The Long Run Blog

Critical Thinking on Money, Finance, and Economics

The Minimum Wage is not Enough

Karl, you ignorant, coldhearted, Canadian schlub.

Many like you have argued the negative economic consequences of the minimum wage. I suggest those are a pittance and irrelevant. The issue is one of protecting the exploitation of workers by their greedy corporate masters and building on the foundation of our economic system – the middle class. This may sound a little strange coming from someone who describes himself as a free market capitalist, but I am one of those lucky people who have gone from relatively rich to poor and back. How did that happen? Fidel Castro.

Let me debunk the macroeconomic arguments first. The common arguments suggest that the minimum wage hurts small businesses, drives inflation, encourages employers to downsize and outsource to cheaper labor markets, and ultimately and artificially increases the cost of goods beyond their value. But in the final analysis, the minimum wage does not even provide an income that reaches the poverty line.

 First off, let’s take a look at the claim that the minimum wage leads to inflation. The figure below shows that the minimum wage and the CPI have both roughly increased seven-fold in the period between 1960 and today. Aha, you might say! That’s a perfect correlation! Sure, but correlation is not causation. If you take a look at the next chart, you can clearly see that there are historical events that have nothing to do with the change in minimum wage. For example, in the 1970’s, inflation was driven by self inflicted, misguided policies that led to an oil crisis, long gas lines at gas stations, and runaway interest rates.

Consumer Price Index vs Minimum Wage

Consumer Price Index vs Minimum Wage

 

 

 

 

Timeline of Major Financial and Political Events

Timeline of Major Financial and Political Events

 

 

The lost jobs argument also doesn’t hold water in a macro sense. Once again, the reality is that the total number of jobs added has grown despite increases in the minimum wage. Zero growth and job losses can again be attributed to other factors. The loss of jobs to cheap labor markets because of the minimum wage is a canard. Everyone benefits from lower costs, especially those who earn a minimum wage. The problem is that industry does a miserable job of developing its workforce into higher skilled and therefore better paid jobs. We can’t, nor do we want to compete with the rest of the world based solely on the cost of our labor. Our economy has been built on innovation and a higher productivity than the rest of the world. 

Lastly, the ups and downs of corporate earnings and dividends have zero correlation with the minimum wage as shown by the chart below. 

S&P500 Earnings and Dividend Growth vs. Minimum Wage

S&P500 Earnings and Dividend Growth vs. Minimum Wage

 

 

 

Moving away from the numbers, the argument that says the minimum wage is not designed to provide a living wage – that flipping burgers, making beds, or pumping gas (back in the day) is not a career – is elitism at its worst. Not everyone has the capability to become a doctor or to break into the PGA tour. Should we deny someone who is willing to fill a “menial” job a chance at the American (or Canadian) dream?

In 2009, the federal minimum wage will increase to $7.25/hr. or $15,080 annually. It is estimated that less than 5% of the workforce is paid minimum wage. The poverty level in 2007 was $21,027, or around $10 per hour, which is the rate at which the guys hanging around Home Depot will work around home, tax free. In 2007 there were 37 million Americans living below the poverty level. Furthermore, the minimum wage has failed to keep up with inflation. Personally, I find the term “minimum” to be problematic. It seems to me that the minimum wage ought to be pegged to the poverty level for starters. 

While we’re willing to throw trillions of Dollars at Wall Street, Detroit, and hundreds of pork projects, we are unwilling to consider bailing out those who need it the most, those living below the poverty line. What would that cost? To bring the 5% of the population that is earning the minimum wage up to the poverty level would cost $90 billion per year. That’s 4.5% of the estimated cost of the stimulus package. It’s 0.7% of our GDP. Not only is it a drop in the bucket, most of it goes right back into the economy through consumer spending, which benefits everyone.

Rush Limbaugh and some of his pals argue against the minimum wage by asking “why stop at $7.25, why not make it $20 or $100?”  Well, that’s a strawman Rush, no one is suggesting that. What happened to the compasionate conservatism? 

