Bryan Caplan  

Phase-In: A Demagogic Theory of the Minimum Wage

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Increases in the minimum wage are usually "phased-in."  Instead of raising the minimum wage overnight, the law usually specifies a series of steps.  The Fair Minimum Wage Act of 2007 increased the prior $5.15 minimum wage in three steps: 
...to $5.85 per hour 60 days after enactment (2007-07-24), to $6.55 per hour 12 months after that (2008-07-24), and finally to $7.25 per hour 12 months after that (2009-07-24)... 
Ron Unz's proposed increase, similarly, has two steps.  In his own words:
The initiative is targeted for the November 2014 ballot. If it passed early in 2015, the minimum wage in California will go up to $10 an hour; early in 2016 it would be raised to $12 an hour. In other words, the initiative in a couple of stages would raise the minimum wage of all California workers to $12 an hour.
What's the point of these byzantine time tables?  Why not just immediately impose the minimum wage you actually want?  On the surface, the steps seem like an implicit admission that sharply and suddenly raising the minimum wage would have the negative disemployment effects emphasized by its critics.  The point of the steps, then, is to turn a dangerously sharp and sudden hike into a harmlessly slow and gradual hike.

On reflection, though, this argument makes very little sense.  Giving people more time to adjust to incentives normally leads to larger adjustments, not smaller.  If you suddenly raise the gas tax, for example, there is very little effect on gas consumption.  But if people expect the gas tax to go up years before the higher tax kicks in, many will buy more fuel-efficient cars, leading to a large behavioral response.  Minimum wage hikes should work the same way: Employers' long-run response should exceed their short-run response.  If minimum wage advocates want to minimize the disemployment effect, they should remember the old adage about ripping off a Band-Aid: One sudden pull and you're done.

On reflection, though, there is another major difference between employers' response to sharp-and-sudden versus slow-and-gradual minimum wage hikes: visibility. 

If the minimum wage unexpectedly jumped to $12 today, the effect on employment, though relatively small, would be blatant.  Employers would wake up with a bunch of unprofitable workers on their hands.  Over the next month or two, we would blame virtually all low-skilled lay-offs on the minimum wage hike - and we'd probably be right to do so. 

If everyone knew the minimum wage was going to be $12 in 2015, however, even a large effect on employment could be virtually invisible.  Employers wouldn't need to lay any workers off.  They could get to their new optimum via reduced hiring and attrition.  When the law finally kicked in, you might find zero extra layoffs, because employers saw the writing on the wall and quietly downsize their workforce in advance.

If you sincerely cared about workers' well-being, of course, it wouldn't make any difference whether the negative side effects of the minimum wage were blatant or subtle.  You'd certainly prefer small but blatant job losses to large but subtle job losses. 

But what if you're a ruthless demagogue, pandering to the public's economic illiteracy in a quest for power?  Then you have a clear reason to prefer the subtle to the blatant.  If you raise the minimum wage to $12 today and low-skilled unemployment doubles overnight, even the benighted masses might connect the dots.  A gradual phase-in is a great insurance policy against a public relations disaster.  As long as the minimum wage takes years to kick in, any half-competent demagogue can find dozens of appealing scapegoats for unemployment of low-skilled workers.

Most non-economists never even consider the possibility that the minimum wage could reduce employment.  Before I studied economics, I was one of these oblivious non-economists.  But if minimum wage activists were as clueless as the typical non-economist, they wouldn't bother with phase-in.  They'd go full speed ahead.  The fact that activists' proposals include phase-in provisions therefore suggests that for all their bluster, they know that negative effects on employment are a serious possibility.  If they really cared about low-skilled workers, they'd struggle to figure out the magnitude of the effect.  Instead, they cleverly make the disemployment effect of the minimum wage too gradual to detect.



COMMENTS (34 to date)
BZ writes:

This question seems awfully easy to answer: can't we just ask them why they do it?

My own conspiracy theory reaffirms your first intuition -- that the steps are to make things easier on the economy by giving adjustment time, whatever that means. The fact that this is empirically suspect theory is not a problem in a world where economics is seen as a branch of Astrology.

teen wolf writes:

Orrr it's a concession made for credibility's sake or to appease opponents of an increase. It still doesn't make it smart, but it's probably safer to assume that people are dumb, rather than intelligent and devious.

teen wolf writes:

Also literally almost everyone considers the possibility that minimum wages decrease employment. I mean, there are plenty of examples of people that don't, and they are either not very smart or willfully ignorant, but even some of the most rabid minimum-wage activists concede that there's a tradeoff and they prefer the higher wages side of it. I'd posit that the counter-intuitive possibility that higher minimum wages can raise employment is something that very few non-economists consider.

teen wolf writes:

It's just weird that your argument requires minimum wage activists to be so blinded by ideology that they... don't actually want welfare to improve for low-income workers.

