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Monday, January 13, 2014

Pondering the Minimum Wage

As frequent readers know, I'm against minimum wage legislation.  As I've written previously:
However, from the perspective of an unskilled and inexperienced person who cannot provide adequate value to justify being paid the minimum wage, minimum wage laws are egregiously unfair.  The minimum wage law says to that person, "you may not work for anybody, any time, under any circumstances since no rational business person can justify hiring you at the required wage".
Ignoring the freedom aspect and the damage it does to at least some of the poor who would like to work but are unable to because of minimum wage laws, I think it's possible to make a case for minimum wage laws on practical grounds in at least certain hypothetical situations.

Consider the following hypothetical situation.  Let's say the minimum wage is $10 per hour and everybody in the private sector makes the minimum wage.  Let's say that there's a fixed tax of $90 per hour for every employee.  Also, assume no profits and no other costs.  The total cost to employers is therefore $100 per hour.  Also assume that the only cost to the employers for producing their products is the $100 per hour for the wage and the tax.

Now let's say that the public sector employees are paid $900 per hour and their only activity is to dig holes and fill them back in and/or to manage the hole activity.  There would thus be 1 government employee for every 10 private sector employees and the government employees would be paid 90 times the private sector employees for doing absolutely nothing useful.

In this hypothetical situation, raising the minimum wage from $10 to $20 per hour would be hugely stimulative.  The private sector employees would have twice as much money to spend while the cost of labor would only rise 10% (from $100 per hour to $110 per hour) since the $90 per hour tax remains fixed and the price of products would also only need to rise 10%.  The employees would be better off AND business would probably expand AND hire more employees.

In effect, in this situation, raising the minimum wage acts like a government spending cut and reduces the dead weight of the government relative to the productive economy.  Instead of an 900% tax on productive wages, there would only be a 450% tax on productive wages which is effectively a very large tax cut.  This would be hugely beneficial to everybody EXCEPT the government employees who essentially get a pay cut of 10%.

To the extent that reality overlaps partly with this hypothetical situation, a rise in the minimum wage could actually boost both wages and employment.  The hypothetical situation can be generalized to high fixed costs per employee, either due to regulation, taxes, or general costs of doing business.

One of the things I find interesting about economic studies about the effect of minimum wage legislation is that over time, raising the minimum wage has less and less adverse impact.  For example:
Until the mid-1990s, a strong consensus existed among economists, both conservative and liberal, that the minimum wage reduced employment, especially among younger and low-skill workers.[21] In addition to the basic supply-demand intuition, there were a number of empirical studies that supported this view. For example, Gramlich (1976) found that many of the benefits went to higher income families, and in particular that teenagers were made worse off by the unemployment associated with the minimum wage.
Then the infamous Card and Krueger (CK) "bombshell" struck:
In 1992, the minimum wage in New Jersey increased from $4.25 to $5.05 per hour (an 18.8% increase) while the adjacent state of Pennsylvania remained at $4.25. David Card and Alan Krueger gathered information on fast food restaurants in New Jersey and eastern Pennsylvania in an attempt to see what effect this increase had on employment within New Jersey. Basic economic theory would have implied that relative employment should have decreased in New Jersey. Card and Krueger surveyed employers before the April 1992 New Jersey increase, and again in November–December 1992, asking managers for data on the full-time equivalent staff level of their restaurants both times.[51] Based on data from the employers' responses, the authors concluded that the increase in the minimum wage increased employment in the New Jersey restaurants.
And while there was and is contentious debate about everything about CK, what is striking is that modern studies show little if any negative impact in direct contrast to studies from earlier last century.

My belief (I say this as someone who runs a business and has to constantly deal with overwhelming, stifling, and increasing regulation and taxes on all fronts), is that the increasingly onerous government impositions on business, especially small business and especially businesses that hire lower wage employees, acts pretty much like the drag of a government digging and filling in holes.

That's why the minimum wage did empirically have a significant negative impact decades ago, but doesn't make much difference (to a point) anymore.  The government is dragging us down.

5 comments:

Bret said...

I added a minor edit this morning: "Instead of an 900% tax on productive wages, there would only be a 450% tax on productive wages which is effectively a very large tax cut."

Hey Skipper said...

And while there was and is contentious debate about everything about CK, what is striking is that modern studies show little if any negative impact in direct contrast to studies from earlier last century.

Yet academic studies aren't the only way to find the answer.

Back in the halcyon days of the 1990s, The Economist ran an article about how its high minimum wage was pricing young people out of the job market. In arriving at its conclusion, it compared two otherwise largely similar economies, France and the US, and noted the vastly higher French unemployment rate among those under 24.

