David R. Henderson  

Tim Taylor on Minimum Wage Increase

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Tim Taylor, aka, the Conversable Economist, has a good post on the minimum wage. He makes one crucial error, though. Quoting from his own book, he writes:

Here's an insight for opponents of a higher minimum wage to mull over: Let's say a 20 percent rise in the minimum wage leads to 4 percent fewer jobs for low-skilled workers (as some of the evidence suggests). But this also implies that a higher minimum wage leads to a pay raise for 96 percent of low-skilled workers. Many people in low-skill jobs don't have full-time, year-round jobs. So perhaps these workers work 4 percent fewer hours in a year, but they get 20 percent higher pay for the hours they do work. In this scenario, even if the minimum wage reduces the number of jobs or the number of hours available, raising it could still make the vast majority of low-skilled workers better off, as they'd work fewer hours at a higher wage.

Tim goes on to point out that the tradeoff is not nearly that favorable for the minimum wage when you play out the consequences for the 4 percent who would lose their jobs:
There's another side to the argument, however. The short-term costs to an individual of not being able to find a job are quite large, while the benefits of slightly higher wages are (relatively speaking) somewhat smaller, so the costs to the few who can't find jobs because of a higher minimum wage may be in some sense more severe than the smaller benefits to individuals who are paid more. Those costs of higher unemployment are also unlikely to be spread evenly across the economy; instead, they are likely to be concentrated in communities that are already economically disadvantaged. Also, low-skill jobs are often entry-level jobs. If low-skill jobs become less available, the bottom rung on the employment ladder becomes less available to low-skilled workers. Thus, higher minimum wages might offer modest gains to the substantial number of low-skilled workers who get jobs, but impose substantial economic injury on those who can't.

So where's his error? In the first quoted paragraph. Specifically this sentence:
But this also implies that a higher minimum wage leads to a pay raise for 96 percent of low-skilled workers.

No it doesn't. Tim's assuming, incorrectly, that the 96 percent are all employed at wages between the old minimum and the new minimum. In fact, the wage distribution is much wider than that. I'm guessing that he's thinking of the rule of thumb that a 10% increase in the minimum wage leads to a 1 to 2% decrease in youth employment, where youths are people age 16 to 24. But the majority of youths are earning above even the new minimum that many people propose. And even a large percent of relatively unskilled workers are likely be earning above the new minimum wage. Next time you're at McDonald's, ask the person behind the counter what his/her hourly wage is. So, absent ripple effects, they won't see any increase. Moreover, a substantial portion of the workers above the old minimum but below the new minimum are earning close to the new minimum and won't see much of an increase. This latter point doesn't contradict Tim's claim because he didn't say they get a big increase. But some of his readers may be misled on that point and so the point is worth making.

Moreover, it seems unlikely that the employers who were paying below the new minimum and now keep most of those workers at the new minimum will simply be passive and won't adjust other parts of the pay package and all in one direction: downward.

Tim makes a good case against a higher minimum wage. But in those two respects, he understates the case.


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CATEGORIES: Labor Market



COMMENTS (14 to date)
John Thacker writes:
Moreover, it seems unlikely that the employers who were paying below the new minimum and now keep most of those workers at the new minimum will simply be passive and won't adjust other parts of the pay package and all in one direction: downward.

By "other parts of the pay package" are you referring to benefits and other non-wage compensation here? The transition to part time work makes it more likely that benefits could be cut.

David R. Henderson writes:

@John Thacker,
By "other parts of the pay package" are you referring to benefits and other non-wage compensation here? The transition to part time work makes it more likely that benefits could be cut.
Mainly, yes, but also training that takes employer's or other more senior employees' time.

Phil writes:

Let's suppose that a 20 percent increase leads to, on average, an 10 percent increase in pay for low-skilled workers, and a 4 percent drop in their numbers.

It looks like it's a net gain, doesn't it? You have the same number of people, making 5.6% more than before (96 percent are making 10 percent more money, 4 percent drop to zero).

It still sounds like a reasonable policy, though, doesn't it? Take 5.6% from the rich employer and give it to 96% of the poor employees.

But, prices will have to rise. How much? My guess is, enough to cover most of the 5.6%. (Is there an argument that it has to cover *all* of it? Does it depend on elasticity of demand for the product?)

So this policy takes a bit of money from each consumer, and a LOT of money from unemployed low-skill workers (in the sense that it takes their entire job), and gives it to employed low-skill workers.