Which I guess is possible and maybe true of a certain sect of activists, ie the anti-corporatists, but I mean, really?

note: I'm ignoring your ruthless demagogue theory because lol and replacing it with something way more realistic and it still doesn't make sense

Pat writes:

Another question I'd ask is, "Why isn't it pegged to inflation?" Phasing in a minimum wage increase without indexing to inflation will reduce the effects of the law. This is intentional. Economically illiterate voters for whom this is aimed will not realize that inflation will reduce the real impact of future minimum wage increases.

teen wolf writes:

Bryan,

I just want you to know that you made a bad post. It would have been a good post if you just said "Most minimum wage increase proposals have a phase-in, and this isn't good because yadda yadda."

But you didn't do that. You hardly even considered the economics of whether or not a gradual or quick increase would be best. Or maybe you did, but you didn't feel like explaining it because you were really excited about this new conspiracy theory you thought of. It would make a neat sub-plot on like House of Cards or something, but afaik this blog isn't a performance art piece where you present cool fiction ideas as reasonable political economy.

an honest reader,

Teen Wolf

P G writes:

I'm not sure that the right story is that they are cunning, I could imagine a similar situation where the advocates want the minimum wage to be imposed suddenly, but low-wage employers would prefer a phase-in, so that they can adjust their expectations.

Since voters don't think about adjustment effects anyway, it's a low-cost thing for politicians to grant to interests aligned with low-wage employers. The activists are likely to be on an edge of the issue, but the median voter (in congress) will be closer to a deal with a phase-in, so once that compromise is offered that's the one they'll back, seeing that no better deal will present itself.

Justin Ross writes:

I believe this was the subject of the below Journal of Political Economy article: http://www.jstor.org/stable/10.1086/250078

Don Boudreaux writes:

Teen Wolf,

Where in Bryan's post does he offer a conspiracy theory? I don't see one in there.

Also, Bryan did enough, for the purposes of his point, of the economics of fast vs. slow increases in the minimum wage. Perhaps some intricate theoretical considerations beyond the ones that Bryan clearly and correctly identified might make the purely economic case for gradual hikes in minimum wages relatively stronger. But I, for one, don't see what these might be. Because Bryan hit the main points, the burden weighs on you, if you wish your criticism of Bryan's post to stick, to explain what theoretical considerations Bryan missed.

Santiago writes:

This would apply to Card and Krueger as well, the legislation in NJ was passed in 1990 but the increase didn't take place until 1992.

MingoV writes:
Most non-economists never even consider the possibility that the minimum wage could reduce employment.
I worked at a number of minimum wage jobs between ages 14* and 22. I knew back then (1970s) that an increase in the minimum wage meant that some of us workers would be fired. Some economists claim there are no negative affects of increasing the minimum wage. I doubt that any of them worked at a minimum wage job.

*In NY, 14-year-olds could do farm labor such as picking crops. Pay was minimum wage or by amount harvested such as a dollar per gallon of cherries.

Pajser writes:

I'm aware that minimum wage might lead to some unemployment. It is not necessary but it is possible - and very likely, indeed. Still, some increase of minimum wage might be beneficial. It is better that 2 workers work for $10 each than that 3 workers work for $6 each. With some redistribution, without or with help of the state - every worker is better off with 2 × 10. Why slow increase of min wage? To give some time to all these people to adapt. Not to hide anything.


ilya writes:
Why not just immediately impose the minimum wage you actually want?

People may present the following reasoning by which minimum wage controls are said to be welfare-enhancing:

  • companies provide training to workers;
  • since workers can take their training with them, companies can't capture 100% gains from training;
  • therefore companies under-train;
  • if minimum wage rises, companies have no choice but to train workers more;
  • some workers can't be trained and should leave to go into disability rolls/welfare/colleges OR
  • the newly set up government training programs;
  • in the new equilibrium you get the same workers doing similar things, but more effectively, thereby producing more;
  • everyone is happier than before!

For the purposes of this post it doesn't matter whether this model is correct or whether you and me agree to it; what matters is that this is one of the models 'before the eyes' of people who push for higher minimum wages.

