The Minimum Wage and Unemployment, or, Bye Bye, Miss American Pie (No such thing as a Free Lunch)

With all of the talk of the economic ~~recovery~~ tailspin engendered by the Obambi administration, one government mandate has slipped under the radar with relatively little fanfare. This is an increase in the federally mandated minimum-wage up to $7.25 per hour. It is the latest in three hikes in the minimum wage, dating from two years ago: the minimum wage was raised to $5.85 per hour on July 24, 2007; to $6.55 / hour on July 24 2008; and finally to $7.25 / hour last week.

The Obambi administration is using it as a platform to proclaim more of their race-class-gender warfare, as on MSNBC's website, where the Secretary of Labor is quoted as saying

"This well-deserved increase will help workers better provide for their families in the face of todays economic challenges. I am especially pleased that the change will benefit working women, who make up two-thirds of minimum wage earners."

Let us take for example the Economic Policy Institute, founded in 1986, and which counts on its board such luminaries as Bill Clinton's Labor Secretary Robert B. Reich. There is a paper from before the current round of hikes in the minimum wage, here, which seems to argue that raising the minimum wage, based on a number of studies, does not cause significant job loss among minumum-wage employees. To quote:

"responding to concerns that both sets of data were not from an official government source, Card and Krueger expanded their research to include analysis of ES-202 data from the federal Bureau of Labor Statistics. These data are employer-provided and collected by state employment security agencies for unemployment insurance tax purposes and, as such, represent a virtual census of employment. Using these data, Card and Krueger find that their original results remained the most plausible—that the minimum wage increase in New Jersey had no effect on employment in the fast-food industry (Card and Krueger 2000)."

Now, how can this be? It is surely axiomatic that if an item is priced above the market equilbrium value, that demand for that item plummets, right?

Yes and no. What? Am I saying there is no such thing as supply and demand? Well, not exactly. The idea of supply and demand is a useful concept, but it is idealized. Supply and demand is often explained by the example of the price of chocolate bars -- would you buy this candy bar if it was just a penny? How about two pennies? A dime? A quarter? Fifty cents? Seventy five? And on, and on, until finally nobody is willing to pay five or ten dollars for a candy bar. A similar description is given on the demand curve, in terms of profits -- the price minus the fixed cost -- how many candy bars will you produce for a profit of 100 dollars a candy bar? Fifty dollars? One dollar? A quarter? And so on, for the supply curve. And so the equilibrium, supply and demand price of the chocolate bar is the price at which the number of candy bars offered matches the number of candy bars demanded. (Make mine dark chocolate, please.)

At this point, it is worth pointing out that hiring by an industry is not quite the same thing as one individual decision whether or not to buy a widget: it is based not on one single individual, but on many individuals, a population. And this means that not only do you have some number of workers who decide whether they are going to work for a given wage -- you actually are choosing from a population of workers who are offering to work at your job. And by raising the price you offer (in a static world) you increase the caliber of applicants. Someone who might not consider your job for five dollars an hour, who normally works for ten dollars an hour, just might consider taking your job at eight dollars an hour if times get tough(+). In addition, there is the possibility that the higher class of workers have less absenteeism, fewer sick days, and greater productivity than the original workers.

There are a couple of other factors at work as well. Let us look at the blog Half-Sigma for an article on Elasticity of Demand and the Minimum Wage. They show the surprising result that there might not be a sharp dropoff in demand at one specific price. The concept of demand elasticity takes the supply-demand curve and quantifies it. To put it in English -- if something is VERY cheap to begin with, and it doubles in price, it's still very cheap, so you won't notice much change in demand. But if something is VERY expensive to begin with, then a further increase in price might make for a very noticeable drop in demand. The examples the blog uses are the price of gasoline vs. the price of cars:

"This example demonstrates the principle that low priced goods have low elasticities of demand. This is why the price of gasoline doubled yet there was no decrease in demand. The price of gasoline is low compared to the much higher price of the motor vehicle it powers. On the other hand, if the price of cars doubled, I'm sure you'd see a decrease in the number purchased. "