I’m not going to take a cheap shot at overpaid CEO’s. It’s an altogether different problem that is unrelated and perhaps the subject of another post. I’m not going to discuss the political pandering aspect of the minimum wage debate either. Dogs bark, politicans pander.

In summary, a small adjustment to the minimum wage can make a huge difference in the living standard of millions of Americans at a negligible cost (if any) to the rest of us. We need to stop competing on wages and start competing on innovation and productivity again.

 

 


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January 28, 2009 - Posted by | Econ Policy, Economics |

28 Comments »

  1. What about small-business owners that are in bad finical situations? How are they going to afford to pay their employees the new wage?

    Comment by Timothy Clemans | January 28, 2009 | Reply

  2. Just in case people don’t get the reference (Julio and I are “children” of the 70s), the slag at the top is a tribute to Saturday Night Live (the original cast). Dan Aykroyd and Jane Curtin would do a “debate”. Jane would give her opinion (all very liberal and ’70s) and then Dan Aykroyd would begin his conservative counter argument with “Jane, you ignorant sl*t.”

    http://snltranscripts.jt.org/78/78iupdate.phtml

    Julio and I heartily agreed his post should begin with such a tribute. It was either that or “Coke? No. Pepsi.” (Or was it supposed to be “Coke. No Pepsi.”)

    Comment by kamamer | January 29, 2009 | Reply

  3. I love the SNL reference (child of the 80s, but I got it). However, I’d like to nitpick, if I may.

    First, I doubt people seriously argue that minimum wage laws drive inflation and unemployment or cut deeply into corporate profits. However, the argument is that minimum wages increase costs, by definition, which leads to higher inflation, higher unemployment, and lower corporate profits had there not been minimum wage laws.

    Second, your first graph shows minimum wage increasing more slowly than inflation, which means the real minimum wage is lower over time. This makes a direct comparison between minimum wages and percentage changes in earnings in the third graph rather meaningless.

    Third, no one is denying laborers the chance at any national dream. The question is one of economics, not sentiment. If it were the latter, Rush would have a point.

    Fourth, the definition of the poverty level, and the calculation, especially in the United States, is rather meaningless. To index minimum wage to a measure with a tenuous link to reality is objectionable.

    Fifth, there are/were actual economic reasons for saving (certain) banks. Ensuring that the credit crunch didn’t get even worse, as it seemed it would, was crucial not just to Wall Street, but all Americans (and consequently, the world). But no good reasons have been presented for why a “bailout” of minimum wage workers is necessary, other than moral populism. More importantly, no evidence has been presented that it would work.

    Finally, the reasoning that one group can be helped at a negligible cost to everyone is the basis of pork-barrel politics and reckless spending. It’s the reason lobbyists exist. After all, 300 million Americans won’t miss a dollar each, but that’s a large amount when it is collected. Just because we can doesn’t mean we should.

    I’d like to point out that I’m not picking on Julio because I have my mind made up. I’d just like to see better economic arguments from the pro-side.

    So, to sum up, I’m reaching into my box of references and … I award you no points, and may God have mercy on your soul.

    Comment by The Fiery Scribe | January 29, 2009 | Reply

  4. I feel Julio was given an untenable position by luck of the draw :)

    Comment by kamamer | January 29, 2009 | Reply

  5. I agree, kamamer. I definitely sympathize.

    Perhaps Brett would like to make it a contest for his readers to post the best argument(s) in support of minimum wage. I’d give it a go just to tickle my brain.

    It could even be a regular event where readers can play the Devil’s Advocate on issues, against the prevailing ideas/theories in economics.

    Comment by The Fiery Scribe | January 29, 2009 | Reply

  6. Very interesting idea, TFS. Let me think about that. We have such a good rapport using the comment section for DA positions, I don’t want to ruin that either. We’ll have to think about how to incorporate such an idea. Keep thinking about it and shoot us some ideas. Thanks.