Viewed through this model, it makes sense why there should be a waiting period between the announcement and implementation of minimum wage requirements:

  • companies need time to try 'upgrading' the personnel to see which employees deserve higher wage, and which don't;
  • college applications take time;
  • unemployment programs prefer to process new unemployed gradually;
  • government retraining programs need to be set up in advance

Underwriterguy writes:

Pajser:
Isn't it 3 at $6 or 2 at $10 and 1 at $0?

Pajser writes:

Underwriterguy, yes, ( 2 × $10 + 1 × $0 ) vs ( 3 × $6 ). From libertarian point of view the first is better (size of the cake ...). From communist point of view, the first + some redistribution.

EconomicFreedom writes:

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Taeyoung writes:

"If you sincerely cared about workers' well-being, of course, it wouldn't make any difference whether the negative side effects of the minimum wage were blatant or subtle."

No, but if you cared about workers' well-being wouldn't you want to avoid layoffs? Getting fired is pretty traumatic for the people laid off and can have negative effects on their future employability, so if you could bring about the same labour market effect gradually, through reduced hiring and natural attrition, wouldn't the latter be obviously preferable?

I mean, this doesn't even seem like a close question.

SaveyourSelf writes:

Well met, Bryan Caplan. Solid arguments.

James writes:

Pajser,

Your remarks to underwriterguy suggest that you don't know very much about libertarian thinking.

Let me help: Libertarians define the size of the cake as the total output in goods and services, not the nominal value of wage income. If a higher minimum wage reduces employment, output goes down because there are less workers producing goods and services.

Even with redistribution, the disemployment effect of a minimum wage leads to a less wealthy society. Do you seriously see this as desirable?

Pajser writes:

James, let me see. From libertarian point of view, 2 × $10 + 1 × $0 is worse than 3 x $6 — for whole society. Because one worker doesn't work. But from same point of view, 2 x $10 + 1 x $0 is better for these three low skilled workers: they work less and they are paid more. Is it right now?


john hare writes:

Pajser,

In your scenerio, either three workers produce 120 hours of work per week for $720.00, or two workers produce 80 hours of work for $800.00. It sounds like you are saying less work and more money is a net win. You seem to be forgetting that third worker that earns zero.

Do you take from the two productive to support him, or do you let him starve? If you choose to let him starve, he has lost big time. If you choose to let him be supported by the two still working, then the workers will resent the "dead weight" of the "lazy". Worse is that they will produce less hours of production which means that the 3x6 vs 2x10+1x0 actually becomes 3x0 when the jobs the other two would have done are sent off shore.

Pajser writes:

John Hare - It is possible that all workers frequently change short-term jobs; in that case redistribution is not needed. If workers do not change jobs frequently, some redistribution from employed to unemployed workers are necessary. Of course, redistribution opens complicated issues..

Caplan's post argue that people who support minimum wage do not think about low skill workers who'll stay without job. Comparison 2×10+1×0 vs. 3×6 is meant to show how I think and why I am not concerned with loss of jobs.

Nathan Smith writes:

Good argument, Bryan. Though Ilya also has good points.

I would note that minimum wage advocates could (a) be aware of the unemployment effect but (b) think it's worth it for higher wages for workers' welfare and (c) still want to deceive the public for politics' sake.

I think if we raised the minimum wage to $12/hour, the unemployment effect would be so obviius that even a phase-in couldn't mask it.

Remember that the harms of the minimum wage go beyond just unemployment (and lower labor force participation). People will also be forced into less desirable jobs on non-wage dimensions such as fun and human capital development.

Seth writes:

Do studies like at the time window around when the hike takes place or from the time it is announced?

Jam3z Aitch writes:

A good argument, but I do have one quibble on the political side. It could be that supporters propose phase-ins in order to buy political support from opponents. It's a lot easier to get people to accept bite-size changes that cumulatively add up to a full-meal change than it is to get them to swallow the whole meal at once.

From my conversations with minimum wage increase supporters, and my observations of politicians (as a political scientist), I'm dubious that there are many who understand the point you're making. I suspect ignorance is more at play than clever nefariousness.

That is, I suspect it's not just voters who are irrational, but a large number of the legislators who've been elected by those voters.

