David R. Henderson  

Minimum Wage: The Missing Explanation

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LET THEM WORK

In essence, we have seen the rise of a large class of "zero marginal product workers," to coin a term. Their productivity may not be literally zero, but it is lower than the cost of training, employing, and insuring them. That is why labor is hurting but capital is doing fine; dumping these employees is tough for the workers themselves -- and arguably bad for society at large -- but it simply doesn't damage profits much. It's a cold, hard reality, and one that we will have to deal with, one way or another.

This is from Tyler Cowen and Jayme Lemke, "10 Percent Unemployment Forever?" Read the whole thing--it's not long--and you'll notice that they don't even spend a sentence on a highly likely explanation for at least some, and maybe a good portion of, the current high unemployment rate among the least skilled workers.

They write:

Note that unemployment is low for workers with a college degree, only 5 percent compared with 16 percent for less educated workers with no high school degree. This is consistent with the reality that less-productive individuals, who tend to have less education, have been laid off.

They also write:
But it's harder to explain why unemployed workers can't find new jobs for less pay, especially if output is recovering, profits are high, and corporations are sitting on a lot of cash.

So the unemployment rate among relatively unskilled workers is high--16 percent--and it's hard to explain why they can't find jobs "for less pay?" No, it's not, at least for some of them. The missing explanation is the minimum wage. On July 24, 2009, it increased by 70 cents an hour to $7.25 an hour. Given that there was deflation that year, the real increase was about 12 percent.

Economists have estimated that a 10 percent increase in the minimum wage causes a 1 to 3 percent drop in the number of jobs held by youths (defined as people age 16 to 24.) (That does not imply a -0.1 to -0.3 elasticity, as many people think, for the simple reason that most youths in jobs prior to a minimum wage increase are making well above the minimum wage.)

A 10 percent increase in the minimum wage would, therefore, cause a loss in youth jobs (starting from about 16 million employed) of about 160,000 to 480,000. A 12 percent increase would cause a loss of about 190,000 to about 570,000 jobs. And that's due just to the increase in the minimum wage. The minimum wage, itself, therefore, is responsible for more than those 190,000 to 570,000 missing jobs.

This estimate is in the ballpark of that estimated by labor economist and minimum-wage expert David Neumark. In an article in the Wall Street Journal, "Delay the Minimum Wage Hike," June 12, 2009, he wrote:

The best estimates from studies since the early 1990s suggest that the 11% minimum wage increase scheduled for this summer will lead to the loss of an additional 300,000 jobs among teens and young adults


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CATEGORIES: Labor Market , Regulation



COMMENTS (33 to date)
Seth writes:

I've always been grateful for my first employer's willingness to employ me before I was of age and pay me less than minimum wage.

I learned a lot of good lessons on that first job assembling bicycles in the back room of a shop for $4 cash each and I was the envy of my friends who wished they could find such a lawbreaker to employ them.

I also soon learned a valuable lesson in opportunity cost when I discovered that I could make more mowing lawns.

Maniel writes:

I think the statistics become less meaningful as people are driven from the regulated to the less-regulated economy. Family businesses (dry cleaners, restaurants, gardening services) and underground businesses (drug trafficking) pick up the slack. Since the minimum wage primarily kills jobs for the poor, who have little political power or influence, it is seen as a nice "gift" from politicians to the working class. Statistics from statists follow to show that no-one is injured; statistics from "heartless" economists are dismissed by the media.

givejonadollar writes:

Sure, minimum wage laws hurt more than they help. Most people if given the choice to live on the street, or work at McDonald's, would work at McDonalds.

But, with welfare, and other programs, like student aid, a lot of people will just go to school to simply "get by" and then still never amount to much due to the big debt they now have to pay back.

It's a rotten system all around. If only true capitalism led the way, but we all gripe about that all day. ;)

Brett writes:
I've always been grateful for my first employer's willingness to employ me before I was of age and pay me less than minimum wage.

Same here. My first job was for my uncle, at far less than minimum wage.

