Tag: small business

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.

Pro-business? Wilbur Ross Channels Hillary Clinton

On Wednesday members of the Senate Finance Committee questioned Secretary of Commerce Wilbur Ross about the costs to American businesses of the administration’s tariffs. Ross was unsympathetic:

When Thune warned that the drop in soybean prices (caused by China’s retaliatory tariffs) was costing South Dakota soybean farmers hundreds of millions of dollars, Ross responded by saying he heard the price drop “has been exaggerated.”…

Ross told Sen. Mike Enzi (R-Wyo.) that he’s heard the rising cost of newsprint for rural newspapers “is a very trivial thing,” and he told Sen. Benjamin L. Cardin (D-Md.) that it’s tough luck if small businesses don’t have lawyers to apply for exemptions: “It’s not our fault if people file late.”

That reminded me of then-First Lady Hillary Clinton’s response in 1993 to a small businessman about how her health care plan might raise his costs:

“I can’t go out and save every undercapitalized entrepreneur in America.”

Seems like lots of Washington operators don’t care much about the burdens that taxes, regulations, mandates, tariffs, and other policies impose on small businesses and their employees.

Savings and the Decline of Small Business Entry

A recent paper from the Brookings Institute raises an important observation that businesses are “becoming older,” that is, the age profile of American business is increasingly dominated by older firms.  One reason is that the entry rate of new businesses has been steadily declining for decades. 

While this decline has been witnessed across firm size, it has been most dramatic among small firms.  One potential contributor to the decline in new small businesses is the long run decline in the personal savings rate.  According to the Census Bureau’s Survey of Business Owners, the number one, by a long shot, source of capital for new businesses is the personal savings of the owner.  For firms with employees, about 72 percent relied upon personal/family savings for start-up capital.  The other dominate sources of capital, credit cards and home equity, were much less frequently used.  Recent legislative changes (2009 Card Act) and a volatile housing market have made those sources less reliable in recent years.

The chart below compares the trend in entry rates for new business establishments with less than five employees with the personal savings rate.  The correlation between the two is 0.62.  While both the decline in business entry and savings are likely driven by common macroeconomic factors, it seems plausible that if households have fewer saving, they are also less likely to be able to start a business.  My preferred response would be to eliminate policies, such as those in the tax code or current monetary policy, which penalize savings.  I suspect others might have different suggestions.

The Federal Reserve vs. Small Business

Given all the attention that the Federal Reserve has garnered for its monetary “stimulus” programs, it’s perplexing to many that the U.S. has been mired in a credit crunch. After all, conventional wisdom tells us that the Fed’s policies, which have lowered interest rates to almost zero, should have stimulated the creation of credit. This has not been the case, and I’m not surprised.

As it turns out, the Fed’s “stimulus” policies are actually exacerbating the credit crunch. Since credit is a source of working capital for businesses, a credit crunch acts like a supply constraint on the economy. This has been the case particularly for smaller firms in the U.S. economy, known as small and medium enterprises (“SMEs”).

To understand the problem, we must delve into the plumbing of the financial system, specifically the loan markets. Retail bank lending involves making risky forward commitments, such as extending a line of credit to a corporate client, for example. The willingness of a bank to make such forward commitments depends, to a large extent, on a well-functioning interbank market – a market operating with positive interest rates and without counterparty risks.

With the availability of such a market, banks can lend to their clients with confidence because they can cover their commitments by bidding for funds in the wholesale interbank market.

At present, however, the interbank lending market is not functioning as it should. Indeed, one of the major problems facing the interbank market is the so-called zero-interest-rate trap. In a world in which the risk-free Fed funds rate is close to zero, there is virtually no yield be found on the interbank market.

In consequence, banks with excess reserves are reluctant to part with them for virtually no yield in the interbank market. As a result, thanks to the Fed’s zero-interest-rate policies, the interbank market has dried up (see the accompanying chart).

 

Without the security provided by a reliable interbank lending market, banks have been unwilling to scale up or even retain their forward loan commitments. This was verified in a recent article in Central Banking Journal by Stanford Economist Prof. Ronald McKinnon – appropriately titled “Fed ‘stimulus’ chokes indirect finance to SMEs.” The result, as Prof. McKinnon puts it, has been “constipation in domestic financial intermediation” – in other words, a credit crunch.

When banks put the brakes on lending, it is small and medium enterprises that are the hardest hit. Whereas large corporate firms can raise funds directly from the market, SMEs are often primarily reliant on bank lending for working capital. The current drought in the interbank market, and associated credit crunch, has thus left many SMEs without a consistent source of funding.

