Cato Institute
1000 Massachusetts Ave, NW
Washington, DC 20001-5403

Phone (202) 842 0200
Fax (202) 842 3490
Contact Us
Support Cato

The Cato Review of Business & Government


We welcome letters from readers, particularly commentaries that reflect upon or take issue with material we have published. The writer's name, affiliation, address, and telephone number should be included. Because of space limitations, letters are subject to abridgment.

The Minimum Wage


"The Minimal Case for the Minimum Wage" (Regulation, 1987 Number ¾) Exposes the weaknesses in arguments for raising the minimum wage. Unfortunately the minimum-wage hike contained in the Fair Labor Standards Act (H.R. 1834) will likely pass Congress under election-year pressure from organized labor. This is bad news not only for business, but also for the marginally skilled, poor, and young workers whom this legislation will affect the most.

According to the Congressional Budget Office, the proposed increase in the minimum wage could cause the loss of up to a half-million jobs nationwide. That job loss would be most keenly felt among groups in the labor force with the lowest wages-and especially among young people. The U.S. Department of Labor says that 60 percent of all minimum wage earners are between the ages of 16 and 24.

Most of these are not working poor people struggling to feed a family, but young people trying to get entry-level job experience. Fewer than 14 percent of minimum wage earners are heads of households trying to support families. Ironically the poor will be hit the hardest by the increased inflation that is sure to follow a major hike in the minimum wage.

Perhaps the threat of inflation is the single most potent argument against raising the minimum wage. Government mandates of this type, which add nothing to private-sector productivity, are the root cause of inflation and recession. The congressional Budget Office estimates that the annual inflation rate would jump by about 0.3 percentage points under the current minimum wage proposal. That's bad news for everybody.

Labor markets should determine wages, not election-year politics. But until the leadership of Congress pays heed to the economic arguments against government mandates on business-especially the profound case against an increase in the minimum wage-we are bound to repeat the mistakes that have plagued our prosperity in the past.

Andy Ireland
US Representative
10th District, Florida


Many of the conclusions of the Burkhauser and Finegan study of income trends among low-wage workers ("The Minimal Case for the Minimum Wage") have been verified by other recent studies. They all dispel the common misperception that increasing the federal minimum wage will help the working poor. But these studies, as well as the recent "phantom" Congressional Budget Office report on the impact of a minimum wage increase on employment and inflation, have not deterred Congress's desire to enact such an increase. In my view, a more effective approach would be to refocus the debate toward state autonomy in setting minimum wage rates.

Last year 15 states and the District of Columbia raised their minimum wages, and another 17 states are considering legislation this year. Some of the increases are relatively small, others relatively large (although none as large as the increase to $5.05 an hour proposed in the Kennedy-Hawkins legislation). In either case, the state minimum wage increases reflect the distinct dynamics of the nation's regional economic markets and work force.

For example, California and Connecticut, which have unemployment rates of 5.6 percent and 3.8 percent respectively, set their minimum wage rates at $4.25 an hour. Only the District of Columbia has a higher minimum wage. Conversely, Louisiana, with a 12 percent unemployment rate, does not have a minimum wage law.

Clearly a substantial increase in the federal minimum wage would have a greater adverse impact on those states with weak labor markets or strong service-oriented economies. This was made evident by the 1988 study by Richard B. McKenzie, sponsored by the National Chamber Foundation. It concluded that "the South will be the region with the greatest job loss, approximately one-third of the total employment loss."

States should be given the flexibility to tailor their minimum wage laws to meet the diverse characteristics of their local economic markets. An additional increase in the federal minimum wage will obviously distort those markets. But focusing attention on the "nationwide" impact only dilutes the magnitude of those distortions.

David Dreier
US Representative
33rd District, California

The Twisted Pair


Roger Noll's prescription for increased competition in local telephone service ("The Twisted Pair," Regulation, 1987 Number 3/4) is a welcome beam of wisdom at a time when our entire government, except the beleaguered Judge Greene, seems to share the fantasy that local telephone monopolies transcend all known economics and can be allowed to enter new markets at will, with no danger that they will exploit captive customers and bottleneck facilities.

