David R. Henderson  

Minimum Wage Increase Will Reduce Poverty Even Less than I Thought

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In a post earlier this month, I reported on a Brief Analysis I did for the National Center for Policy Analysis, drawing on a journal article by Sabia and Burkhauser, showing that a hypothetical increase in the minimum wage from $7.25 an hour to $9.50 an hour would not be well targeted on poor households. The reason is simple: the vast majority of low-wage workers are not in poor households.

I was pleased to see that bloggers Tyler Cowen, Greg Mankiw, and John Cochrane linked to my post.

Tyler Cowen recently did a post pointing out that the Sabia/Burkhauser results on this issue have not, as far as he knows, been challenged.

I was careful not to say that an increase in the minimum wage would not reduce poverty. I did lay out how, if some of the low-wage workers lose their jobs, the gains to minimum wage workers would be less. But that job loss doesn't mean that increasing the minimum won't reduce poverty.

But now that I have thought more about it, there's more to say. The reduction in poverty you estimate using a Sabia/Burkhauser approach will overstate the reduction in poverty. Why? Because it's a partial equilibrium approach. Sabia and Burkhauser--and I'm not faulting them for this--don't ask the following question: If the minimum wage rises and if the reduction in jobs is minimal, what happens to the households that buy the goods and services produced by low-wage workers?

When the minimum wage increases, costs for employers of low-wage workers rise. When costs rise, the supply curves and marginal cost curves shift up. When the supply curves and marginal cost curves shift up, prices rise.

Who pays those prices? In many cases, households that are close to poverty. When they pay higher prices, their real income falls. When their real income falls, some of them will become poor.

Moreover, when poor people pay higher prices they become poorer. Although that will not show up as increase in poverty--they were already poor--it's not good.

As Steven Landsburg puts it:

The minimum wage takes from the (mostly) relatively poor people who buy a lot of fast food and gives to the (mostly) relatively poor people who serve it. When I go into McDonald's in the morning, most of the customers strike me as less well off than the nice lady who serves me my Egg McMuffin.

So, whereas the direct effect of the minimum wage increase is to reduce poverty, this indirect effect will increase poverty. Which effect would dominate? It's an empirical issue. My gut feel is that the direct effect would dominate and poverty would fall. But I don't have a strong gut feel that the direct effect is much bigger than the indirect effect.

The clearcut implication, though, is that the hypothetical minimum wage increase would reduce poverty even less than I had thought.


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COMMENTS (17 to date)
Daniel Kuehn writes:

Could you explain a little more why you think it's a partial equilibrium effect in the Sabia/Burkhauser approach? I ask out of ignorance of Sabia-Burkhauser. If it's anything like some of the other major papers out there I would think it would be general equilibrium (excluding cross-border spillovers, which should cancel out... how big those are is an empirical question). If you take, for example, Dube, Lester, and Reich employment rates you are looking at employment impacts net of all effects including changes due to rises in prices. Conceptually there are direct and indirect effects of the sort your mention, but you can't pull them apart in - for example - DLR. It's the total effect.

But maybe Sabia-Burkhauser's approach is different?

Daniel Kuehn writes:

I have been writing a lot about the state time trends that Bob Murphy has been musing on lately, but I feel like I need to get to Meer and West and the flows, as well as Sabia-Burkhauser.

As a general reaction to the poverty reduction question, it sounds reasonable to me but I'm not sure poverty is the right lens to look through. I think a few basic calculations show in the first place that it's going to be more relevant for a broader category of low income families than poor families per se.

$7.25 x 35 hours x 50 weeks for someone that actually takes some time off but maybe doesn't have paid vacation and has a generous amount of hours on the cusp of full and part time (OR two part time jobs) gives you $12,687. That already exceeds the poverty line for a single person, and is just a few thousand short of a family of two. If you add minimum wage workers to the family, family income grows faster than the poverty line.

So this is not a poor person's policy from the beginning and certainly not if we're talking about the people making as high as $9.50. You don't even need to go to the data you just need to do a few thought experiments.

Whether it's well-targeted or not is a different question. A lot of these families are still low-income. We seriously consider expanding SCHIP to them, for example, even if not all benefits. I'm not sure how marginal these households are but as we've seen, one minimum wage earner in a household can account for a difference of up to 100% of the FPL, so losing that second or third person could make the family at 300% suddenly at 200%, or the family that's at 200% suddenly 100%. So it's not like these families are in a position where they're marginal workers - their income really matters even if they're not below the poverty line.