    Comment by Brett | January 29, 2009 | Reply

  7. From what I’ve read, the consensus among economists who study the minimum wage is that it eliminates jobs for the lowest skilled workers.

    Which makes sense– if you believe that increasing the cost of something will reduce the demand for that something, then increasing the cost of low-skilled labor should reduce the demand for that labor.

    If you don’t believe that increasing the cost of something will reduce the demand for that something… umm… extraordinary claims require extraordinary evidence.

    Recently “ironman” at the Political Calculations blog went through a very detailed look a teen unemployment figures over the last few years, and estimates that about one million teenagers lost their jobs because of the increase in the minimum wage. And before you ask, yes, he controlled (or did his best, anyway) for the overall drop in employment because of the recession.

    Plotting overall employment against minimum wage increases is a red herring; since only 1.2% of the population makes the minimum wage, even if ALL of those people lost their jobs that would be only a 1.2% change in overall employment– which, given all the other stuff that affects employment, might not even be a statistically significant change.

    Comment by gavinandresen | January 30, 2009 | Reply

  8. Oops, I mis-remembered the percentage of people making minimum wage from Karl’s post– 1.2% is the number of head-of-households (4-6% is the number of people making minimum wage).

    Anybody here know enough about statistics to figure out how large the variation in employment would have to be to find a statistically significant effect of the 15 data points we have on minimum wage increases since 1960?

    Comment by gavinandresen | January 30, 2009 | Reply

  9. 1m teenagers huh? Was he able to control for a substitution effect? If there is a recession and more skilled labor needs to survive by applying for those min wage jobs instead of $14/hr jobs they had, they will no doubt displace unreliable/unproven teens right? That substitution has nothing to do with min wage. So unless he was able to control for that, I don’t buy it.

    I think there are too many variables to control for the effects, particularly over decades. Just the composition of the economy alone will have a large impact. As Karl pointed out, the percent on min wage is so low that the effect is hard to isolate.

    Comment by Brett | January 30, 2009 | Reply

  10. RE: the substitution effect: good question.

    If it is all (or mostly) substitution effect, then we should see NO effect of raising the minimum wage on teens (versus more skilled workers) during a time of rising employment, right?

    Comment by gavinandresen | January 30, 2009 | Reply

  11. The “smoking gun” graph is here. Teens started losing their jobs at the end of 2006, BEFORE the economy tanked (general employment was still rising).

    There COULD be another factor that explains the drop. But it seems to me that the increase in the minimum wage meets my skeptical criteria (it is a simple explanation that fits the data and agrees with my understanding of how economics– price, supply, and demand– work).

    Again, read all the economic detective posts for all the logic.

    Comment by gavinandresen | January 30, 2009 | Reply

  12. To be honest, I’m not sure. I haven’t spent a lot of time thinking through the possibilities. Perhaps there is another effect in times of rising employment? For example, we experienced a couple of decades of increasing participation by women in the workforce. To the extent that supply of labor has an unskilled but willing and reliable component, that could affect teens. But only 20% of min wage earners are over 25 you say. Perhaps that min wage job went to a mom re-entering the workforce and the employer paid her $1/hr more because of the reliability factor. So she is not longer in the min wage data, but is certainly affected by the min wage floor. I see so many permutations, I really don’t know if such data depicts an accurate conclusion.

    Comment by Brett | January 30, 2009 | Reply

  13. gavin, our comments 11 and 12 got crossed. 12 should come before 11, so let me address #11.

    Honestly, the graph convinces me of nothing. The teen employment trend was down for some time before the first min wage hike took effect. After the first hike, teen employment trended flat to up until the second hike. The second hike coincided with a tanking economy. So I can’t really draw good conclusions from this.

    Comment by Brett | January 30, 2009 | Reply

  14. The trend started around the time Congress passed the minimum wage law. Employers aren’t stupid, they can see that their labor costs are scheduled to rise and will adjust their hiring practices accordingly.

    The test of critical thinking is being able to make testable predictions, right? So here’s a testable prediction:

    Regulatory changes that make unskilled labor more expensive (like increasing the minimum wage) will result in less hiring (relative to the hiring of skilled labor).