That said, I wonder if the minimum wage helps minimize the existence of favela-like slums in the US. There are probably a lot of foreign workers willing to come to the US to work for, say, $2/hour, but that won't exactly buy you much in the way of housing.

David R. Henderson writes:

@Seth,
Great story! Thanks.
@Brett,
The effect is in the other direction. The minimum wage law gives foreign workers a competitive advantage by giving credibility to their promise not to report the employer. See my 2006 article here.

MCH writes:

There was a post here quoting John Goodman on Obamacare as a health minimum wage in addition to the cash minimum wage, with Obamacare potentially making that health minimum wage amount to +$2.28 per hour for an individual without a family and +$5.89 per hour with a family. I think it is fair to put some of the blame on Obama and his policies.

Also, I'm looking at that graph by Robert Higgs on net private business investment. I'm surprised that they can say investment is fine?

DNV writes:

I don't see the minimum wage as a missing explanation.

It's entirely consistent with the hypothesis that "Their productivity may not be literally zero, but it is lower than the cost of training, employing, and insuring them."

To me, it's a subsequent (and more detailed question) to ask what is driving employee costs to exceed employee product (maybe it's min wage, maybe it's immobile labor, maybe it's a million other things).

PAUL writes:

[Comment removed pending confirmation of email address. Email the webmaster@econlib.org to request restoring this comment. A valid email address is required to post comments on EconLog.--Econlib Ed.]

Charles R. Williams writes:

I know several people working at the $7-$10 range. I live in a relatively depressed area. People at this level can find jobs if they want them after a search of a few months. Turnover is high and constant at this pay level. Part of the issue is that extended unemployment benefits combined with expansions in student aid and government funded medical care have reduced the marginal incentives to work.

At higher pay levels people face a much tougher job market and insufficient government assistance. There are people in a really tough spot but they are not the ones near the minimum wage.

Tyler Cowen writes:

DNV is exactly right. Plus, it was a very short piece and we did not have the word count to explain minimum wage logic to our readers, preferring to focus on another point.

Krishnan writes:

Re: Tyler Cowen

That is a non-answer.

Do laws mandating the minimum wage have an effect on the employment of low skill workers?

There are many studies indicating as such - and yes there are always limitations in any piece - but seems to me you did not want to address that fact.

David R. Henderson writes:

@Tyler Cowen,
But if DNV is "exactly right," why mention the word count? Is the minimum wage relevant or not? Or, a separate way of saying it, do you think there's anyone who would be willing to work and any employer who would be willing to hire, at a wage between 0 and $7.25? Do you think this is a small number of people or at least hundreds of thousands of workers and thousands of employers?

Thomas DeMeo writes:

A couple of generations ago, these workers were mixed in with a larger, more diverse talent pool of workers, providing a more positive peer environment. Now, the weakest workers are filtered down into a more concentrated group and are far less likely to be exposed to strong peers.

Also, massive improvements in efficiency make for higher consequences. Now, it is entirely plausible for someone earning minimum wage to make a mistake which costs many thousands of dollars.

The limiting factor for almost all low wage workers is level of personal responsibility, not productivity. Someone who isn't particularly productive is one thing. Someone who can't follow simple directions, and who often destroys product from mistakes or neglect is another matter.

David R. Henderson writes:

@Thomas DeMeo,
All good reasoning. It would be interesting to know the extent to which the lack of mixing that you talk about is itself due to the minimum wage pricing the least-skilled workers out of the mix.
But let's take your point as given and make the extreme assumption that none of them were priced out of the mix. They were still priced out of jobs. Do you really think that everyone willing to work for more than 0 and less than $7.25 would mess up in the way you suggest?

Daublin writes:

Gracious to say so, Tyler, but it would have been better not to write the following: "But it's harder to explain why unemployed workers can't find new jobs for less pay, especially if output is recovering, profits are high, and corporations are sitting on a lot of cash."

If it's easy to explain, why not say so? You would think from the article that high unemployment is some big mystery. It looks rather easy to explain, especially for portable, low-skilled labor.

Note it's not just minimum wage, either. There are a number of ways that the overall cost of hiring is going up, e.g. required medical care.