That's why the minimum wage did empirically have a significant negative impact decades ago, but doesn't make much difference (to a point) anymore. The government is dragging us down.

That is kind of hard to say without knowing the total cost of employment, isn't it? For, say, someone working at McDonald's, how much has the non-wage cost of an employee increased?

In the EU, non-wage costs average 24% of total employment cost. Oddly, that number isn't easy to find for the US, but it has to be lower.

It sounds like a 10% increase in the minimum wage is more significant than your hypothetical suggests.

Bret said...

Hey Skipper wrote: "In the EU, non-wage costs average 24% of total employment cost."

I think that doesn't take into account a lot of costs. For example, let's say that I have a foundry that makes some sort of metal thing and for every 10 manufacturing employees I have to buy a smoke stack scrubber for $10 million per EPA regulations. After financing, the effective fixed cost per employee could be many tens of dollars per hour, but the EU would NOT include that as labor costs. 2nd example: for every 10 manufacturing employees I may need a full time accountant at $100 per hour. Not only would that $100 per hour not be included as a cost of hiring the $10 per hour employees, it would lower the "non-wage costs" percentage (per the EU definition) because fringe, etc for the $100 per hour employee would be lower than for the $10 per hour employee.

Even just taking the 24% of the EU's average E$28 is E$7 per hour which is a much higher percentage (100+%) for someone making the U.S. minimum wage.

Hey Skipper wrote: "Oddly, that number isn't easy to find for the US, but it has to be lower."

No. EU governments cover a lot more than the U.S. government which instead imposes costs on the businesses.

For example, consider health care cost mandates which I think are likely to sink the vast majority of small businesses, especially those with a plethora of low-wage workers, over the next few decades.

Clovis e Adri said...

Bret,


That's an interesting point.

One thing that gives me pause when I hear people saying that higher minimum wages do not decrease poverty is that it contradicts the experience I've seen down here.

AFAIK, there are solid indications that increasing minimum wages had a measurable role in diminishing poverty levels over the last 20 years in Brazil.

Still, most of the arguments over why it should not happen in the economy look pretty reasonable to me, in a superficial analysis.

Maybe the catch is in something along the lines you displayed here. I am sure that, whatever onerous you think govt. impositions are in the US, they are orders of magnitude more onerous down here.

Hey Skipper said...

[Bret:] I think that doesn't take into account a lot of costs. For example, let's say that I have a foundry that makes some sort of metal thing and for every 10 manufacturing employees I have to buy a smoke stack scrubber for $10 million per EPA regulations.

If that is the case, then sure. Heck, in my job, for every 20 or so pilots, my company has to buy a $100 million dollar airplane. But that would distort the calculation beyond all reason.

What makes sense is the total direct wage and non-wage costs of employing one additional min-wage worker. In the US, that is 6.5% for social security, and another few percent for UI insurance. I'm certain there are other things I haven't accounted for, but probably not much.

That is why I say that adding a couple dollars an hour to a min- (or even low) wage workers hourly pay is substantial, because non W-2 employment costs are quite low here.

But we are talking about min-wage jobs here.

[Clovis:] AFAIK, there are solid indications that increasing minimum wages had a measurable role in diminishing poverty levels over the last 20 years in Brazil.

That could well be, but I think you would have to eliminate other explanations first. Perhaps the foremost one is large a portion of the working population is at minimum wage.

If it is zero (which is probably the case where I live -- my daughter's very first job was very entry level, and she was getting $10, $2.25 above the min wage.), then it is possible that the economy itself, through demand for labor, is what reduced poverty.

If I was to become Head Dude What's in Charge, I would eliminate the minimum wage, and provide a sliding scale earned income tax credit with each pay check (i.e., the more a worker earns, the less the EITC, but the reduction wouldn't be so steep as to act as a disincentive for earning more.)

The advantages is that it would probably essentially eliminate unemployment in the places where it is worst. (Low wage workers in the rest of the world would probably be worse off, because US companies might well onshore everything to take advantage of local wages as those in China, and without all China's problems). Also we could probably eliminate a whole bunch of useless (or worse) welfare programs. Beyond that, min wage jobs are often in sectors that have many less well off customers, so increasing the min-wage will have the effect of increasing prices on those who can afford it least. (I don't think there are any min-wage workers at my company, and scarcely anyone on min wage uses my companies services.)

However, taxation might have to become much more progressive to pay for it (although eliminating a bunch of welfare programs that are just perpetuating problems might minimize that). Also, about 23% of EITC payments are either fraudulent or incorrect.

So there's that.