    The “experiment” is then:
    Find a country with good data on wages and employment. Wait until a minimum wage increase is announced, and see if the percentage of low-skilled workers decreases.

    You agree that raising the minimum wage to $50 per hour would put people out of work, yes?
    (well, if it were possible to enforce such a silly law– in reality we’d just get a much bigger “underground” economy)

    (which makes me wonder if increases in the minimum wage increase the number of people working under-the-table, or if it increases illegal immigration…)

    Comment by gavinandresen | January 30, 2009 | Reply

  15. Timothy, job creation in a macro sense has little to do with minimum wage. Most minimum wage jobs are in agriculture, hospitality (including restaurants, etc.), and construction industries. Historically, the percentage of minimum wage jobs have decreased as a result of competition and collective bargaining. Sure, some small businesses may go away or not be formed at all if they are heavily dependent on labor and have razor thing margins. As long as there is a need for their products or services, someone will fill the need and someone will do it profitably. Since unskilled labor is fungible, it can move around much more easily than skilled labor.

    Fiery, I agree with you that it is silly to make the economic argument that minimum wage laws drive inflation and unemployment or cut deeply into corporate profits. While economic theory supports the argument the data doesn’t. support it.

    The point of the S&P earnings chart was to show that earnings and dividends swing substantially year on year regardless of minimum wage hikes. Yes, my numbers are nominal, but adjusting them would not change my conclusion. To your point though, the minimum wage has not kept up with inflation.

    You’ve touched on a the issue of whether the poverty level is meaningless. That’s an interesting debate for later but let me just ask anyone out there if they think a family of four living on $20K per year is anything but poor. Why would linking the minimum wage to a measure that has a methodology behind it, whether you agree with it or not, be worse than just throwing an ex-recto number out there like we do now?

    Lastly, Fiery, I’m more worried about Obama and the crew on Capitol Hill having mercy on my wallet than God on my soul.

    Gavin, I’m glad you raised the teenage employment argument. The definition of minimum wage has evolved over time just like the purpose of social security. Minimum wage was not intended to be a living wage just like social security was not meant to be supplemental to your employer’s pension or as a safety net. I don’t buy the argument that the increase in minimum wage caused the drop in teenage employment. Teenage employment is dropping because unemployment is climbing. Also, if you look at 1996 and 1997, the total number of jobs added actually went up after sequential increases in the minimum wage.

    Brett, that’s an interesting point about demographics. The two income family is one that was pretty much unheard of when I was a kid. There is also the effect of immigration (legal or not). The US birthrate is at an all time low. Where is the unskilled labor that is (will be) happy to work at minimum wage coming from? Gavin touched on this issue also.

    Comment by Julio | January 30, 2009 | Reply

  16. “The trend started around the time Congress passed the minimum wage law. Employers aren’t stupid, they can see that their labor costs are scheduled to rise and will adjust their hiring practices accordingly.”

    The graph also conveniently begins with the Dems winning as if to make a political statement. Maybe it was in a down trend for the whole year prior? Also, the fact that teen employment rose after the increase needs more reflection. I’m just not seeing any convincing data in the graph.

    “Regulatory changes that make unskilled labor more expensive (like increasing the minimum wage) will result in less hiring (relative to the hiring of skilled labor).”

    Not necessarily. If the increased cost of unskilled labor is still more productive per dollar of cost than skilled labor (i.e. more economical), there would be no change. Furthermore, if the environment is such that the increased cost can be passed through to the customer, it shouldn’t make a difference. You see this with other inputs to production- when the cost of sheetrock and lumber climb because of strong housing demand, it only increases price to the buyer without denting demand for the volume of sheetrock or lumber.

    Comment by Brett | January 30, 2009 | Reply

  17. Man, after fighting with WP to post a graph, here it is:

    So, is the rise in teen unemployment a function of the min wage or simply a symptom of total unemployment? I submit the graph you linked to was framing the data to make their ideological point rather than illustrating the whole picture.

