It Is OK That Raising The Minimum Wage Hurts Someone

Economists like to talk a lot about Pareto improvements.  This is the idea that you can make a change that improves life for somebody and hurts nobody. A Pareto improvement is obviously always an good idea.  Nobody could object by definition!  Economists like to create mathematical models of the world Pareto optimality is an easy ethical concept to model.  Deontological ethical systems and virtue ethics is harder to put into mathematical equations and all other ethical systems are more controversial.  Thoughtful, well-intentioned people have criticisms of all the major ethical systems, but a Pareto improvement is literally impossible to criticize.  Except that in real-world societies (as opposed to mathematical models) Pareto improvements are so ephemeral, it is hard to find any example of one.

The concept is completely useless in the real world because it is tantamount to unanimous assent and if everyone agrees to a change it will happen automatically without any need for economists to give expert opinion.  That makes them ephemeral at best.  Any real-world issue that does not immediately resolve itself must deal with tradeoffs where some people will win and others lose.  Economists have had to devise a method for dealing with with tradeoffs in order to maintain their relevance for all real-world issues.  That method is an ethical system I call mutilitarianism.  The mutilitarian rule is simple.  Maximize the sum of total monetary costs and benefits.  The problem is that if one rich person gains and everyone else loses, economists still say that this is a great improvement if the gains of one rich person is greater than the losses of everyone else.  Most people disagree (perhaps because they have not had sufficient training in economics).

Mutilitarianism is like a system where people can have as many votes as they have dollars. Whoever has the most dollars gets the most votes and that makes it an extremely elitist ethical system.  Mutilitarianism is biased towards recommending policies that increase inequality.  For example, the standard textbook explanation of minimum wages is that they reduce ‘efficiency.’  Efficiency  is the mutilitarian ideal in which aggregate net monetary income is maximized.  When economists say the word ‘efficiency’ they are almost always talking about their mutilitarian nirvana.  In theory, minimum wage laws should indeed reduce efficiency, but the effect has been so small that empirical studies on minimum wage regulations can’t even reliably show any reduction in efficiency.  Some studies show a small reduction, but others actually show a small increase in efficiency.  Whatever efficiency loss there is seems to be less than the margin of measurement error.

But minimum wage laws do redistribute income.  That is the real motivation behind the controversy that makes it so political.  So how should we decide if a minimum wage is a good idea?  It is wildly popular.  A majority of both parties support it.  In total, 71% of Americans want it.  In a democracy we would get an increased minimum wage.  But politicians don’t always do what is popular.  They favor elite interests over the will of the median American and a majority of politicians oppose raising the minimum wage.  Also, politicians are influenced by the opinion of their economic advisers who say that a minimum wage is inefficient in theory (although probably only slightly inefficient in practice).

Economics should change its standard for ethical judgements and adopt a more democratic ideology.  We should explicitly study how many people benefit from a change rather than examine how many dollars are the benefit. In a rare example of this kind of analysis, the economists at the Congressional Budget Office (CBO) studied the distribution of the benefit of the minimum wage this week. Kevin Drum noticed that their results indicate that raising the minimum wage would have a net benefit for probably well over 80% of Americans.*  It tends to hurt only the richest 20% of households.  But politicians pay more attention to the desires of the top 20% than to the bottom 80%, so they oppose it.  Economists also tend to be in the richest 20% of households, so their advice may be somewhat self-serving too.

There are certainly other ways to help the low wage earners besides the minimum wage.  Germany achieved low inequality without any minimum wage.  But real median income is lower now in the US than it was nearly two decades ago, so if a minimum wage can help 80% of American households at a modest cost to the top 20%, then it should be done because the top 20% have been getting a lot richer whereas the median household has not.

The worst case for a minimum wage is that it increases unemployment among low-income people.  David Neumark and William Wascher make this case in their book Minimum Wages. But their main thesis is that the minimum wage raises unemployment among teenagers and I would argue that that is a good thing for America. American teens work much more than teens in other rich nations (xls) and we would be better off as a society if they would put more effort into education than into making money to spend on fast food, fast cars, and other consumption goods.  Many of the college students I teach would be better off in the long run working less at their minimum wage jobs (even if that means borrowing more), and putting more emphasis on their studies.

Household income is more important than unemployment (particularly teen unemployment) and if household incomes rise despite working less time, that is a very good thing. That is exactly what the CBO study suggests for about 80% of Americans.  We would all like to get more money in less time and that seems to be the scenario that the CBO is predicting.  Higher incomes despite slightly higher unemployment for the bottom 80% of Americans.  It may not be the best way to help the bottom 80%, but I see no reason to let the best be the enemy of the good.