January 27, 2017 3:15PM

The Curse of Motivated Reasoning against Econ 101

Earlier this month, James Kwak penned an extensive critique for The Atlantic of the Econ 101 view that government-imposed minimum wage rates lead to job losses. There is a lot of muddled thinking in the article, not least that it constantly conflates poverty and inequality. But for the sake of brevity, here are 9 observations:

  1. The theoretical and empirical literature does suggest the minimum wage question is more complex than first imagined, and it should not surprise us that reality lies somewhere between the perfectly competitive model of the labor market and the monopsonistic one, depending on the time and sector analyzed.
  2. However, the bulk of the detailed empirical literature still supports Econ 101’s prediction that raising wages by government dictat reduces labor demand, particularly for certain groups (the young and lowest skilled). Of course, the “bite” of the minimum wage is significant. That an increase from $7.25 to $8 may not have a large effect on the labor market does not mean that a rise to $15 wouldn’t have a much bigger effect.
  3. Reductions in labor demand need not mean higher unemployment per se (and so tracking time series of unemployment against minimum wage rates is unhelpful.) It may affect hours offered, lower the quality of jobs as firms cut back on financing training, or lead to cuts to other employee benefits. More recent evidence also stresses the dynamism of the labor market – minimum wage hikes may not manifest themselves through immediate job cuts (not least because of redundancy costs and stickiness of contracts/orders), but can lower the propensity to hire in future and hence slow job growth.

  4. Kwak’s explanations for why Econ 101 might be wrong seem like motivated reasoning. One potential explanation is that firms in sectors affected by the minimum wage have significant market power. If a firm is a monopsonist, then theoretically you can increase both wages and employment by raising the minimum wage. In reality the days of the so-called ‘company town’ are over. Looking at the industries in which most minimum wage workers actually operate: food preparation, serving, sales, personal care and office support and administration – does anyone think these aren’t very competitive industries?
  5. Kwak uses Keynesian logic to claim that low paid workers’ higher marginal propensity to consume means minimum wages can boost demand in the economy. Of course, this ignores any contractionary effects arising from lower profits, higher prices or reduced employment. It’s worth noting Keynesian theories are also predicated on the idea that market wage rigidities are precisely what leads to unemployment when an economy contracts (so it’s difficult to see why that would be any different with state-imposed rigidities).
  6. Another argument outlined is that minimum wage hikes can improve productivity. It is said that firms paying more can reduce employee turnover and attract higher skilled workers. This is a variant of the ‘efficiency wage hypothesis.’ But the efficiency wage hypothesis is precisely a theory of persistent unemployment! Even in that theory, much of the productivity gains that firms can theoretically get from paying higher wages occur from being able to hire the best workers in an industry. If *every* firm is mandated to pay a higher wage, then these gains are lost, and so the line of argument cannot be generalized to the whole economy.
  7. The hurdle in assuming there is some form of free lunch that firms are not exploiting is that a government setting a minimum wage must know more about the potential productivity of individual firms’ workers than the firms themselves. Even if this were true, which is highly doubtful, it need not be the case that setting a minimum wage to reduce turnover would be good for economy-wide productivity. A higher wage in certain sectors might reduce the incentive for workers to move to higher-skilled, higher-paying sectors over time by building or investing in human capital – actually lowering the productive potential of the economy in the long-term.
  8. Kwak writes: “Even if a higher minimum wage does cause some people to lose their jobs, that cost has to be balanced against the benefit of greater earnings for other low-income workers.” This is undoubtedly true, but in the rest of the article he seems to really judge the morals of those who seek to protect the rights and opportunities of low-skilled individuals. If he and other advocates want to advocate for significant minimum wage increases, he also has to own the estimated 500,000 low skilled workers on the scrap heap from raising the minimum wage to $10.10. This might be uncomfortable, but then the minimum wage has uncomfortable roots – with UK Fabians desiring it precisely to exclude the low-skilled, disabled and migrants from working.
  9. Finally, despite repeated allusion to the idea that raising the minimum wage would be a good way of reducing poverty, Kwak produces scant evidence to that effect. Joseph Sabia’s work – reported in a Cato bulletin – actually suggests that minimum wages are a badly targeted anti-poverty policy. He found workers earning between $7.25 and $10.10 per hour overwhelmingly live in non-poor households (the unit by which we measure poverty). In fact, only 13 percent of those affected lived in poor households, while nearly two-thirds lived in households with incomes over twice the poverty line. In other words, many people earning slightly above the current minimum wage may be second earners (particularly part-time) or young people who live in households where total household income is above the poverty line.