Other “Channels Of Adjustment” To Minimum Wage Hikes

The “Fight for $15” scored a victory Monday as New Jersey Governor Phil Murphy signed legislation for the state to hit a $15 per hour minimum wage target by 2024. Vermont is considering similar legislation, and I testified to their Senate Economic Committee about the proposal on Tuesday.

Earlier this week I wrote on the bad arguments used to justify such policies. But in my written evidence for Vermont I also discussed the consequences.

There’s been a long back-and-forth about the impacts of minimum wages on jobs and hours, which I shan’t repeat here. But I also tried to address advocates’ insistence that other “channels of adjustment” exist, meaning employment levels or hours might not fall.

This is true – every business affected will react differently, depending on their industry, business model, staffing practices or ability to pass increased costs onto consumers.

But the key point is this: unless we presume there is currently monopsony power wielded by companies, or firms are passing up profit-enhancing opportunities that would come from boosting pay,  these other adjustments are not costless.

It’s tempting when advocating policy to engage in motivated reasoning, claiming there are no trade-offs from minimum wage hikes and imagining everyone will benefit. In the case of increasing the minimum wage to $15, this is wishful thinking.

1)   Improved productivity

It’s sometimes said businesses can cope by taking steps to improve productivity to maintain their profitability. But improving worker productivity itself is costly.

Boosting productivity might require replacing inexperienced low-skilled employees with more experienced, higher productivity employees. This comes with search and turnover costs in the short-term and reduces opportunities for low-skilled workers in the longer-term. We know this can have a scarring effect on young workers, who lose entry-level job opportunities that provide basic skills and habits, including punctuality, and dealing with customers and colleagues. David Neumark and Olena Nizalova found that, even their late 20s, workers who had been exposed to high minimum wages when they were younger worked less and earned less. This effect was especially strong for blacks.

“Improving productivity” might instead entail putting pressure on workers to produce more, cutting their hours so they are more productive in hours they do work, or cutting back on side perks and benefits. These amount to a worsening of the work environment for employees, offsetting some of the gains from the wage increase.

Higher minimum wages might also deliver higher productivity by encouraging the automation of low-skilled jobs. In the past decade we have seen the proliferation of supermarket checkout machines, iPads to order food in restaurants or fast-food outlets, and the use of apps to replace human employees for checking in for flights, ordering tickets and other activities. Shake Shack in New York, preempting the minimum wage hike, trialed a largely staff-free restaurant. Some fast-food outlets are even exploring the possibility of burger-making machines.

Of course, some of these trends represent pure, cost-effective free-market innovation. But continually raising the minimum wage incentivizes labor-saving capital investments, acting like a subsidy to automation. Based on data from 1980-2015, economists Grace Lordan and David Neumark found “that increasing the minimum wage decreases significantly the share of automatable employment held by low-skilled workers, and increases the likelihood that low-skilled workers in automatable jobs become nonemployed or employed in worse jobs.” The effects were particularly damaging for older workers previously in manufacturing jobs.

2)   Firms taking the hit to profits

Some claim companies will just have to take a hit to profits. No doubt some firms will accept a worse bottom line in the short-term, and perhaps adjust their hiring plans on a forward-looking basis. Others might see a permanent fall in profitability if they are in more concentrated markets. But lower profit rates discourage firms from entering markets, or cause some existing firms to close, especially those with razor thin margins. If you do not believe this, it is difficult to claim you believe in capitalism.

3)   Boosts to consumer spending

$15 minimum wage proponents sometimes claim that low-paid workers’ propensity to spend additional earnings means minimum wage hikes boost demand and raise the level of GDP, benefiting the broader economy. But this ignores contractionary impacts from lower profits reducing investment, higher prices reducing other spending or reduced employment opportunities cutting some people’s incomes. Standard economic theories suggest that, overall, increasing a price floor brings more distortions to the economy. An overwhelming majority of economists (69% to 4%) disagree with the idea that a $15 minimum wage would substantially boost aggregate economic output.

4)  Reduced turnover

By raising the minimum wage rate, it is claimed, firms will benefit from reduced staff turnover, with happier and more productive employees. But if this were a net benefit to the firm, wouldn’t they be raising wage rates already? That some firms do, and observe benefits, does not mean you can generalize that effect to the whole economy. It is also unclear why it is assumed reduced turnover would be good for productivity at an economy-wide level. The higher wage for low-skilled workers might reduce the incentive, on the margin, to leave the company for better positions or to seek promotion or invest in human capital, especially if there is wage compression. This could reduce economy-wide measured productivity over time.

In short, not all firms will adjust to higher minimum wages by cutting back the number of jobs or hours of employment. But other reactions to minimum wage hikes are not costless. Absent monopsony power or employers misestimating the best wage to incentivize workers, there is no free lunch.