    Comment by Brett | January 30, 2009 | Reply

  18. Brett, if you take the time to read ironman’s entire argument, you’ll see this graph which shows teen employment (as a percentage of teen population) beginning in 2005. Noisy but mostly stable, until the end of 2006 (a year before the recession started), and then it dropped.

    And in this post he explains: “we’re going to identify a period of time in which the number of teens in the U.S. workforce would appear to be in equilibrium with the rest of the U.S. workforce, find the range in which we would expect all the measures of the relative number of teens to be the result of natural causes, then identify where and when something not natural results in breaking that established state of equilibrium.”

    Maybe he carefully constructed the data he was looking at and the conditions for when to start measuring to tell a story; that’s certainly possible. That’s why I say that the critical test is to wait for another minimum wage increase somewhere and then use the SAME techniques to measure the same effect.

    You could also go back in time, although it’s possible ironman is really clever, and tweaked his methodology so that his story matches previous increases in the minimum wage (I have no idea what answer you’d get if you went back to when previous minimum wage legislation was passed).

    Comment by gavinandresen | January 30, 2009 | Reply

  19. What jobs are disappearing as a result of minimum wage laws today? None. They are already gone via outsourcing, which has been going on since the industrial revolution started. The minimum wage jobs that are remaining can not be easily outsourced. How do you outsource harvesting crops, construction, hospitality? It’s the loss of higher wage jobs that’s hurting us.

    Comment by Julio | January 30, 2009 | Reply

  20. Responding to “is the rise in teen unemployment a function of the min wage or simply a symptom of total unemployment?” — for the full argument go here.

    The base BLS unemployment data is misleading (see, for example, Paul Krugman, “Conscience of a Liberal” from last year). There’s a mysterious decline in the number of EMPLOYED teenagers during from the end of 2006, and it’s a bigger decline than the number of UNEMPLOYED teenagers.

    Or, in other words, a bunch of teenagers left the workforce, but were not counted as “unemployed” in the BLS stats. More than you can account for by the decline in economic conditions (and the timing isn’t right, either, with the teens losing their jobs before the recession started).

    And responding to Julio:

    What makes you think outsourcing is a big factor in eliminating low-skilled jobs? According to the economic data I’ve seen, technological innovation (more efficient manufacturing techniques, for example) is a much, much bigger factor than outsourcing (I can dig up a reference, but maybe that discussion could wait for another debate another time…)

    Comment by gavinandresen | January 30, 2009 | Reply

  21. Another data point, from the center-left Economic Policy Institute (pdf of the study here):

    “Almost three-fourths of labor economists (73%) believe that a mandated minimum wage increase set at 150% of the current wage would result in employment losses. Similarly, more than two-thirds of labor economists (68%) believe a mandated minimum wage would result in employers hiring more applicants with greater skills, and nearly one-third (31%) believe there would be no change in hiring practices.”

    As I said in my first comment, the consensus of professional economists who specialize in labor issues is that increasing the minimum wage results in jobs losses for low-skilled workers.

    (The point of the EPI paper is to argue that increasing the Earned Income Tax Credit is a much better way of helping low-skill workers than increasing the minimum wage.)

    Comment by gavinandresen | January 30, 2009 | Reply

  22. Gavin,

    Correct me if I’m wrong, but this back and forth started with:
    “From what I’ve read, the consensus among economists who study the minimum wage is that it eliminates jobs for the lowest skilled workers.

    Which makes sense– if you believe that increasing the cost of something will reduce the demand for that something, then increasing the cost of low-skilled labor should reduce the demand for that labor.”

    To which I responed with something about a possible substitution effect. I FULLY GRANT that raising the min wage MAY (even likely) eliminate jobs for the lowest skilled workers. I agree that it makes intuitive sense too.

    In my haste to reply, I redefined your statement. This was caught as I wasted time crunching my own data. I was arguing that raising the min wage doesn’t eliminates min wage jobs necessarily, whereas you concluded it eliminated jobs for the lowest skilled, but not necessarily net jobs.