As it turns out, these “small” businesses make up a big chunk of the U.S. economy – 49.2% of private sector employment and 46% of private-sector GDP. Indeed, the untold story is that the zero-interest-rate trap has left SMEs in a financial straightjacket.

In short, the Fed’s zero interest-rate policy has exacerbated a credit crunch that has been holding back the economy. The only way out of this trap is for the Fed to abandon the conventional wisdom that zero-interest-rates stimulate the creation of credit. Suppose the Fed were to raise the Fed funds rate to, say, two percent. This would loosen the screws on interbank lending, and credit would begin to flow more readily to small and medium enterprises.

Max Baucus, ObamaCare’s Lead Author, Sees ‘Huge Train Wreck Coming Down’

I should probably just turn this one over to Sam Baker at The Hill:

Sen. Max Baucus (D-Mont.) said Wednesday he fears a “train wreck” as the Obama administration implements its signature healthcare law.

Baucus, the chairman of the powerful Finance Committee and a key architect of the healthcare law, said he’s afraid people do not understand how the law will work.

“I just see a huge train wreck coming down,” Baucus told Health and Human Services Secretary Kathleen Sebelius at a Wednesday hearing. “You and I have discussed this many times, and I don’t see any results yet.”

Baucus pressed Sebelius for details about how HHS will explain the law and raise awareness of its key provisions, which are supposed to take effect in just a matter of months.

“I’m very concerned that not enough is being done so far — very concerned,” Baucus said.

He pressed Sebelius to explain how her department will overcome entrenched misunderstandings about what the healthcare law does.

“Small businesses have no idea what to do, what to expect,” Baucus said.

Citing anecdotal evidence from small businesses in his home state, Baucus asked Sebelius for specifics about how it is measuring public understanding of the law.

“You need data. Do you have any data? You’ve never given me data. You only give me concepts, frankly,” Baucus told Sebelius.

Sebelius said the administration is not independently monitoring public awareness of specific provisions, but will be embarking on a substantial education campaign beginning this summer.

Baucus is facing a competitive reelection fight next year, and Republicans are sure to attack him over his role as the primary author of the healthcare law.

A messy rollout of the law’s major provisions, just months before Baucus faces voters, could feed into the GOP’s criticism.

Wednesday’s hearing wasn’t the first time Democrats — including Baucus — have raised concerns about the implementation effort. But while other lawmakers have toned down their public comments as they’ve gotten answers from Sebelius, Baucus said Sebelius has not addressed his fears.

“I’m going to keep on this until I feel a lot better about it,” Baucus told Sebelius…

Enrollment in the healthcare law’s insurance exchanges is slated to begin in October, for coverage that begins in January. Baucus, though, said he’s worried exchanges won’t be ready in time.

“For the marketplaces to work, people need to know about them,” Baucus said. “People need to know their options and how to enroll.”

Who knew that running the health care sector would be hard.

CBO Perpetuates Small Business Administration Myth

A new brief from the Congressional Budget Office discusses the role of small businesses in the economy and how they’re affected by federal policy. The CBO cites the Small Business Administration as one example of how federal policy favors small businesses over larger businesses:

Assistance from the Small Business Administration (SBA), through loan guarantees that enable small firms to borrow at more attractive terms (for example, lower interest rates and fees) than they might otherwise obtain.

That’s the popular perception of the SBA’s loan guarantee programs, but I would argue that it’s inaccurate for two reasons:

  1. The Government Accountability Office has calculated that SBA 7(a) loans only account for a little more than one percent of total small business loans outstanding. Veronique de Rugy and I looked at the top 15 industries that received SBA-backed loans from 2001-2010 and found that only 0.5 percent of the small businesses that comprise these industries received loans backed by the SBA. Thus, rather than helping small businesses compete against big businesses, SBA loan guarantees mainly help a tiny share of small businesses compete against other small businesses.
  2. The real winner from the SBA’s loan guarantees is the banking industry—particularly large banks. In 2009, the top 10 lenders (out of 2,600 total lenders) accounted for close to one-quarter of the SBA’s flagship 7(a) loan guarantee program’s volume. Wells Fargo & Co. alone accounted for 7.3 percent of the total 7(a) loan volume. Other large banks in the top ten include J.P. Morgan Chase, U.S. Bancorp, and PNC Financial Services Group. Although lawmakers portray the SBA’s loan programs as a boost for small businesses, the programs are actually a form of corporate welfare for some of America’s largest banks.

See this Cato essay for more on why the Small Business Administration should be abolished.