Valerie Keefe writes:

So this should create significantly lower 15-24 employment, hmm?

http://srv116.services.gc.ca/dimt-wid/SM-MW/rpt2.aspx?lang=eng&dec=5

Well, Canada and the US did a little accidental experiment there, and the Canadians, who raised their minimum wage about 40% in productivity terms, and 60% in real terms, gave us a 1.7% fall in 15-24 employment from 2000 to 2012, from 56.2 to 54.5%. 25-64 employment increased by 1.9% from 74.5 to 76.4%. That's an increased spread of 3.6%

The Americans, who let their minimum wage fall in GDP/hour terms, saw their 15-24 employment fall 13.7%, from 59.7 to 46%. Meanwhile 25-64 employment fell by 5.3% from 77.5% to 72.2%. That's an increased spread of 8.4%

http://stats.oecd.org/Index.aspx?DatasetCode=LFS_D

So again, the country that raised its minimum wage in GDP/hour terms saw a smaller widening of employment rate spreads than the country that allowed theirs to fall. That's a very small amount of disemployment for such a job killer. Canada and the US are both large, developed, economies, which have similar consumption patterns and had similar 25-64 to 15-24 employment ratios at the outset of the decade. Both are running below their estimated potential GDP, the US by 6% and Canada by 3%, and interestingly, half of the US decline, 6.6%, occurred by 2007. Now if the 2001 recession is the same magnitude of economy-reorganizing disaster that the 2008 recession was, you'll forgive me for noting that most neoliberal pundits haven't said so yet.

Canada heavily subsidizes its tuition and loans are freely available, so it can't be a rush into education, though with a job market this discouraging, I wouldn't be surprised to see enrollment numbers up, as college-age adults flee the workforce.

It can't be resources. Have you seen the spreads on Brent Crude vs. Tar Sands oil recently? Not to mention that the trend would've favoured US employment gains.

The labour supply curve is relatively inelastic and downward sloping, but despite the arguments of the Cowenites that low-wage workers are paid near their marginal productivity (which means that the exit of the bottom 2 percent from the labour force would only reduce output by 0.3%) you can only strangle wage share so long before work doesn't pay.

It's sad when people who call themselves the heirs of Adam Smith don't bother to read what he had to say:

What are the common wages of labour, depends everywhere upon the contract usually made between those two parties, whose interests are by no means the same. The workmen desire to get as much, the masters to give as little as possible. The former are disposed to combine in order to raise, the latter in order to lower the wages of labour.

It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into a compliance with their terms. The masters, being fewer in number, can combine much more easily; and the law, besides, authorizes, or at least does not prohibit their combinations, while it prohibits those of the workmen. We have no acts of parliament against combining to lower the price of work; but many against combining to raise it. In all such disputes the masters can hold out much longer. A landlord, a farmer, a master manufacturer, a merchant, though they did not employ a single workman, could generally live a year or two upon the stocks which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year without employment. In the long run the workman may be as necessary to his master as his master is to him; but the necessity is not so immediate.

We rarely hear, it has been said, of the combinations of masters, though frequently of those of workmen. But whoever imagines, upon this account, that masters rarely combine, is as ignorant of the world as of the subject. Masters are always and everywhere in a sort of tacit, but constant and uniform combination, not to raise the wages of labour above their actual rate. To violate this combination is everywhere a most unpopular action, and a sort of reproach to a master among his neighbours and equals. We seldom, indeed, hear of this combination, because it is the usual, and one may say, the natural state of things, which nobody ever hears of. Masters, too, sometimes enter into particular combinations to sink the wages of labour even below this rate. These are always conducted with the utmost silence and secrecy, till the moment of execution, and when the workmen yield, as they sometimes do, without resistance, though severely felt by them, they are never heard of by other people.

Gabriel writes:
Getting fired is pretty traumatic for the people laid off and can have negative effects on their future employability, so if you could bring about the same labour market effect gradually, through reduced hiring and natural attrition, wouldn't the latter be obviously preferable?

Staying unemployed for a long period is also "pretty traumatic" and probably worse for your future employability than being fired right after a big minimum wage.

Why is it better for the insiders to keep their jobs and the outsiders to remain outside of the job market because of reduced hiring?

Floccina writes:
Well, Canada and the US did a little accidental experiment there, and the Canadians, who raised their minimum wage about 40% in productivity terms, and 60% in real terms, gave us a 1.7% fall in 15-24 employment from 2000 to 2012, from 56.2 to 54.5%. 25-64 employment increased by 1.9% from 74.5 to 76.4%. That's an increased spread of 3.6%

The Americans, who let their minimum wage fall in GDP/hour terms, saw their 15-24 employment fall 13.7%, from 59.7 to 46%. Meanwhile 25-64 employment fell by 5.3% from 77.5% to 72.2%. That's an increased spread of 8.4%

I though that was due to Canada's superior banking system.