    It does appear likely that raising the min wage displaces the most fungible of all labor- the least skilled. But is NOT clear at all that raising the min wage loses any amount of net jobs.

    So, now that we exercised out brains a bit, did you want to make a policy statement based on this or was it simply an observation?

    Good job and thanks for the vigorous exercise!

    Comment by Brett | January 30, 2009 | Reply

  23. My policy statement would be: increasing the minimum wage hurts the very people who most need help: low-skilled, low-payed workers. Therefore, it is bad public policy to increase the minimum wage. The best way to help low-paid workers is to grant them refundable tax credits (or just give them money outright, if you can do it in a way that doesn’t discourage them from working, if they can).

    Thanks for putting up with my torrent of links and arguments; the minimum wage issue is one of the windmills I’ve been tilting at for a while…

    Comment by gavinandresen | January 30, 2009 | Reply

  24. The earned income tax credit for someone who is not paying taxes is another name for welfare. I’d rather make the choice of not buying or paying more for a product I need or want than funding another government giveaway. At least at the employer level there is theoretically value added.

    EITC is the government’s own brand of trickle down economics.

    Comment by Julio | January 31, 2009 | Reply

  25. Julio,

    Thanks for the reply. Excellent points, overall. Just a few thoughts:
    I think measuring actual economic data, either earnings or inflation, over time as a factor of wages is headed in the wrong direction, as per my first argument. That being said, if the minimum wage is not keeping up with inflation, technically, the difference between the (real) market price and the (real) minimum wage is lower, meaning the dead-weight loss is lower. This would translate to better earnings overall, although the factor may not be large.
    It would be interesting to measure the differences in earnings for labor-intensive industries vs capital-intensive industries, especially those which require a low skill-set level. I’m not sure how one would collect that data, but it could make or break your argument.

    I disagree with the calculation of an absolute level of poverty, mainly because the measure seems rather arbitrary. For example, US$20K a year is a rather substantial amount of money, even in Hong Kong, where I live. I know people who sustain a home for just a bit more than that. The real questions are the price level and what determines the price level.
    Mind you, I’m no fan of the relative measure of poverty either. I’m leaning more towards the idea that there is no objective measure of poverty, but it is, as you say, a matter for another day.
    The problem with linking minimum wages to an arbitrary measure, like the poverty level, is that they weaken the argument for each other, by association. If a minimum wage is linked to the poverty level and no one can really get paid less than minimum wage, by theory, no one can be below the poverty level. What use, then, is the poverty level? Of course, they could fall below the poverty level because they work an insufficient number of hours. But if they do, what use is minimum wage?

    Heh, finally, that was a quote from Billy Madison. I have no worries about Obama or taxes; I had to pay a total of US$69 in taxes for an income about US$22K last year. There were no typos in that last sentence.

    Comment by The Fiery Scribe | February 1, 2009 | Reply

  26. Fiery – Billy Madison? Ouch!

    Comment by Julio | February 2, 2009 | Reply

  27. Here’s a never considered concept for an economic stimulus package that is centered not only on President Obama’s package, but also on the minimum wage, immigration, outsourcing and exporting Technology, which I feel would stimulate the economy faster than what’s been presented in both the House and Senate.

    http://ourcountryspresident.wordpress.com/2009/02/09/minimum-wage-the-key-to-an-economic-stimulus/

    Comment by Tom Awtry | February 9, 2009 | Reply

  28. Tom – thanks for the link. It sounds to me like Congress has their shotgun locked, cocked and ready to fire. I’m not a fan of the bailouts or pork spending. It’s worse if it’s done with debt.

    I agree that immigration needs to be controlled but my approach would be to import brains, not brawn. I would also be against barring outsourcing – that would make us less competitive against the rest of the world. You could imagine gray markets arising like purchasing drugs from Canada that are manufactured here because the price is lower there.

    Comment by Julio | February 9, 2009 | Reply


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