Tag: minimum wage

Misconceptions of the Efficiency Wage Hypothesis

In an otherwise largely fair write-up of the disagreements and controversies surrounding the economics of minimum wage laws, a blog I was cited in yesterday made a common error in discussing the so-called “efficiency wage hypothesis.” Here’s the extract (my emphasis):

But if employers have monopsony power (they have enough market power to influence the wage rate in their industry) then the impact of a minimum wage is to raise employment (up to a point). Furthermore, the efficiency wage theory suggests that a minimum wage could help raise employment by increasing productivity and lowering turnover.

This last sentence is a misreading of economic theory.

Many do claim that higher minimum wages can lead firms and workers to improve productivity in ways that avoid job losses, whether that be through more worker effort, less staff turnover or whatever. And there’s no doubt that in some cases, firms and workers adjust in this way.

But the efficiency wage theory itself is actually a market failure theory of unemployment. It does not suggest that raising the minimum wage could increase employment. It suggests that in certain sectors where the costs of replacing labor are high, firms pay above market wages out of fear that lowering them would reduce their workers’ productivity substantially. The consequence is that the specific sectoral labor market does not clear, resulting in at best excess supply of workers in that sector (who subsequently have to find employment in other sectors at lower wages) or at worst more unemployment in the economy as a whole.

Economics 101 Still Works

The economist Herbert Stein, chairman of the Council of Economic Advisors under Richard Nixon, once quipped,

Most of the economics that is usable for advising is at about the level of the introductory undergraduate course.

One lesson from such courses is that minimum wage laws reduce employment, so this is reassuring:

I critically review the recent findings regarding the effects of minimum wages on employment. Contrary to often asserted statements, the preponderance of the evidence still points toward a negative impact of permanently high minimum wages.

From Jesus Fernandez-Villaverde at the University of Pennsylvana.

Minimum Wages and Bad Use of Terminology

A news story today leads with the headline “Minimum-wage hikes could deepen shortage of health aides” (h/t David Boaz). The key section (reported on ABC News):

It’s a national problem advocates say could get worse in New York because of a phased-in, $15-an-hour minimum wage that will be statewide by 2021, pushing notoriously poorly paid health aides into other jobs, in retail or fast food, that don’t involve hours of training and the pressure of keeping someone else alive.

Contained within this story is some bad economic reasoning and terminology but also an interesting, but rarely discussed, effect of minimum wages.

First, the mistake. Take the headline. The basic economics of the minimum wage tells us the raising the statutory price of labor above some equilibrium will lead to a reduction in the quantity of labor demanded. But it also says there will be an increase in the quantity of labor supplied. Far from causing a “shortage” of health aides then, raising the minimum wage leads to a surplus of labor. Raising the pay rate increases the return to working in the industry relative to being on welfare, and presuming budgets are unchanged (the article explains that most home care is paid by government programs), the quantity demanded falls at the same time. The gap that arises is precisely the “unemployment effect.”

It’s not clear then why raising a minimum wage would lead to fewer people seeking to be home care or health aides. Assuming demand is fixed, it would lead to fewer people being health care aides or health care aides being less available (shorter working hours etc). Yet that is not what the article claims—it suggests supply of available workers is falling, despite the pay-off to the job increasing.

What’s the point that the article is getting at then? It can be the case that raising a minimum wage changes wage rate differentials between industries. The article states that the average home care wage is about $11 per hour, whereas a quick Google search suggests many low-paid retail and fast food jobs may pay less than that in certain regions. If a hypothetical fast food job would pay $9 per hour in a free market and a home care job $11 per hour, then raising the statutory minimum to $15 can eliminate the differential. This makes fast food jobs more attractive on the margin, particularly given the home care training, and could mean the relative supply of workers increases in these industries compared to home care.

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.

Workers Will Get a Raise Today — or Will They?

The legal minimum wage will increase in 20 states today. The Wall Street Journal news story on that fact starts out accurately enough:

Minimum wages will increase in 20 states at the start of the year, a shift that will lift pay for millions of individuals and shed light on a long-running debate about whether mandated pay increases at the bottom do more harm or good for workers.

But it quickly segues into the same error that afflicts most such stories:

In California, the minimum goes up 50 cents, to $10.50 an hour, boosting pay for 1.7 million individuals.

Wages are also going up in many Republican-led states, where politicians have traditionally been skeptical of the benefits of minimum-wage increases.

In Arizona, one out of every nine workers is slated to receive a wage increase….So will tens of thousands of workers in Arkansas, Michigan and Ohio….

In all, about 4.4 million low-wage workers across the country are slated to receive a raise because they earn less than the new minimum in their respective states.