So all the commentary so far - from you, Cowen, etc - seems fine as far as it goes but I think it's still clearly a policy targeted at lower income families.

David R. Henderson writes:

@Daniel Kuehn,
Could you explain a little more why you think it's a partial equilibrium effect in the Sabia/Burkhauser approach?
Sure, Daniel. They don’t consider any price increases when the minimum wage increases. So you could even say that it’s even more partial than our usual definition of partial equilibrium. The reason I’m not faulting them is that it’s hard to know how one would do it. You would have to have really good data on which companies are hiring that low-wage labor and on who is buying their goods and services.

Jon Murphy writes:

When discussing minimum wage, I stick to the theory for several reasons:

1) As Don Boudreaux says "theory is utterly necessary for the interpretation of data."

2a) I've yet to see a plausible reason why minimum wage would act differently from other price controls. There have been lots of hypotheticals (monopsony, increased demand, for example), but nothing that really makes sense to me or validates the data I see in the real world.

2b) The explanations that are given appear more to try to fit a preconceived notion onto the facts rather than interpret the facts within a known framework.

For example:

Every January, I go to on a religious retreat at the Emery House SSJE monastery in West Newbury, MA. Every time I am there, it snows. I once went go to a SSJE monastery in South Carolina instead of Emery. It snowed there, too.

The theory is: it is cold in Massachusetts in January. When the temperature is below freezing, it snows instead of rains.

The theory puts the data into a known framework that coincides with other situations (weather patterns in the rest of the country, for example).

But what if someone else came along and said "Clearly, this data shows the theory to be wrong! When Murph went to a monastery in South Carolina, it snowed there, too! Snow doesn't happen in South Carolina! Murph must bring the snow!" What would happen? That person would be laughed out of town. I'm sure he could come up with all kinds of fancy models to show his hypothesis, but it would oppose all common sense.

A blogger whose name I have seen all over the place today had a comment regarding minimum wage that I rather liked: "Is there any other issue where the data conforms so strongly to basic economic intuition, and yet is widely written off as a coincidence?" (He was referring to his charts here)

Daniel Kuehn writes:

David - Gotcha. I thought it was a claim about minimum wage workers. Those estimates should be total effects. But you're thinking beyond that.

The poverty thresholds are adjusted for the price level too, so hopefully this shouldn't muck it up too much.

MingoV writes:

A minimum wage issue I rarely see mentioned is the high cost to businesses due to pay ladders.

If the minimum wage rises by two dollars, it will equal or exceed to hourly rate of a more experienced employee. She will need a similar wage increase. The same is true at the next pay level and the next pay level.

I saw this in a lab I directed. Five recently hired phlebotomists got minimum wage. When it increased we had to raise the pay of the other ten phlebotomists. That made their pay almost as high as medical technician, so they got a pay raise. That put them close to technologists, so they got a pay raise. So did the supervisors. The administrators and I were the only ones who had no pay raise. The total cost was very high for a lab with a 2% profit margin.

Phlebotomists are paid minimum wage?

David R. Henderson writes:

@Daniel Kuehn,
The poverty thresholds are adjusted for the price level too, so hopefully this shouldn't muck it up too much.
Good point, but remember that they’re looking forward in time to a hypothetical minimum wage increase, and I’m willing to bet $ to doughnuts that they take the poverty level cutoff as given and don’t try to figure out how much prices will rise with the increase in the minimum wage.

As Rob Bray demonstrates in his comprehensive paper last year on the Australian Minimum Wage, this is a very complicated problem to measure. Surveying the international evidence he found;

Canada was also the focus of analysis by Strobl and Walsh (2011). They found, between 1981 and 2004, that a higher minimum wage was associated with a fall in the teenage employment to population ratio and with an increase in poverty. This latter occurred because of the loss of teenage employment in low income families. Similar findings are also found by Sen, Rybczynski and Van De Waal (2011) who found that a 10 per cent increase in the minimum wage was associated with a 3 to 5 per cent drop in teenage employment and a 4 to 6 per cent increase in families with incomes below the Canadian Low Income Cut-Offs (LICO) – a measure frequently used in Canada as an income poverty line.

