Minimum wage problems?

Until the 1990s, most economists believed that the minimum wage was a major cause of unemployment because that is what the canonical supply and demand model predicts.

If wages rise, more people will want to work (increasing the quantity of labor that is supplied) but employers would want to buy less labor (reducing the quantity of labor demanded). The gap between the supply and demand is the quantity of unemployed workers. But surprisingly, that doesn’t seem to happen in most cases! There are a couple theories for why this is the case, but the most common one is that employers have more market power than employees and artificially hold down wages. The minimum wage, according to this theory, simply raises the wage back closer to what the competitive equilibrium would be. A related theory is that the minimum wage could mostly cause a transfer of some monopoly profits from landowners to go to workers.

Steven E. Landsburg is a libertarian who dislikes government actions like the minimum wage, but even he agrees that the minimum wage does not significantly increase unemployment.

…here’s what most labor economists believe: The minimum wage kills very few jobs, and the jobs it kills were lousy jobs anyway. It is almost impossible to maintain the old argument that minimum wages are bad for minimum-wage workers.

In fact, the minimum wage is very good for unskilled workers. It transfers income to them. And therein lies the right argument against the minimum wage.

Ordinarily, when we decide to transfer income to some group or another—whether it be the working poor, the unemployed, the victims of a flood, or the stockholders of American Airlines—we pay for the transfer out of general tax revenue. That has two advantages: It spreads the burden across all taxpayers, and it makes politicians accountable for their actions. It’s easy to look up exactly how much the government gave American, and it’s easy to look up exactly which senators voted for it.

By contrast, the minimum wage places the entire burden on one small group: the employers of low-wage workers and, to some extent, their customers. Suppose you’re a small entrepreneur with, say, 10 full-time minimum-wage workers. Then a 50 cent increase in the minimum wage is going to cost you about$10,000 a year. That’s no different from a $10,000 tax increase. But the politicians who imposed the burden get to claim they never raised anybody’s taxes.

If you want to transfer income to the working poor, there are fairer and more honest ways to do it. The Earned Income Tax Credit, for example, accomplishes pretty much the same goals as the minimum wage but without concentrating the burden on a tiny minority. For that matter, the EITC also does a better job of helping the people you’d really want to help, as opposed to, say, middle-class teenagers working summer jobs. It’s pretty hard to argue that a minimum-wage increase beats an EITC increase by any criterion.

Brad Delong disagrees about the burden of minimum wage laws:

I–and almost everybody else I’ve talked to–think this is dead wrong: the incidence of the minimum wage ‘tax’ falls almost entirely upon the customers of firms that employ minimum-wage workers, and that’s pretty much all of us. It’s not as though the owners and managers of firms that employ minimum-wage workers have no other options. So I believe Landsburg is wrong: the burden of the minimum wage is broadly distributed across all taxpayers…

Now I like the EITC… But the EITC is a program that uses the IRS to write lots of relatively small checks to tens of millions of relatively poor people who satisfy picky eligibility rules. This is not the IRS’s comparative advantage… The EITC is a good program, but it a costly program to administer, and it is administered imperfectly to say the least.

The minimum wage, on the other hand, is nearly self-enforcing: its administrative costs are nearly nil, for workers… have a very strong incentive to drop a dime on bosses who violate it. From a government-administrative and error-rate perspective, it’s a very cost-effective program.

The right solution, of course, is balance: use the minimum wage as one part of your program of boosting the incomes of the working poor, and use the EITC as the other part. try not to push either one to the point where its drawbacks (disemployment on the one hand, and administrative error on the other) grow large.

Another effect of the minimum wage is that it increases productivity of workers through the “efficiency wage” effect. Workers have lower turnover and get more training and employers invest in more equipment to make labor more efficient. When employers substitute robots for workers, one would think that that would produce unemployment, but instead, historically it has led to higher wages. This is another theory to help explain why the minimum wage doesn’t cause significant unemployment. As Matthew Yglesias says:

one major line of criticism from outlets like the Wall Street Journal editorial page and Forbes’s Tim Worstall is that big increases in [minimum wages] only leads to job loss via automation. Both critics point to initiatives at McDonald’s and Wendy’s to automate more of the service process, and warn that robots, rather than workers, will be the real winners if liberals succeed in boosting minimum pay.

This is doubly wrong… there’s no reason to think this would be a bad scenario.

If minimum wage hikes really do spur the creation and adoption of high-quality new equipment to automate elements of, say, the food service industry, then that would be a very positive outcome that implies minimum wage hikes are a great idea. Productivity-enhancing technology, after all, is a crucial pillar of social and economic progress. The problem in recent years is that we haven’t had nearly enough of it…

Right now the retirement age is rising from 65 to 67, and most people think it will have to go up to 70. If robots can do a lot of the work instead, we could put it back down to 65 or even to 62 while still growing the economy. We could give more financial support to college students so fewer of them are doing part-time food service work. We could give new parents more paid leave time and mandate four weeks of paid vacation for everyone.

It would be great!

Worry that the robots won’t take the jobs

The scenario to worry about with minimum wage hikes is that no technological solution will emerge. Restaurant operations will remain about the same, but employing people to work in them will get more expensive.

In pricey, crowded cities… Operating a restaurant will become less lucrative, which… will mean lower returns for landlords, which is a small price to pay for better living standards for low-wage workers.

But in less crowded, less expensive locations…, it will just mean fewer restaurants open and those that do open will keep shorter hours [and unemployment rates could rise].

This is the biggest question about minimum wage rules

Whether a legislative push for high pay can actually spur the development and deployment of new productivity-enhancing technology is really the big unknown about the minimum wage. The economics literature has an enormous amount to say about how to efficiently distribute a fixed stock of resources, but has not really succeeded in shedding much light on where innovation comes from or what policies support it.

Existing studies of the labor market impact of minimum wage hikes generally find very small effects on employment based on very small wage increases. The question they ask is essentially whether a small hike in the wage floor introduces a small inefficiency into the labor market or whether it corrects for an existing inefficiency that… employers [have some monopsony] pricing power over workers.

This is an interesting question, but the wage-innovation question is a much more difficult — and yet important — one. The prevailing conventional wisdom in Western policy circles over the past generation has been that innovation is something that just happens. The government can help it along by providing an educated workforce and funding some basic R&D, but certainly can’t just summon productivity-enhancing technology into existence by waving a magic minimum wage wand. But that’s really just an assumption, not a proven proposition.

The fact that so many minimum wage skeptics think it’s intuitively wrong is telling and interesting. A cheap labor economy, after all, doesn’t offer as many incentives for companies to identify and promote managers who are skilled at finding, developing, and deploying labor-saving technology. Perhaps if [higher minimum wage laws force] companies to eschew cheap labor, they will respond by innovating and reducing their need for workers.

One of the theories for why technological innovation took off in northern Europe and caused the industrial revolution was the fact that wages in northern Europe were some of the highest in the world. That gave businesses a large incentive to invent labor-saving machines. When numerous businesses invented new technologies, the industrial revolution was born. That didn’t happen in China or India and labor despite their head start in technology and one theory to explain Europe’s edge was the fact that wages were so low in China that it was easier to just hire more cheap labor to get work done rather than hire expensive engineers to build expensive machinery that would replace labor. A minimum wage law could have a similar effect and that might be why we cannot see evidence that they have had much effect on unemployment.