Tag: productivity

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.

The Rationale for Minimum Wage Increases

This morning I gave oral testimony to the Vermont Senate Economic Committee on their proposal to raise the state minimum wage to $15 an hour by 2024. As part of my written evidence, I explored in detail the rationale for minimum wage hikes from the “Fight for $15” campaigners and other think-tanks. Below is a slightly edited version of that section of my testimony, which has wider applicability.

Theoretically, a minimum wage hike can improve the functioning of a labor market when employers are “monopsonistic.” When firms have significant labor market power over employees, raising a wage floor can increase both pay for workers and employment levels. Some economists have argued that most firms do have a slight degree of monopsony power over their employees. This suggests a modest minimum wage can, in some cases, actually improve economic efficiency, ending so-called “exploitative” low wage rates without reducing employment.

But those advocating minimum wage hikes across America today do not use this economic line of argument. Bureau of Labor Statistics data shows 84 percent of employees paid at or below the federal minimum wage work for businesses in retail, leisure and hospitality, and education and health services. These industries do not tend to be characterized by powerful companies which dominate local labor markets. The theoretical economic case for minimum wage hikes to solve “market failures” is therefore weak.

Instead, proponents of higher minimum wages assert that legislation should deliver some target level for minimum hourly wages to fulfill other objectives. Their rationale is really about giving minimum wage earners more money. And they use a host of metrics to show that, currently, minimum wage earners are just not being paid enough.

But what should determine where the minimum wage level is set? Ideas seemingly differ across $15 wage proponents. Some implicitly argue that minimum wages should be set to cover certain essential living costs. Democratic presidential primary candidate Elizabeth Warren, for example, suggested this when she claimed:

When I was a kid, a minimum wage job in America would support a family of three. It would pay a mortgage, keep the utilities on and put food on the table. Today, a minimum-wage job in America will not keep a mama and a baby out of poverty.

Others prefer different metrics. In testimony to this committee, David Cooper of the Economic Policy Institute documented extensively how current minimum wage rates had not “kept up” with average wages or economy-wide productivity levels, and did not provide incomes for full-time workers to cross certain poverty thresholds.

None of these claims are disputable as facts. But I want to suggest that those metrics are not appropriate for judging what the Vermont minimum wage should be. Devoid of broader context, they are misleading and might lead to damaging policy conclusions.

Cost of living: It’s important to remember that employers pay employees for the perceived value of the work undertaken, not to compensate workers for their rent, food, energy, transport, clothes or child-care bills (which will differ hugely by family and are beyond employers’ control).

High living costs are a very under-discussed cause of economic hardship. My own research has found typical poor American households face higher prices on essential goods and services due to misguided interventions and regulations that cost them between $800 and $3,500 in total per year.

Rather than tackle the causes of these high prices, minimum wage hike campaigners want businesses to bear the cost of compensating workers for their living expenses. This is not economically sensible. Putting the full burden of the cost of living on shareholders and customers of low wage employers, divorcing pay rates from the work employees undertake, market conditions, and firms’ ability to pay, could risk a significant diminution in low wage job opportunities.

Productivity: Economy-wide labor productivity has risen faster than minimum wage rates over the last fifty years. Given productivity changes should affect worker total compensation levels, $15 wage campaigners imply that minimum wage workers are being paid below what their productivity commands.

But comparing productivity gains of all workers to speculate what hourly wage rates should be for minimum wage workers alone is misguided. After all, different industries experience different productivity growth rates over time.

Sadly, a productivity growth series solely for minimum wage workers is not available. But long-term data for the food services industry might be a reasonable proxy. Bureau of Labor Statistics data show that from 1987 to 2017, labor productivity in the food service sector rose by an average of just 0.4 percent per year (with unit labor costs increasing by 3.2 percent per year). If the minimum wage had been pegged to this productivity measure, it would have increased by 13 percent in real terms – from $7.16 in 1987 (2017 dollars) to $8.06 in 2017.

The actual 2017 federal minimum was, of course, $7.25 in 2017 and the Vermont minimum wage was $10. Using this productivity series and start date then, the Vermont minimum wage is now higher than justified by food service productivity improvements since 1987.

This does not prove that Vermont minimum wage rate increases have exceeded the productivity growth of all minimum wage employees, nor does it tell us what the minimum wage level should be according to this measure (given the necessary arbitrary start date). But it does show the danger of making spurious comparisons between economy-wide productivity and minimum wage rates. Pegging minimum wage rates to aggregate productivity trends might lead us to deliver much higher wage floors than justified by the productivity of workers in certain sectors, causing significant job losses or other adjustments.

