** minimum wage

Topics: Regulation
27 Sep 1993

From: ervan

I'm writing this mostly in response to a conversation that
Hildegard and I started. I thought that I had one or two useful
things to say; so, I decided to torture the rest of you with it :-)

For a given set of preferences, rising prices lower demand.
This is true for every commodity, though some are very inelastic.
What if congress passed a law making it illegal to sell cars for less
than $20K? People that buy cars already costing more than $20K
wouldn't care. Companies selling cars costing more than $20K wouldn't
care either. But what about the person who wants an $8K Hyundai?
Well, he has to spend $20K. Is he going to buy a Hyundai for $20K?
No way. He might suffer the extra cost and pay $20K for a Cadillac
and get more car than he needs. Or, he might not be able to afford a
car. Is there any possible way to see this as an improvement in the
state of the world (leaving aside pollution which is not relevant to
the example)? Clearly not. Fewer cars will be sold. Demand for low
cost transportation will go unmet. Others will pay more than they
need too. This is just what S&D would predict. GM might be happy
that it sells more Cadillacs, but this is the same profit a monopolist
would make. Do you think monoplies are efficient? (*)

What about labor monopolies? For example, unions are granted
monopoly power of plumbing and electrical work in most cities. This
is not just a matter of licensing to insure quality but granting to
the union the right to restrict entry. It keeps up union wages but it
prevents people who want to be plumbers from plumbing. Since supply
and demand is not permitted to set the proper wage rate, unions use
artificial mechanisms, seniority, nepotism, and racism being common
ones. While this might be good for the union members who have jobs,
does anyone believe that it is good for society as a whole? For those
who worry only about the poor, this makes housing less affordable for
the poor. It prevents poor people from having second jobs doing their
neighbors plumbing (or wiring or whatever). Meanwhile union members
are typically paid well, $20/hour+. Or consider taxis, there are only
so many taxi licenses available (in Houston and other places are
similar). Even if I have a chauffer's license, I cannot give you a
ride for pay. Again, for you liberals, if you want to save gas for
all of those single occupant cars out there, how about letting people
settle their real costs and time value differences in cash so that the
economics of car pooling can be made to work? Government protected
monopolies are inefficient.

This is just what minimum wage is like. Artificially raising
the price of labor will cause demand to shrink and induce
unemployment. Some people will pay more for the remaining labor but
only at the cost of being inefficient. If you have any doubts about
this, see [1] or [2] for a more detailed analysis.

As another example, about a month ago, I was sitting on my
front porch reading when a fellow came by and was begging to do yard
work. He was staying at some kind of a shelter but he had to earn
some small amount of money to partially pay his rent. Well, my
entertainment time is worth about $5/hour (meaning I'm reluctant to
pay more than that for fun). So, I would have hired this guy for
$4/hour to mow or weed the patio (truly an unpleasant job). The
problem is that would have been illegal. So, I simply told him that I
had nothing for him to do. He kept looking. Had I hired him, he
would have more money, I would have had more time to do research
(which society values more than my weeding my patio). But no, thanks
to minimum wage this guy has no job, society loses my productive value
and I end up wasting my time weeding my patio. Everybody loses. In
this particular case, the problem is further complicated by the fact
that I would have been required to file social security taxes. The
frictional cost of having to screw with the paperwork is so great that
I would either have violated the law (likely) or not been willing to
pay even $4/hour.

Let me try another example. Let's say I have a wheat farm and
I hire laborers to drive my combines and harvest the wheat. The price
of wheat is $4/bushel. My base costs are $3.96/bushel (seed,
fertilizer, herbicides, interest on the land and machinery). Now, the
fellow I want to hire can drive well enough to harvest 100 bushels/
hour (a low number in the real world, but this is just a hypothetical
example). That means he is producing $4.00 of wheat /hour. If I have
to pay him $4.25/hour, I'm losing money. I'm not going to lose money.
Instead, I'll do something else with the land. So, somebody is out of
a job. I'm making less money (since I would have preferred to grow
wheat to the 2nd best option) as a 'poor' farmer. There is less wheat
in the world to feed the hungry (and the price just went up for the
rest because production went down). This is a good thing ?!?

Actually, farm labor is exempted from minimum wage because
it was clearly foolish. It's just as foolish elsewhere but there
are political factors that keep it from being recognized.

Thinking about minimum wage tends to be muddled because the
effect of a 50 cent increase seems like something any employer could
absorb. What if we increased the minimum wage to $20/hour? Would
that be a good thing? No! It would be catastrophic. Even those
who support raising the minimum wage a little are not willing
to pursue their reasons consistently. Why is an extra 50 cents
good but not an extra $1 or an extra $15?

So, some facts about minimum wage:
1) It causes unemployment
2) It raises wages for people who stay employed, at least short term
3) It reduces economic efficiency (i.e. GNP)
Which leaves one interesting question:
Q) Is it a good way to redistribute income?

I want to note, for the socialists amongst us, that (3) does
not mean the 'evil rich' have fewer Mercedes, it means that prices go
up in general and that the poor have relatively less money to buy food
for their kids, less money to buy good housing, and the 'evil rich'
have less money to use to buy goods which create jobs for the poor.
Witness the luxury tax which even congress finally agreed was terrible
for the poor because of the jobs that it destroyed.