Nathan Smith writes:

To valerie:

Obviously, there are LOTS of confounding variables in the US-Canada comparison. The two biggest: (a) the US had a massive banking crisis in 2008; and (b) natural resource prices surged in 2000-2012, helping Canada and hurting the US.

The Adam Smith quote is cute, but are you seriously suggesting that US labor markets are characterized by widespread monopsony and/or collusion among employers to hold down wages?

It's funny how often minimum wage advocacy actually reinforces my conviction that it's a function of economic illiteracy.

john hare writes:

Pajser,
In the scenerio we are discussing, this minimum wage hike has affected the whole country, which means that those unemployed low productive workers are not going to find jobs. All the jobs in that catagory are impacted simultaneously. So high unemployment for for the low skill people.

As an employer myself, I see a dimension that I think you are missing. Two workers of similar skill and equipment cannot produce as much product or service as three workers. Given some means of increasing their productivity by 50%, the rational employer will have already applied those means to achieve a cost structure of 2x$6 instead of 3x$6. A 33% labor saving is enormous in a buisness that is making under 10% net profit.

I also believe you are ignoring the origin of the money used to pay these workers. It is always from the customer at some point. the 66% wage increase you postulate will always come from the customer as there is no other source for the money. When the $6.00 Big Mac meal goes to $10.00 due to the wage increase, I'm out of there, and probably will have plenty of company.

It is my opinion that you are likely one of the people that have a base concept that businesses make so much profit, that raises would simply be a minor cut in executive salaries and stock holder dividends. That belief would make your argument entirely rational to you. If I am wrong, let me apologize in advance.

Valerie Keefe writes:

Nathan Smith -

1. That's why you should look at the rates during the Bush Expansion. Also, Canada also suffered the effects of the financial crisis, running an output gap a little larger than half the size of the US output gap

2. Yes, I am saying monopsonistic behavior, collusion, mostly implicit, and the natural leverage that employers enjoy is driving wages below the level we'd see in a classical free market. You don't think workplace requirements enjoining disclosure of wages isn't evidence of employers engaging in first-degree price discrimination? Talk about economic illiteracy.

3. I don't think I advanced a particular wage level, though I do prefer 25-30% of GDP per hour worked as a target. But that said, when that $6 Big Mac meal goes to $10, I expect the manager would be fired for making labour 100% of their factor costs. With a wage bill around 30%, however, and the realization that asset prices can also fall, I don't think that Big Mac's looking any pricier than $7, and now purchased with a $12/hour minimum wage, is only going to cost 35 minutes labour instead of the 50 minutes it cost before.

I always love the sheer economic illiteracy of someone who believes that asset prices can never fall to maintain yield for new entrants in response to a shift in the market for inputs. Falling real yields translate to a fall in asset prices translate into recovering yields. It's not about making a lower rate of return. It's about being handed a capital loss to after all the capital gains won over four decades of brazen regulatory capture. And if those gains were squandered because rentiers captured the company from increasingly disinterested and short-term-movement-focused shareholders, well, caveat emptor, I think. So no, money doesn't always come from consumers, so sorry. If you don't believe me, tell me why construction wages don't track house prices dollar-for-dollar, since companies in your model have to make the exact same amount of absolute profit in all instances.

It should also be noted that Canada and the US have similar median-minimum wage spreads (Canada a bit more egalitarian at 1.51 to the US' 1.58, so that minimum wage increase is probably making that Big Mac affordable to the millions who are buying it.

Tom West writes:

Valerie, the problem is that there enough uncontrolled variables in any economics experiment that the results are essentially irrelevant to the discussion.

Among those who dislike the minimum wage, any study that shows something other than increasing unemployment are, by there very nature, flawed. If they weren't flawed, then they would have come up with the correct result, increasing unemployment.

Outside of a few extremely generally accepted theories, economics in the real world is mostly a matter of affiliation. You simply choose the experiments that fit your world-view and ignore the rest as flawed because, well, they produce results that can't possibly be true.

Applies pretty much to all sides.

Readme writes:

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Taeyoung writes:

Re: Gabriel

Why is it better for the insiders to keep their jobs and the outsiders to remain outside of the job market because of reduced hiring?

Endowment effect.

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