Poverty: A stated ambition of $15 minimum wage advocates is to lift households above poverty thresholds. Minimum wage hikes can achieve this by raising incomes for minimum wage earners. Yet poverty is measured at the household level. The very reason why minimum wages were not used as a primary tool to reduce poverty for households in recent decades is that they were not considered particularly well targeted or effective.

First, people who earn around the minimum wage are often not from poor households. In 2014, the economist Joseph Sabia estimated just 13 percent of workers on hourly rates between $7.25 and $10.10 lived in households below the poverty line. Many people earning around the current minimum wage rate are second earners (particularly part-time) or young people who live in households with parents not in poverty. Second, minimum wage hikes could have adverse consequences on employment prospects by raising business costs.

That’s why economists have long concluded that in-work income transfers to families with children through programs such as the earned income tax credit (EITC) are better targeted at reducing poverty. Many believe they are preferable to minimum wages as a poverty reduction policy, because they encourage work while boosting incomes of poor households, rather than discouraging employers from hiring (though they come with other problems).

Yet poverty thresholds themselves ignore the EITC and other transfers that have expanded in recent decades. Comparing the income for a full-time minimum wage earner to poverty thresholds is therefore very misleading on the living standards many households actually enjoy.

In short, the metrics that $15 minimum wage advocates use to make the case for substantial hikes are not economically sensible benchmarks. For all the noise and economics-y language of their arguments, economists generally oppose manipulating prices to obtain social policy objectives.

Your focus in considering this policy proposal should center instead on traditional labor market economics.

Changing the legislated minimum wage affects both:

1)   the incomes of minimum wage workers who maintain their jobs and hours

2)   the number of jobs and hours of work employers demand, and broader working conditions, due to the change in business costs.

Standard economics tells us that, in most cases, raising the minimum wage will boost 1) and reduce 2). What becomes crucial then is considering the potential size of these two effects and judging their importance to achieving your objectives. The first requires drawing on economic evidence. The latter is more a question of philosophy.

 

Why Do We Pay So Much More for No Progress?

That is the question asked by Scott Alexander and John Cochrane in discussing high school education, college and infrastructure spending. Despite rising funding, it is not clear outcomes are improving.

Scott highlights the example of K-through-12 public education where spending has increased substantially since 1970 but test scores have remained stagnant. He asks:

Which would you prefer? Sending your child to a 2016 school? Or sending your child to a 1975 school, and getting a check for $5,000 every year?

On college he presents a similar counterfactual:

Would you rather graduate from a modern college, or graduate from a college more like the one your parents went to, plus get a check for $72,000?  (or, more realistically, have $72,000 less in student loans to pay off)

He also highlights the rising cost of infrastructure spending through the example of a New York City subway:

1900…it’s about the inflation-adjusted equivalent of $100 million/kilometer today… In contrast…a new New York subway line being opened this year costs about $2.2 billion per kilometer

As Scott outlines, the underlying crisis here is made all the worse by the fact that new technologies and globalization should have put downward pressure on the costs of provision.

Two questions arise: why is this happening and what can be done about it?

This requires a huge amount of research. Certainly it cannot be answered in a blog post. But I want to suggest an analytical framework for thinking about these examples that can be applied in each case to work out what is going wrong. This is all the more necessary because the absence of meaningful prices in the public sector makes measuring productivity much more difficult than in the full market sector of the economy.

Rather than merely comparing money spent to outcomes, we can break things down as follows:

Taxpayer dollars -> Inputs -> Production process -> Outputs -> Outcomes (quality-adjusted outputs)

Take schooling. We pay money in through taxes.  These are used to fund the labor (teachers, administrators etc), to build schools, and to pay for the goods and services used within schools. The schools then operate. And those inputs work to produce measurable outputs in terms of number of children being taught, hours of teaching, exams prepared for etc. But what we really care about is outcomes, which are linked to but not quite the same thing (think test scores). This is best thought of as a measure of quality-adjusted output. Productivity (to the extent we can measure it) can be thought of as the ratio of outputs to inputs, whereas what we ultimately care about here is improving the effectiveness of money spent (outcomes over taxpayer dollars).

A Wall Street Journal Column Understates the Size of U.S. Manufacturing

The Wall Street Journal’s December 1 “Ahead of the Tape” column, by Kelly Evans, says “manufacturing is a relatively small part of the economy; It employs about 9% of the work force and accounts for about the same percentage of GDP.” Actually, manufacturing accounts for about 12 percent of nominal GDP.  But that, too, is misleading.  