MikeDC writes:

Tyler,

If DNV is exactly right, why did you spend your words writing on the productive side of the equation rather than the cost side?

I can think of several obvious (and likely sizable) factors increasing cost per worker in low wage labor markets:
* Increased minimum wage.
* Increased opportunity cost of taking a job due to unemployment benefits.
* Increased non-monetary compensation requirements via health care regulations.

Given how obvious these factors are, it seems downright odd to focus on the productivity factors.

Philo writes:

MikeDC has it exactly right. I get the impression that Tyler often tries too hard not to look like a right-wing extremist, and thus avoids making negative comments about liberal shibboleths such as the minimum wage.

Thomas DeMeo writes:

@David Henderson-The minimum wage probably does contribute to segregating the weakest workers, but the changing nature of work is the driving factor here.

Everyone willing to work for less than the minimum wage won't mess up, but enough will that less and less employers will see it as profitable to pursue that segment of workers.

Consider a job stocking shelves in a Walmart today vs. a KMart thirty years ago. Today, Walmart wants to track the price and location of each item real time in the supply chain. Mistakes made by a below average stocking clerk thirty years ago were tolerated or missed altogether. Today's Walmart turns their inventory over twice as fast, but they need their employees to interact with technology in fairly precise ways to make that work.

Who wins? A retailer who can stock shelves with employees making $5 an hour, or Walmart, who can maintain a state of the art inventory management system, but needs better clerks and has to pay $9 hour?

fundamentalist writes:

The minimum wage issue is very important at this point. If the costs of hiring, training and paying entry level workers is too high, obviously the minimum wage is too high.

But it's harder to explain why unemployed workers can't find new jobs for less pay, especially if output is recovering, profits are high, and corporations are sitting on a lot of cash.

The highest unemployment is in capital goods producing industries, just as every other depression in history. Those industries are capital intensive and a lot of capital became worthless in the bust. Workers who depended upon that capital are jobless now.

Workers formerly employed in capital goods industries will not find more work until businesses invest in new capital. They have high profits and large amounts of cash because they are not investing in capital equipment which would require more employees to operate that equipment. And they're not investing because of the regime of uncertainty caused by DC.

The demand curve for labor has shifted very far to the left because of massive destruction of capital. Without that capital, the marginal revenue product of labor is negative, so that workers would need to pay companies for a job.

And keep in mind Mill's law, which Hayek said is the acid test for good economists: the demand for commodities is not the demand for labor. The demand for labor will increase when businesses feel confident enough that Washington won't squash them if they invest.

jc writes:

http://www.cbsnews.com/stories/2010/01/14/60minutes/main6097706_page5.shtml?tag=contentMain;contentBody


"Football has never been more important to the island than right now, because this season there's been more than the usual trouble in paradise. The island may lose its tuna industry. One cannery, Chicken of the Sea, has left. And because the U.S. Congress wanted to help Samoa by imposing American minimum wage, Governor Tulafono is worried that the last cannery, Starkist, could look to other shores."

From a 60 minutes story about NFL players in Samoa.

David C writes:

300,000 jobs comes out to 0.1% of the total population. What if we eliminated the minimum wage? I'm guessing even your highest estimate would put the number at well under 2 million jobs. It's a partial explanation, but there's probably something bigger going on.

RE: MCH

Here is the John Goodman post you were referring to. As Hyena notes in the comments, the actual figure which John Goodman later admits to is $1 an hour. Always read John Goodman's work with skepticism. He's prone to exaggeration and distortion, kind of like Paul Krugman (read second comment).

Tom West writes:

Do you think there's anyone who would be willing to work and any employer who would be willing to hire, at a wage between 0 and $7.25? Do you think this is a small number of people or at least hundreds of thousands of workers and thousands of employers?

I think we can all assume that there is at least some additional unemployment caused by a minimum wage. However, unless you're a politician (where admitting that your preferred policy has any cost is suicide), let's ask the real question: Are the net benefits of the minimum wage law higher than their costs?