Every one of those sentences assumes facts not in evidence. What these new laws do is ensure that no worker can be paid less than a statutory minimum. They cannot ensure that every worker with a minimum-wage job will still have one if his employer required to pay more. They won’t prevent employers from replacing labor with technology, such as these McDonald’s order-taking kiosks. McDonald's kiosk

The Journal isn’t alone, of course. Here’s the Associated Press lead:

It will be a happy New Year indeed for millions of the lowest-paid U.S. workers. 

And CBS:

Millions will ring in the new year – with a raise. The minimum wage is going up in 20 states and Washington, D.C. as well.

And a Washington Post headline:

There’s some really good news for low-wage workers this weekend

What all these chipper stories fail to take into account is the possibility that some low-wage workers will lose their jobs because their work just isn’t worth the new minimum wage or the employer can’t be profitable with higher costs. There’s abundant evidence that higher minimum wage laws reduce employment, especially among young and minority workers. If only Journal reporter Eric Morath had read this op-ed headline in the Journal a year ago:

The Evidence Is Piling Up That Higher Minimum Wages Kill Jobs

Economist David Neumark, perhaps the leading student of the effects of minimum wage laws, wrote:

Economists have written scores of papers on the topic dating back 100 years, and the vast majority of these studies point to job losses for the least-skilled. They are based on fundamental economic reasoning—that when you raise the price of something, in this case labor, less of it will be demanded, or in this case hired. 

Among the many studies supporting this conclusion is one completed earlier this year by Texas A&M’s Jonathan Meer and MIT’s Jeremy West, which reaffirmed that “the minimum wage reduces job growth over a period of several years” and that “industries that tend to have a higher concentration of low-wage jobs show more deleterious effects on job growth from higher minimum wages.”

The broader research confirms this. An extensive survey of decades of minimum-wage research, published by William Wascher of the Federal Reserve Board and me in a 2008 book titled “Minimum Wages,” generally found a 1% or 2% reduction for teenage or very low-skill employment for each 10% minimum-wage increase.

I hope these stories will prove accurate, that millions of low-wage workers will get higher wages and that the new minimum wage rates will not reduce the growth in jobs that Americans need. But I’d have to shut my eyes to economic theory and empirical evidence to believe that. In fact, you’d pretty much have to be an economics denier to believe that a mandated increase in the price of labor won’t reduce the amount of labor demanded.

 

Two Minimum Wage Charts for Andy Puzder

Donald Trump has tabbed Andy Puzder to lead the Department of Labor. Puzder is the CEO of CKE, the restaurant outfit (read: Hardee’s and Carl’s Jr.). CKE, thanks to Puzder saving it from the bankruptcy hammer, employs 75,000 workers (read: jobs). Puzder knows that “high” minimum wages, such as the $15 per hour one thrown around by progressives, is a job killer for low-skill workers.

During his nomination hearings, Andy Puzder will no doubt be grilled about his views on “high” minimum wages. His inquisitors will trot out glowing claims about the wonders of a $15 per hour minimum wage, as did President Obama in his 2014 State of the Union address. As the President put it: “It’s good for the economy; it’s good for America.” Not so fast.

The glowing claims about minimum wage laws don’t pass the most basic economic smell tests. Just look at the data from Europe. The following two charts tell the tale and should be tucked into Andy Puzder’s briefing portfolio.

There are six European Union (E.U.) countries in which no minimum wage is mandated (Austria, Cyprus, Denmark, Finland, Italy, and Sweden). If we compare the levels of unemployment in these countries with E.U. countries that impose a minimum wage, the results are clear. A minimum wage leads to higher levels of unemployment. In the 21 countries with a minimum wage, the average country has an unemployment rate of 11.8%. Whereas, the average unemployment rate in the seven countries without mandated minimum wages is about one third lower — at 7.9%.

Seattle’s Minimum Wage Increase: Sky Is Not Falling Yet, but “Ambiguous” Effects for Low-Wage Workers Due to Negative Unintended Consequences

The debate over the Seattle experiment has generated more heat than light to this point. A new report from Jacob Vigdor and his colleagues at the University of Washington attempts to shed some light on the effects of the first incremental stage of the increase. They use data from the state’s Employment Security Department from when the law was passed through the fourth quarter of 2015, at which point the minimum wage stood at $11 per hour. This does not include the second stage of increases that took place January 1, 2016, or the further increases that will eventually bring it to $15 per hour and much higher thereafter. The early results show the mixed effects of the first incremental increase, there does not appear to be much evidence of firms being driven out of business, and some low-wage workers have seen their hourly wage increase, it also reduced the employment rate and hours, with the end result for these low-wage workers being “ambiguous and likely fairly small.”

The report only analyzes the first initial stage of the scheduled minimum wage increases, as the authors note and as illustrated in Figure 1. In addition, due to the timing of the study, it can only capture the short-run effects of this first incremental increase. As such, this analysis cannot provide insight into the impact of future additional increases to the minimum wage or what the longer-run effects might be.

Pages