For Spain;

Pinoli (2010) considered the impact of changes in the minimum wage in Spain. The analysis suggests that in some cases adjustment to new minimum wages is made in anticipation of change, and as a result is not wholly identified in studies that simply consider post increase changes. The modelling suggests a 10 per cent increase in the minimum wage for a young adult will generate a fall of 4.7 per cent in the probability of employment prior to the change, and 6.7 per cent after.

Also in Iberia;
A negative impact of minimum wage increases on employment was also found in Portugal. Centeno Duarte and Novo (2012) report that for minimum wage and other low paid workers a one per cent increase in the minimum wage resulted in a reduction of 0.5 per cent in the likelihood of these workers remaining in employment. The effect was larger for those on the prevailing minimum wage, for those working in manufacturing relative to services and young people. The effect on successful job search was more severe than that on continuing employment.

And plenty more information that should be read by anyone seriously interested in the effects of the minimum wage.

william davis writes:

"When costs rise, the supply curves and marginal cost curves shift up. When the supply curves and marginal cost curves shift up, prices rise.

Who pays those prices? In many cases, households that are close to poverty. When they pay higher prices, their real income falls. When their real income falls, some of them will become poor.

Moreover, when poor people pay higher prices they become poorer.."

Are you arguing that the MW increase may change relative prices or the "price level"?

David R. Henderson writes:

@william davis,
Are you arguing that the MW increase may change relative prices or the "price level"?
Really good question, William. I realize now that I wasn’t clear. If the minimum wage doesn’t cause anyone to lose a job, then output is essentially the same and the price level is essentially unchanged. Then the effect I’m talking about would be on relative prices. So one would need to show, to make my point, that low-income people spend a bigger share of their budget than high-income people do, on goods produced by low-wage people. Thus the McDonald’s example.
However, there is still strong reason to believe that a minimum wage increase of that magnitude would cause substantial job loss. That means less output. Lower output means a higher price level.

Sam O. writes:

I find this topic very interesting, but I am somewhat of a novice to economics. Having said that, I've often heard the argument made that minimum wage needs to be raised because it hasn't been adjusted for inflation. But this argument assumes that the average wages across the workforce were keeping up with inflation. And I don't believe this is the case. For the year ending March 2012, I've read that average wages increased by 1.7%, while inflation was increasing at 2.7%. I would think this would add to the idea that a minimum wage increase would shift the supply curve, thus raising prices on consumers that are already struggling to keep up with higher costs.

I may be completely wrong in my thinking, and I am hoping someone on this thread can point me in the right direction

Floccina writes:

Some would say that poor people do not eat a McDonald's because it is much cheaper to eat at home.

[broken, miscoded link removed.--Econlib Ed.]

Floccina writes:

Along the lines of what Daniel Khuehn said above, note that The University of Florida estimates one years living expanses of $10,880. They are not thinking that their students will live in poverty. People often enjoy their college time despite quite low spending, so I often think that what poor people need most is not more money the public good of peaceful street and safety for home beak ins. Therefore instead of Min wage hikes or even wage subsidies perhaps better would be to end the war on drugs reform other criminal laws and put better and more police in areas where poor people live, would be a better way to help.

If middle class boys victims of homicide at the rates that poor blacks are, something would be done.

Hernan writes:

Anyone who is single and working full-time for minimum wage is clearly not happy. Anyone with dependents and working full-time for minimum wage is struggling. No one really appreciates low-paying jobs but teenage kids who still have a safety net to rely on. Minimum wage jobs aren't real jobs. They might make perfect sense in economic theory but people aren't just input objects in a production formula. Perhaps the government should enforce employers pay a higher wage to employees that barely get by.

David R. Henderson writes:

@Hernan,
Perhaps the government should enforce employers pay a higher wage to employees that barely get by.
Hernan, That would be a very cruel policy for those who lose their jobs as a result.

Warner Henry writes:

The "Minimum Wage" concept is a fraud- It has masqueraded as being aimed at the poor, but as many have pointed out, it actually has the opposite effect on the poor. The real purpose is so that all wages can be moved up; but to have that, the irony is that the poor end up subsidizing the middle class. Then there's all those people who are put out of work; a double-whammy...
The "Negative Income Tax" proposed by Milton Friedman many years ago would transfer money to the poor without disrupting everything else....

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