Oddly enough, I don't find it hard to believe that given the (admirable) programs that aid the working poor, a substantial lowering of minimum wage laws might *cost* the government money, as the loss of wages by the millions who produce a surplus at the current minimum wage, but don't have pricing power to keep more than the new minimum wage heavily outweigh the new income by those who can now obtain jobs. If the government is essentially topping everyone up to some minimum level with various benefits, it could be a substantial transfer of outlays from business wages to government programs.

Chris Koresko writes:

Question to the room: Would it be more useful to view a minimum wage law as a ban on low-paying jobs than as a floor on wages?

This would suggest a different oversimplified picture: thinking of the law as a wage floor suggests that employment is unchanged but wages rise for workers in existing low-paid jobs. Thinking of it as a ban prompts one imagine that wages are static but low-paid jobs vanish.

Of course what really happens is probably a combination of the two... right?

Maniel writes:

@Chris: “Would it be more useful to view a minimum wage law as a ban on low-paying jobs than as a floor on wages?”
My answer is “yes;” the minimum wage eliminates whole classes of jobs. Picture a poor neighborhood where unemployment is high and the relative number of businesses is low. Although it is not an exact science, most entrepreneurs put a price on risk. In such neighborhoods, the risk (and potential cost) of crime is high; if there is no compensating cost reduction (e.g., from wage rates), a positive cash flow is less likely and entrepreneurs are less likely to open businesses in the first place.
Who knows what the right minimum wage is? Who knows the education level, skill level, age, background, need, mobility, and desire of every entry-level worker? If the legitimate (as opposed to underground) market for labor were deregulated in poor neighborhoods, and people unable to work in the regulated market were now able to find jobs, unemployment would begin to drop, risk would begin to drop, profits would begin to rise, worker capabilities would begin to rise, and (surprise) wages would begin to rise.
Unless you can find someone to hire you at that rate, the minimum wage is a law against working. I am constantly amazed that the minimum wage gets the support of any so-called “leaders” or “advocates” for the poor; since a disproportionate number of poor folks in the USA are members of so-called “minorities,” is there any more racist government policy than one which excludes them from the work force?

Doc Merlin writes:

Well, its really easy to lower the marginal cost for hiring new workers, just lower the legal requirements for hiring such as medical insurance, instead the admin has done the opposite of this.

@Chris Koresko

"Question to the room: Would it be more useful to view a minimum wage law as a ban on low-paying jobs than as a floor on wages?

This would suggest a different oversimplified picture: thinking of the law as a wage floor suggests that employment is unchanged but wages rise for workers in existing low-paid jobs. Thinking of it as a ban prompts one imagine that wages are static but low-paid jobs vanish.
Of course what really happens is probably a combination of the two... right"

Generally, what happens is that hiring freezes and slowly as workers cycle out they are replaced with capital. So instead of unemployment increasing instantly, we see mostly a slowdown in recovery from deep recessions.

Tom West writes:

is there any more racist government policy than one which excludes them from the work force?

Again, we need to weigh their loss against the loss of those who produce a surplus at the current minimum wage (also heavily minority), but are too easily replaced to demand that wage in the absence of minimum wage laws.

Is there any indication that the net total wages paid to minorities would go *up* if minimum wage laws were removed?

Maniel writes:

@Tom West
Again, we need to weigh their loss against the loss of those who produce a surplus at the current minimum wage (also heavily minority), but are too easily replaced to demand that wage in the absence of minimum wage laws.
If I understand correctly, you are saying that the minimum wage protects the jobs of workers whose pay would otherwise drop “in the absence of minimum wage laws.” That could be true, in the short term, but the decline of the domestic auto industry and the extent of outsourcing are evidence that regulation of the labor market which destroys profitability is unsustainable.
Is there any indication that the net total wages paid to minorities would go *up* if minimum wage laws were removed?
Not that I think this is an important question relative to the opportunities which minimum wage laws destroy, but I think that there may actually be evidence to the contrary, at least in the short term. Market forces, like it or not, are strong; those unable to find work in the regulated sector often seek or accept opportunities in the unregulated economy. For example, prohibition has made drug trafficking a high-risk, high-profit enterprise. Any move from this sector to a minimum (or below) wage job might actually push “net total wages” down. That our prisons are now overcrowded (largely minority occupants) is testimony to the destructive nature of both prohibition and the minimum wage laws.

