase the rate of inflation, wiping out the minimum wage increase benefit within a month or two. In the end it leaves the poor right where they started, poor.

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