My only criticism is that Noll looks to further technological progress-such as radio telephone and cable television becoming cost competitive with the copper wire telephone network-as the basis for increased competition in local service. I think we should look to the past, since regulatory reforms typically lag behind the technological changes that make the existing regime untenable. Historically, the cost structure of telephone networks has shifted toward smaller portions for transmission, and larger portions for switching. Local transmission remains as much a natural monopoly as it ever was, pending the technological progress Noll predicts. But local switching seems to have evolved into a fit arena for competition.

By "local switching" I mean the functions of completing calls within the local network, interconnecting with long-distance companies for calls outside the local network, and a host of enhanced services such as call forwarding and abbreviated dialing. Sophisticated computerized switchboards (PBXs) in large business telephone systems already perform these functions in competition with local telephone companies, but the existing regulatory regime and its resulting pricing structure inhibit this competition and prevent anyone but the local telephone monopolies from offering local switching to the general public.

Competition in local switching would not require any technological advances. At present, when a subscriber's telephone line enters the local monopoly's office, it connects to a "class 5" switch, which performs local switching. Under competition, a subscriber line entering the local monopoly's office would be wired to a "cross connect," a simpler device than a class 5 switch. The cross connect would permanently (but changeably) route each subscriber's line to the competitive switching provider he had chosen. Each competitive provider's own class 5 switch could be located at the local monopoly's office, or at a remote location. Experience with the cellular radio telephone has already solved problems of numbering systems and interconnection when multiple switching systems serve a geographic area.

Thus competition in local telephone service, for which Noll so clearly shows the need, does not have to wait for the cost of alternative transmission technologies to drop to the level of the copper wire network. It waits only for regulators to make "open network architecture" a reality by allowing competition in local switching, and by requiring local telephone monopolies to offer the competitors interconnection that is nondiscriminatory in price and technical quality.

David S. Reed
Washington, DC


"The Twisted Pair" lays out succinctly-perhaps too succinctly- the choices this nation faces with regard to telecommunications. Stated baldly, the article makes it clear that the future holds a return to integrated, but regulated, monopoly unless the monopoly bottleneck of local exchange can be opened by new technology. The possibilities for new technology to achieve this end lie mostly in developing new spectrum-based technologies that do not need an unbroken physical path. But the article is too succinct in describing the difficulties of achieving this end.

It is widely believed that the relatively recent "competitive era" in interstate telecommunications was forced by new technology. This view implies that the same could occur at the local level as well. Future historians of the events of the 1970s and 1980s, however, are likely to point out that it took both new technology and a more receptive regulatory climate for the market to be opened to new technology and competitive entry. Professor Noll passes by too quickly the enormous regulatory hurdles that await new local exchange technologies. These lie mostly at the federal level, despite its public procompetitive posture.

The article describes the behavior of the FCC as procompetitive and deregulatory toward the interstate arena, and accommodating towards the state regulators. This is one explanation of why the FCC has pushed competitive and somewhat deregulatory policies for things like terminal equipment and interstate toll services, while not using its spectrum allocation policies to aid in the development of a more competitive local exchange arena. An alternative hypothesis, however, is that regulators, including those at the FCC, have a very hard time disentangling technical claims about new technologies. As a result, local exchange companies-who have had the research facilities with the greatest reputation-have consistently persuaded the FCC to make spectrum allocations in ways that in fact ensure that the new services created cannot challenge the monopoly of the twisted wire pair. This is most clearly evident with cellular radio, where the technical specifications work to keep the costs higher than would be the case under an alternative cellular plan.

The same inability to sort out and choose among technical options that have the greatest potential for serving market structure goals almost certainly will render ineffective the article's suggestions for how to allow the BOCs back into services now proscribed. Noll suggests that a BOC should be allowed to enter now-forbidden markets if it can show that the service it proposes is unlike any offered by other firms; if there are significant economies in offering an integrated service; and if anticompetitive strategies are technically unfeasible or easily detected. The debate over voice storage and forwarding that led to the repeal of the separate subsidiary requirements for the BOCs is a sobering reminder of how effectively BOCs can use the inability of regulators to make sound policy judgments in the face of competing technical claims. The separate subsidiary requirements initially were imposed to make anti-competitive behavior either unfeasible or easily detected.