Chicago Fed economist William Strauss explains why neither U.S. manufacturing’s share of employment nor its share of GDP captures the actual strength of manufacturing:

Between 1950 and 2007 (prior to the severe recession), manufacturing output was just over 600% higher while over the same period growth in real GDP of the U.S. was only a slightly lesser 560%. Yet, the manufacturing share of GDP declined markedly over this period as measured in current dollar value of output. In 1950, the manufacturing share of the U.S. economy amounted to 27% of nominal GDP, but by 2007 it had fallen to 12.1%. How did a sector that experienced growth at a faster pace than the overall economy become a smaller part of the overall economy? The answer again is productivity growth. The greater efficiency of the manufacturing sector afforded either a slower price increase or an outright decline in the prices of this sector’s goods. As one example, inflation (as measured by the Consumer Price Index) averaged 3.7% between 1980 and 2009, while at the same time the rise in prices for new vehicles averaged 1.7%. So while the number (and quality) of manufactured goods had been rising over time, their relative value compared with the output of other sectors did not keep pace. This allowed manufactured goods to be less costly to consumers and led to the manufacturing sector’s declining share of GDP.

Those who imagine “we don’t make anything anymore,” as Donald Trump claims, don’t grasp the magnitude of America’s industrial productivity gains.

In reality, the U.S. is by far the world’s largest manufacturer, with China trailing by 22 percent according to U.N. data for 2008 and arguably much more when we’re not in recession.

The GM ‘Turnaround’ in Bastiat’s View

GM’s long-rumored initial public stock offering will take place Thursday and self-anointed savior of the U.S. auto industry, Steven Rattner, is pretty bullish about the prospect of investors turning out in droves. 

I’ve been saying for a while that I thought the government’s exposure [euphemism for taxpayer losses] in the auto bailout was in the $10-billion to $20-billion range.

But since investor interest has pushed the initial price up from the $26-to-$29 per share range to the $32-$33 range, Rattner now believes:

[T]his exposure is in the single-digit billion range, and arguably potentially better.

I won’t argue with Rattner’s numbers.  After all, they affirm one of my many criticisms of the bailout: that taxpayers would never recoup the value of their “investment.”  My bigger problem is with Rattner’s cavalier disregard for the other enduring—and arguably more significant—costs of the auto bailouts.

Rattner is like the foil in Frederic Bastiat’s excellent, but not-famous-enough, 1850 parable, That Which is Seen and That Which is Unseen.    Rattner touts what is seen, namely that GM and Chrysler still exist.  And they exist because of his and his colleagues’ commitment to a plan to ensure their survival, along with the hundreds of thousands (if not millions, as some “estimates” had it) of jobs that were imperiled had those companies vanished.  (For starters, I very much question even what is seen here. I am skeptical of the counterfactual that GM and Chrysler would have disappeared and that there would have been significantly more job loss in the industry than there actually was during the recession and restructuring.  But I’ll grant his view of what is seen because, frankly, the specifics are irrelevant in the final analysis).

For what is seen, Rattner admirably admits of a cost.  And that cost is not insignificant.  It is anywhere from $65 billion to $82 billion (the range of the cost of the bailout) minus what is being paid back and what investors are willing to pay for GM shares—in the “single-digit billion range,” as Rattner says.  But Rattner is willing to stand by that trade-off, claiming his efforts and the billions in “government exposure” were a small price to pay for saving the U.S. auto industry, as it were.  It’s merely a difference in philosophy or compassion that animates bailout critics, according to this position.

No.  Not so fast.  All along (quite contemptuously in this op-ed, which I criticized here) Rattner has been unwilling to acknowledge the costs that are unseen.  Those unseen costs include:

  • the added uncertainty that pervades the private sector and assigns higher risks and thus higher costs to investing and hiring (whom might government favor or punish next?);
  • the diversion of resources from productive to political purposes in the business community (instead of buying that machinery to churn out better or more lawn mower engines, better to hire lobbyists to keep Washington apprised of how important we are or how this or that policy might be beneficial to the national employment picture!);
  • excessive risk-taking and other uneconomic behavior that falls under the rubric of moral hazard from entities that might consider themselves too-big-to-fail (perhaps, even, the New GM!);
  • growing aversion to—and rising cost of—corporate debt (don’t forget what happened to Chrysler’s “preferred” bondholders in the bankruptcy process!);
  • the sales and market share that should have gone to Ford or Honda or VW as part of the evolutionary market process;
  • the fruitful R&D expenditures of those more disciplined companies;
  • the expansion of job opportunities at those companies and their suppliers;
  • productivity gains passed on to workers in the form of higher wages or to consumers as lower prices;
  • the diminution of the credibility needed to discourage foreign governments from meddling in markets, often to the detriment of U.S. enterprises.