So, the only possible justification is that it is an efficient
mechanism of redistribution (presuming one even thinks this a worthy
goal). In the interest of moving money downward from the rich to the
poor (which it does in some small measure), it also moves upward from
the very poor (who are now unemployed) to the poor (who now make
slightly more due to a higher minimum wage). As liberals are fond of
pointing out, there are external costs to unemployment. So, the real
cost is not just the lost income, but the higher crime rate
(presumably) and the greater tax burden (to support women on the
dole).

Even if one thinks that anybody making more than (oh say)
$6/hour deserves to be screwed to help the poor, the question is does
minimum wage do that? I.e., if we measure the total income of the
poor, does minimum wage lower it or raise it? I did some research on
this question. Unfortunately, I could not find all of the needed
data. There seems to be a weak consensus that each 1% increase in the
minimum wage increases unemployment by 0.04%. That does not answer
which people become unemployed (not all are at minimum wage) nor does
it answer how much wages go up (how many people make less than what
the new minimum wage would be)? Using some interpolations from the
U.S. statistical abstract about wage distributions, and assuming no
wages are depressed, only raised (which is far too optimistic), it's
pretty much a dead even proposition, i.e. the poor make just about the
same amount of money (and everyone else loses). This is not firm
though.

Returning to GNP for a moment, a 10% increase in the minimum
wage would cause about 500,000 jobs to be lost. For 40 hour/week
jobs that's about $4G of lost production per year. The $4G not spent
on labor will be spent on some other less desirable thing, i.e.
something which cannot be produced as efficiently. Thus the
difference in efficiency of the first choice (low income labor)
versus the 2nd choice times $4G is the direct efficiency loss
to the economy (this does not include the other costs).

So, even if it actually succeeds in redistributing income,
it's a very inefficient mechanism to do so. Not only does it do a
poor job of redistribution, for all of the cost it imposes on the
economy only 20% of minimum wage workers are poor [3,4] (the rest are
children living at home with middle class parents). So it doesn't
even redistribute to the needy people.

For people who get jobs at the new higher minimum wage, that
previous minimum wage often was a training wage. The employer and
employee both expected it to rise in the future. With a higher
minimum wage, the employer simply borrows against future earnings to
pay a higher wage now and takes it out of future pay increases. For
instance, if someone progresses from $4.25 to $4.75 to $5.25, with a
new minimum wage of $4.75, the increase to $5.25 would be delayed for
an amount of time equal to that of the first increase (adjusted for
NPV & risk). Thus, the employee does not actually earn any more
money. This applies only for small increases in minimum wage. Larger
ones would be more painful because this escape hatch would not exist.
So, while the losses are real, the gains are ephemeral.

The significant frictional costs of paperwork and enforcement
agencies budgets also have to be offset against whatever benefit it may
have.

Minimum wage is a dishonest mechanism. The electorate
supports minimum wage only because it believes it to be a free lunch
for increasing wages. The electorate clearly does not support
wholesale redistribution. If that were known to be the only possible
benefit of minimum wage, it would be in deep trouble. Personally, I
don't have any use for the "divine right of majorities" but minimum
wage supporters tend to be big fans of (Social) Democracy.

Finally, let me address the a common non-reason used to
support minimum wage: 'people deserve a better standard of living than
$4.25/hour provides'. Whether or not this is true, it's quite
irrelevant. It's an objection about reality and not politics. The
question is not what do we want, we want everything. I think it's
shameful that some people cannot afford yachts and Porsches (which
are, after all, basic necessities). It just turns out there is not
enough productivity in the world to provide these goods. What we want
doesn't matter. 'What can we get?' is the only relevant question.
What if we imposed the modern standard of minimal living on 19th
century England? It would have caused instant bankruptcy. There were
not sufficient goods being produced to meet that standard no matter
how they were redistributed. The point being that we can impose
irrational standards which are destructive without being catastrophic.
That doesn't mean it's a good thing to do. Utopia is not an option.

If we want to subsidize the poor, there are perfectly
straightforward, politically honest, and tolerably efficient ways to
do so, e.g. a negative income tax.

Summary:
1) It lowers the GNP by causing inefficient allocations of labor.
It certainly hurts everyone except the poor.
2) Minimum wage causes unemployment.
3) It's effect on the total dollar income of low income people is not
clearly positive, *even if* the increases are sustained.
4) The increases are not sustained. The 'winners' win very little
because of the training wage effect.
5) Furthermore, those increases which are sustained are effectively
lessened by increased prices.
(if it helps anybody).
7) What people 'deserve' is a separate issue.

[1] Economics by Lipsey & Steiner
[2] "The Macroeconomic Impacts of Increasing the Minimum Wage" by
Gerard Adams, Journal of Policy Modeling, Summer '89.
[3] "Help for the Middle Class" by James Aley, Fortune, Apr 5 '93.
[4] "Minimum Wage Myths", Nation's Business Jun '87.

(*) Actually some monoplies are efficient, but that's not what's
at issue here. I have in mind imposed monopolies, e.g. a law
that grants a monopoly to one company.

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