Gepap writes:

A yes, the fundamental liberterian fantasy that if we can just pay people less, we will all thrive.

Just a question, when the wages drop, will shop owners and landlords adjust their prices and rents down?

twv writes:

Gepap, it's not a fundamental libertarian fantasy to pay people less. The point is to pay people more.

A minimum wage law does not pay people more. It prohibits some people from being paid less than the wage rate set at minimum. Reduction in a minimum wage law would allow some people, not currently employed, to be paid more than zero in wages.

The fundamental fantasy of Gepap seems to be that all wages lower and rise with the minimum wage.

I'll let others handle Gepap's second question.

Thanks to David Henderson for bringing up the minimum wage. I've been promoting this as an explanation for some time, and have wondered why so few economists bring it up as a cause for low-skilled workers' high levels of unemployment.

Tom West writes:

but the decline of the domestic auto industry and the extent of outsourcing are evidence that regulation of the labor market which destroys profitability is unsustainable.

Can you name *any* society with no (or close to no) labor laws that you think the US should model itself upon?

Even given the crisis that the auto-industry eventually hit, I'm not certain it's necessarily a net loss for the USA to have actually had labor laws and unionization that led to a middle class large enough to encompass the majority of its citizens during the 1950-1990 period. While the unemployment of extremely marginal workers *is* a real cost, I don't think the transfer of the "excessive" wages garnered from the labor laws to the owner class would make the USA today a better place to live for the majority of its citizens.

Tom West writes:

The fundamental fantasy of Gepap seems to be that all wages lower and rise with the minimum wage.

Perhaps not all wages lower and rise with the minimum wage, but many are pegged to it (or some small measure above it). Those people whose marginal product is less than the new minimum wage *are* out of a job. But the vast majority of minimum wage earners earn for their employers substantially more than they are paid. They simply lack the bargaining power (because the labor is low skill) to demand more than the legal minimum.

How odd it is that so few people here can acknowledge *both* the cost and benefit of the minimum wage.

No wonder it is so hard to craft sensible policy.

Maniel writes:

@Tom West
"While the unemployment of extremely marginal workers *is* a real cost, I don't think the transfer of the "excessive" wages garnered from the labor laws to the owner class would make the USA today a better place to live for the majority of its citizens."
Notice that part of this statement is that "workers" and the "owner class" are separate. If I come to work for you and we do not pull together, how successful can your business be? How can we ever compete in a world where successful businesses are built on cooperation? And why would you hire me for more than I'm worth? How will the USA be a better place if your business fails?

Tom West writes:

If I come to work for you and we do not pull together, how successful can your business be?

I fully agree with that sentiment and have worked for small businesses where we all agreed on what salaries could be safely drawn from the company. However, the vast majority of businesses operate on "what is the minimum we can pay our workforce and still function?". This is a reasonable business practice, but it is now matched by workers operating on "what is maximum I can extract from the company?"

Fairly obviously, companies where these principles operate still manage to be quite successful.

And why would you hire me for more than I'm worth?

If, by 'worth', you mean how much money do you bring in to the company, then minimum wage laws mean that you capture more of your 'worth'. (Unless what you're earning for the company is less than the minimum wage, in which case your job disappears).

How will the USA be a better place if your business fails?

The USA has tens of thousands of businesses fail each year. Is it better off for the failure of those businesses? On the individual level, probably no, but the existence of a system where businesses *can* fail is a huge yes that outweighs the cost of those failures.

In other words, business failure is not the *only* metric to be used to gauge success of a policy. Of course, it is one of the metrics.

Minimum wage may well destroy some jobs (and businesses). But I'm fairly certain that the benefits of greater wages to the (rest of the) poorest workers acts as a fairly large benefit.

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