The Economic Policy Institute has released a letter signed by 75 economists–including 7 winners of the Nobel (Memorial) Prize in economics–calling for the federal government to raise the national minimum wage from its current level of $7.25 to $10.10 by 2016. In this post I want to explain how this is possible, and why I remain wedded to the (literally) textbook discussion of minimum wages.
The obvious downside of raising the minimum wage is that it would cause unemployment among low-skilled workers, the very people allegedly being helped. Yet according to the EPI letter, the evidence shows that previous increases in the minimum wage have had “little or no negative effect on the employment of minimum wage workers, even during times of weakness in the labor market.”
If you want to see where these economists are coming from, try this survey article. It documents how the consensus through the 1990s used to be just what we all learned (and taught, for some of us) in Intro: Raising the minimum wage reduces the quantity demanded for low-skilled workers, thereby reducing job opportunities.
Yet from the 1990s onward, the literature began shifting. From today’s vantage point, the new consensus is apparently that modest increases in the minimum wage have little impact on employment. Hence, you have progressive economists clamoring for a hike, who say that the critics relying on “textbook economics” haven’t kept up with the cutting-edge literature.
I have several responses to these developments:
(1) Even among the studies that conclude a hike in the minimum wage will have little discernible impact, the outcome is couched as a “modest” hike. I have seen studies say things like “a 10 percent increase in the minimum wage will have such and such effect.” Yet disregarding price inflation through 2016, the EPI letter calls for a 39% increase! I could be mistaken, but I don’t think there exists a single academic study concluding that a 39% hike in the minimum wage would have no appreciable effect on employment. Thus, even if we stipulated all of the recent empirical studies as gospel, the 75 economists have no basis for their recommended policy. At best they should be arguing that, say, a hike from the current $7.25 to $8 per hour (and thereafter adjusted for price inflation) would not measurably hurt employment.
(2) Again, even taking the new generation of studies at face value, they overlook a major drawback to the progressive goal: The studies look at the absolute growth in employment, rather than the unemployment rate, among low-skill workers. So even if it’s true that, say, a Burger King franchise will hire roughly the same number of teenagers between now and 2020 as it otherwise would have, it might not be the same group of teenagers getting jobs. Rather, at the $7.25 level there will be lower-skilled applicants cycling through, with a high turnover rate as the store manager tries to find the few decent workers in the bunch. At the higher rate of $10.10 per hour, higher-skilled kids (perhaps those from affluent families who are home from college) will enter the mix in greater numbers. The manager will be pickier on the front end in giving somebody a bite at the apple, and there will be less turnover. (Note that this isn’t merely hypothetical; the studies finding “no effect” often cite “lower job turnover” as an explanation for how the firm responds.) Thus, even taking the studies at face value, it is entirely possible that there are a bunch of people with low skills who now can’t get a job, who otherwise would have been able to. They are merely being displaced by higher skilled workers who otherwise would not have been interested in a position paying so little.
(3) Finally, I am not convinced that we should take these new studies at face value. I admit that I have not studied them in depth, but if you look at the discussion in the survey article I mentioned above, here’s what it sounds like: You can take all of the adjacent counties in the country for which you have continuous data over a long period (such as 16 years), where the applicable minimum wage is occasionally different in each county (because they fall in different states). If you “naively” run a regression on this dataset, then the classical consensus emerges: It does indeed seem that a higher minimum wage is associated with a slowdown in the growth of employment. However, this could be a spurious result, because states with high population growth might just so happen to also match the federal minimum wage, rather than setting a higher state level. To correct for this, the newer studies introduced a regional dummy variable into the regression analysis, at which point the negative effect of the minimum wage almost disappears.
If indeed what I just described is what’s going on, then that seems ludicrous. The point of matching contiguous counties is to isolate all other relevant variables, except for the applicable minimum wage. You can’t use the weather (one of the explanations given in the survey article to explain the flaw in the original studies, which did not correct for geography) to explain why people would flock to one county versus the adjacent one.
To repeat, I admit I haven’t personally vetted the individual articles and looked at their t-statistics, but I am very suspicious that their procedure is illegitimately dampening the very real result–which accords with common sense–that raising the price of low-skill labor will cause employers to hire fewer such workers. In short, demand curves slope downward.
UPDATE: At the urging of Ken B. in the comments, I dug up a previous post where I walked through my final point on the contiguous county pairs. Here it is.