11 June 2014

Minimum wage, maximum ideology

Last week, Seattle voters approved a $15 minimum wage, the highest in the country. This rang the bell for another round of the debate about whether the minimum wage is a Good Thing. Simply stated, the question is whether increased wages for some workers will cause other workers to lose their jobs.
It’s hard to understand these arguments without a bit of economic theory. I’m strictly an amateur here, but the principles are simple and can be stated without graphs or equations in three simple rules:
1  A business will sell fewer units of whatever it produces as the unit price goes up (and vice-versa); that’s why Fords outnumber Ferraris.
2  As the business increases the number of units produced, the per unit cost will generally fall (“increasing returns to scale”).
3  At some point, however, per unit costs will start to rise again as the business’s plant becomes too small for its output or the cost of inputs (such as labor) rise to meet the increased demand.
All of these pressures on the business balance out at a sweet spot where the business’s cost of producing one more unit just equals the revenue from that unit. At that optimum output the business maximizes its profit: Make one less unit and revenue will fall by more than cost (lower profits), make one more and costs will rise by more than revenue (again, lower profits).
Finding that optimum output is largely a trial-and-error process, but most businesses get it nearly right for the simple reason that the ones that didn’t are no longer around. It’s a jungle out there.
Raising the minimum wage may force a business to pay some of its workers more. If you pay your workers more, however, then it will cost you more to produce each unit. Which means that the sweet spot—the output level that maximizes profit—will move to a lower output. But as the business reduces output to maximize profit, it will need fewer workers for the reduced output. (The business may also invest in labor-saving machinery that wouldn’t have made sense when wages were lower.)
The theory, unobjectionable in itself, doesn’t tell you the size of the effects. Opponents of the minimum wage argue that the main effect will be lower employment, proponents that the main effect will be lower profits. Economists have done studies—lots of studies—on the effects of a minimum wage, with varying conclusions. Each side gets to cite the studies it likes.
Economists don’t have the luxury of being able to set up experiments where all the variables can be controlled. Occasionally they get “natural experiments,” such as when two bordering states set different minimum wages. But neighboring states can differ in all sorts of ways. And the economists don’t get to compare a $1/hr minimum wage with a $20/hr minimum wage. More like $9 vs $10. With such small differences, general statistical noise is likely to mask any unemployment effects.
Nonetheless, I think most of us can agree that at some level a minimum wage must increase unemployment; if Seattle had raised the minimum wage to $50/hr (about $100,000 a year), a considerable number of Seattleites would probably find themselves unemployed. Sensible minimum-wage advocates understand this, and see the problem as where to set the number. They want it high enough to help people (in the way a $1 minimum won’t) but low enough so that it won’t put substantial numbers of people out of work (as a $50 minimum would). I’ve seen this phrased as finding the “tipping point” below which there is little or no increase in unemployment and above which the increase is substantial. It seems unlikely, however, that there is such a break point, just a smooth rise or fall. Any rise (or fall) in the minimum wage is likely to increase (or decrease) unemployment to some extent; it’s all a question of how much.
Economic theory tells us that any attempt to set prices—including the price of low-skilled labor—will lessen economic efficiency; that is, the value of the goods and services the economy produces will be less than if the prices were set purely by market forces. But even a well-run society will accept market interventions if it judges that the non-efficiency benefits will outweigh the efficiency costs. Consider the income tax: The economic damage caused by people shifting activities to improve their tax position is huge. But we have to finance the government somehow, and income taxes seem the most practicable way. (Actually, a poll tax—that is, a tax that is the same amount for every adult regardless of income—would not affect economic efficiency, but such a tax is a political non-starter.)
That a minimum wage may hurt the economy doesn’t settle the issue; it all depends on the balance of costs and benefits. If Seattle’s adopting a $15 minimum wage will only increase unemployment slightly, then we might favor it. But if it causes lots of low-wage workers to lose their jobs, then it may not be such a good thing. Unfortunately, no one knows which it will be; the effects will be hard to measure after the fact, let alone in advance. Moreover, the effects on one Seattle business may be completely different from the effects on the business across the street, and the effect of a Seattle minimum wage different from the effect of a Tacoma, Topeka, or Tallahassee minimum wage.
Unfortunately, the minimum wage has become a test of ideological purity. Liberals, who are happy to intervene in the market, are all for it, while conservatives, who like market solutions, are solidly against. No one wants to hear that “it all depends.” Nor are purists troubled by the occasional inconsistency: Some of the same people who deny that a minimum wage can throw a substantial number of people out of work will simultaneously argue that low-wage foreign workers are causing American job losses. You can’t have it both ways. If lower labor costs can pull a factory from Massachusetts to Alabama (or Alma Ata), then a rise in the minimum wage can push it there. Similarly, conservatives can’t argue that a minimum wage will substantially increase unemployment, then turn around and claim that jobs don’t migrate to low-wage jurisdictions.
Where do I come out on all of this? Generally, I oppose the minimum wage. I can understand someone supporting it if (a big “if”) the effect on wages is large and the effect on unemployment small. But we seldom know what those effects will be, so supporting a minimum wage seems like a kind of feel-good politics—you support a policy to show the purity of your principles without asking if it really does more harm than good.
I would like to do something for the poorest in our society, but it has to be something that is likely to work. Some public policy wonks argue that an expanded earned income credit (EIC) can raise the compensation of low-wage workers without increasing unemployment. I’m still trying to figure out how I feel about the EIC; If I do, I’ll let you know in a later post.

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