 The list goes on.

 Yet, Rattner, seemingly oblivious to the fact that the economy remains stuck in the mire, speaks triumphantly of the successful auto bailout.  But nobody ever doubted that taxpayer resources in the hands of policymakers willing to push the bounds of legality could “rescue” GM from a fate it deserved.  The concern was that policymakers would do just that, leaving behind wreckage to our institutions not immediately discernible.  But anemic economic activity, 9.6 percent unemployment, and a private sector unwilling to invest is pretty darn discernible at this point.

Rattner should take off the tails, put down the champagne flute, and acknowledge what was originally unseen.

The USPS’s ‘Automation Refugees’

Jim O’Brien, a vice-president at Time Inc. and chairman of the Mailers Council, recently guest-blogged on the U.S. Postal Service’s inspector general’s web site on the subject of “automation refugees.”

O’Brien explains the origination of the term:

Back in 1990, Halstein Stralberg coined the term “automation refugees” to describe Postal Service mail processing employees who were assigned to manual operations when automation eliminated the work they had been doing. Since the Postal Service couldn’t lay off these employees, they had to be given something to do, and manual processing seemed to have an inexhaustible capacity to absorb employees by the simple expedient of reducing its productivity. The result was a sharp decline in mail processing productivity and a sharp increase in mail processing costs for Periodicals class. Periodicals class cost coverage has declined steadily since that time.

O’Brien then tells of visiting seventeen mail processing facilities as part of a Joint Mail Processing Task Force in 1998. During those visits he noted that the periodical sorting machines always happened to be down even though the machines were supposed to be operating seventeen hours a day. Although the machines weren’t working, manual operations were always up and running.

A decade later, O’Brien points out that the situation apparently hasn’t changed:

More Periodicals mail is manually processed than ever, and manual productivity continues to decline. Periodicals Class now only covers 75% of its costs. How can this dismal pattern of declining productivity and rising costs continue more than two decades after it was first identified, especially when the Postal Service has invested millions of dollars in flats automation equipment?

O’Brien probably answered this question when he noted that the USPS couldn’t lay off these automation refugees back in 1990.

As I’ve discussed before, the USPS has a major union problem. A new Government Accountability Office report cites as a problem the fact that most postal employees are protected by “no-layoff” provisions. The USPS must also let go lower-cost part-time and temporary employees before it can lay off a full-time worker not covered by a no-layoff provision.

Unfortunately, recent comments from members of the House Oversight and Government Reform Committee showed an unjustified concern for how potential reforms would affect postal employees. Labor isn’t the only problem facing the USPS, but Congress needs to understand that the postal service’s expensive unionized workforce is a crippling burden.

Six Reasons to Downsize the Federal Government

1. Additional federal spending transfers resources from the more productive private sector to the less productive public sector of the economy. The bulk of federal spending goes toward subsidies and benefit payments, which generally do not enhance economic productivity. With lower productivity, average American incomes will fall.

2. As federal spending rises, it creates pressure to raise taxes now and in the future. Higher taxes reduce incentives for productive activities such as working, saving, investing, and starting businesses. Higher taxes also increase incentives to engage in unproductive activities such as tax avoidance.

3. Much federal spending is wasteful and many federal programs are mismanaged. Cost overruns, fraud and abuse, and other bureaucratic failures are endemic in many agencies. It’s true that failures also occur in the private sector, but they are weeded out by competition, bankruptcy, and other market forces. We need to similarly weed out government failures.

4. Federal programs often benefit special interest groups while harming the broader interests of the general public. How is that possible in a democracy? The answer is that logrolling or horse-trading in Congress allows programs to be enacted even though they are only favored by minorities of legislators and voters. One solution is to impose a legal or constitutional cap on the overall federal budget to force politicians to make spending trade-offs.

5. Many federal programs cause active damage to society, in addition to the damage caused by the higher taxes needed to fund them. Programs usually distort markets and they sometimes cause social and environmental damage. Some examples are housing subsidies that helped to cause the financial crises, welfare programs that have created dependency, and farm subsidies that have harmed the environment.

6. The expansion of the federal government in recent decades runs counter to the American tradition of federalism. Federal functions should be “few and defined” in James Madison’s words, with most government activities left to the states. The explosion in federal aid to the states since the 1960s has strangled diversity and innovation in state governments because aid has been accompanied by a mass of one-size-fits-all regulations.

For more, see DownsizingGovernment.org.