If the employer's product is bought mostly by low-income consumers, the poor are HURT. 96 percent of Wal-Mart employees get a 10 raise, but 4 percent get fired, and millions of poor Wal-Mart shoppers pay an extra few dollars a year to the remaining employees in the form of higher prices.

I dunno, doesn't seem like a well thought-out redistribution to me. If you think low-skill employees should have more money, why not just give them money out of tax revenues instead of screwing around in ways that you can't measure perfectly, but you know hurt other poor people?

Plus, I'm pretty confident there's a large deadweight loss to this, even if I can't come up with an argument to prove it.

justin writes:

This depends on what he means by low-skilled workers. If he simply means "workers who are being paid minimum wage", doesn't his argument still hold?

David R. Henderson writes:

@Phil,
Well put. A couple of responses and picky points.
1. Yes, if the elasticity of supply were infinite (horizontal supply curve), then the consumer would pay the whole cost increase. The cost increase would be less than otherwise to the extent that employers can substitute capital for labor. But still, consumers would bear it.
2. Re Wal-Mart. Wal-Mart would likely not face much of an increase in labor costs because virtually all their employees are paid more than the old minimum and more than the likely new higher minimum that Tim Taylor discusses. Also, much as I am a fan of Wal-Mart, I'm not a fan of Wal-Mart's politics: the CEO a few years ago favored a minimum wage increase. I'm guessing it's to reduce competition from his more-labor-intensive small-store rivals.
3. Re DWL. I'm guessing it's small but that doesn't mean it's small per dollar of redistribution.

David R. Henderson writes:

@justin,
This depends on what he means by low-skilled workers. If he simply means "workers who are being paid minimum wage", doesn't his argument still hold?
Yes, his argument would hold, but his numbers wouldn't. Then the tradeoff would be much tougher. My gut feel is that it would be more like 20 people out of 100 losing their jobs and 80 getting an increase.

Phil writes:

David,

Thanks for the response!

And agreed on Wal-Mart ... it came to mind because many pundits argue that it underpays its employees.

Et tu, Boris;

The London Mayor, who is tipped as a future Conservative leader, urged businesses to "wake up to the huge benefits that paying the living wage delivers”.
"By building motivated, dedicated work forces the living wage helps businesses to boost the bottom line and ensures that hard working people who contribute to London’s success can enjoy a decent standard of living," he said.

If so, then politicians wouldn't have to tell businesses what they'd have learned already, no?

Andrew writes:

Always lost in the minimum wage discussion is what happens to those above the minimum wage. Wage fiat by government dictate doesn't increase the pool of monies available to pay the rest of the workforce.

The losses aren't only felt by those at the bottom end of the income scale.

david writes:
My gut feel is that it would be more like 20 people out of 100 losing their jobs and 80 getting an increase.

Seems a bit high. Wouldn't this reduce the impact:

Moreover, it seems unlikely that the employers who were paying below the new minimum and now keep most of those workers at the new minimum will simply be passive and won't adjust other parts of the pay package and all in one direction: downward.
David R. Henderson writes:

@david,
Yes, it would. That's why it's 20 instead of, say, 40. But remember that it's a gut feel.

john hare writes:

It seems rather simple to me. Any increase in business costs can only be charged to three entities, the business, the employees, or the customers. Unless the business is high profit and willing to settle for less, (unlikely in a competitive market) the employees and customers will pay the increase. If the customers have other options, the employees will carry the whole cost through raises not given and benefits not received. The raises not given and benefits not received`are invisible to the people most affected.

The other problem is that the lower number of employees will likely not produce the same volume of results. This will drive up the cost to the customer unless offset by the raises and benefits not received. This is one of the components of off shoring of jobs.

Another problem mentioned by others is that people that don't enter the work force in the first place do not move up in wages and status in the second place.

Steve Sailer writes:

American libertarians really ought to move on beyond the minimum wage as their all purpose stock example. They've mostly won that policy debate in practice, so the federal minimum wage is pretty minimal these days.

Liam McDonald writes:

@David Henderson.

In regards to your comment about the CEO of Wal-Mart being in favour of increasing minimum wage.
Are you saying that the CEO, supporting the increase in the minimum wage to reduce competition is an unfair business practise? I will admit it is not a nice thing to do to the Mom and Pop shops (if that is in fact why) but I don't think I would really call it unfair. It is working within the confines of Governmental policies and Lord knows that the local shops have certainly used other policies to keep Wal-Mart out of their markets (I'm thinking of local zoning ordinances) so it looks more like tit for tat in my opinion.

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