BOC claims that those requirements had prevented the public from receiving a technologically new and highly beneficial service caused their repeal. This occurred, moreover, despite serious argument that the service was not offered because there was no demand for it. Regulators will not be in a better position in the future than they are today to discriminate between valid assertions about the novelty or benefits from technological developments, or about the needs for waivers of any policies designed to thwart anticompetitive behavior as a precondition for enjoying those developments.

Only if the twisted pair is "untwisted," as the article urges, will competitive forces-and the heightened technological change that those forces encourage-continue to improve the telecommunications offerings available in the United States. The article is also right to call attention to the institutional problems that block the possible emergence of competitive technologies. Unfortunately the institutional forces opposing the steps that are necessary to untwist the pair are much stronger than the article reveals. Unless those forces can be countered, the outcome is almost certain to be a return to the past of regulated monopoly, with all of its inefficiencies.

Nina W. Cornell
Cornell, Pelcovits &
Brenner Economists inc.
Washington, DC

NOLL responds:

The two letters focus on the most problematic and controversial element of my article: that competition in local exchange services will not be made unfeasible by future technological developments. David Reed points out that this rosy view of future technical developments may be unnecessary, for if natural monopoly is present, it is likely to be confined to the conduits connecting customers to the local central office switch. If open network architecture becomes a reality, others can enter to compete with local telephone companies for all switched and information services. If it does not work, Reed's proposal seems to lead to a truly Draconian line-of-business restriction: BOCs get to own the conduit connecting customers to the central office switch, but nothing more! In either case, two conforming regulatory moves are required: unbundling local access charges to separate local loops from central office switches, and permitting entry into literally everything provided by local telephone companies (except the local loop).

The logic of Nina Cornell's argument is a bucket of cold water on David Reed's proposal. She correctly points out that local telephone companies possess important informational advantages in regulatory proceedings, and hypothesizes that the differences between state and federal regulatory policies arise in part for this reason. Both federal and state regulators are prone to give too much to the BOCs in terms of restrictions against competition and relaxation of line-of-business restrictions because they are unduly impressed by the BOCs' promises regarding new technologies.

There is much to recommend this hypothesis. Administrative procedures do advantage participants who possess superior information.

And the history of federal regulation of AT&T provides some good examples to support Cornell's pessimistic prediction. For example, AT&T succeeded in convincing the Federal Communications Commission that "foreign attachments" (that is, customer equipment not manufactured and owned b AT&T) threatened the "systemic integrity" of the national telecommunications network, a claim subsequently disputed by the company's own engineers.

Nonetheless, I am not as pessimistic. First, AT&T lost, despite its far superior technical knowledge. In the 1990s and beyond, failing a backslide into regulated monopoly, AT&T will have to test the validity of its technological visions in the marketplace-where such tests belong-rather than before judges and regulators. Second, the BOCs do not possess the informational advantage that AT&T enjoyed prior to the 1970s. Indeed, AT&T is poised to fight vigorously the reintegration of the BOCs, and despite dire predivestiture predictions, Bell Labs remains a formidable repository of technological sophistication.

Third, if the BOCs win in the short run on largely specious technological grounds and, as a result, invest in a range of economically unwarranted technologies, regulators eventually will notice as the companies ask for ever-higher basic exchange prices. It is reasonable to expect that this will cause a backlash, just as AT&T's ventures into random orbit satellites, picture phones, and foreign attachment interfaces caused a backlash two decades ago. Fourth, the BOCs themselves may tire of regulated monopoly, and use their technological advantages to encourage competition for the purpose of escaping the yoke of regulation. For this to occur, of course, regulators must give them the incentive to behave in this way. The point of my proposal, linking relaxation of line-of-business restrictions to procompetitive actions by BOCs and state regulators, is to create these incentives.

Roger G. Noll
Professor of Economics
Stanford University
Stanford, CA

Subscribe to Regulation