However, it is interesting that one of the comments to the blog uses the counterexample of minimum-wage labor:

"Image a city with two dry cleaners, All-American cleaners that employees parttime workers and Peking Cleaners that uses an extended family that are not paid wages. Payroll expenses for All American cleaners is 30% of expenses. If the cost of labor goes up 40% then payroll expenses as a percentage of total costs goes up. Yet All-American Cleaners cannot raise his prices since Peking Cleaners is not raising their prices. The owners of All-American Cleaners either lowers his profit and thus standard of living, adopts labor saving technology, or sells out to an immigrant family who also has the business advantage of not having a payroll and the associated payroll taxes. An increase in minimum wages gives immigrant run small business a huge advantage versus their competitors. "

"Also it also gives incentive to hire illegal workers and pay them under the table. The higher the minimum wage gets, the more attractive hiring illegal immigrants gets. "

So what we have seen so far is that if the minimum wage goes up, that demand for workers might not go down directly: but that they can eliminate the positions outright, or by productivity increases and automation. Or by finding another group of workers who will do the same job at lower wages: say hello to immigration visas and offshoring. More on this later.

But let us not forget about a population of workers -- in addition to illegal workers coming in from below, we might have higher-paid legal workers coming in from above. If you raise the salary for a low-level job enough, former higher-level workers might come to work at positions which used to be "beneath them"; and that productivity might, or might not increase.

So what happens if workers are willing to do lower-end jobs for the same money? What happens to the supply of workers for those higher-end jobs? Why, it decreases. Because relatively few workers who are currently toiling at minimum wage will be able to jump *up* to a higher-level job, compared to the number who can migrate *down*. This will affect the supply-demand curve for the higher-end jobs -- employers who are unable to fill their ranks will then themselves have to offer more money to replace the workers, or eliminate the positions. So if one set of jobs is subject to a pay increase, there will be a ripple effect: either workers will be cannibalized from other higher paying positions, or positions will be eliminated, or they will seek other low-end employees to do the work -- some of them may even be "illegal immigrants" (err, "undocumented workers") brought in to do "jobs Americans won't do". That is, brought in to do work illegally paid in cash, at below government-mandated wages. This has the effect of "pricing Americans out of the market" -- and eventually, lowering wage scales across the board, and lowering the standard of living.

Just like with paying taxes, the employment market itself is not static. People and companies tend to react to government dictates. In fact, in order to recoup their higher government-mandated labor costs, some companies (who, unlike economists, who are wedded to considering one model at a time) might skip their consideration of employees altogether and make up the higher costs by raising their prices.

And if you mandate higher labor costs across an entire industry, you make this even more likely than before: everyone who is competing is facing the same change in their cost structure at the same time. Which will tend to undo the entire rationale for minimum wage hikes, as the higher price structure ripples through the economy. And, just as in the case of bringing in illegal workers, lowering the standard of living.

But there is one other major element in the labor market which the preceding discussion brings up. Remember when I said that labor markets are dynamic and not static? Companies make decisions based on anticipated costs, and anticipated revenue, going forward, as well as in reaction to the immediate past. And with the promise of large tax hikes, increased hikes in the minimum wage, increased regulatory costs, and increases in the cost of government-mandated health care, it's just not worth taking the risk of expansion. Which means there is just not as much demand for new workers, let alone at a new, higher, government mandated price.

Consider the following article, also from the Economic Policy Institute. This is from July of 2009, after some of the minimum wage hikes of past years have taken effect, and after the change in Congress and the Presidency to Democrat control.

(+)The pool of workers includes everyone from convicted felons (who hope you don't perform a background check) to Nobel-prize level researchers -- as these links show, sometimes they are competing for the same low-level jobs.

(*)And the oddest thing of all is, The Economic Policy Institute, of all people, should have seen this coming.

Their founder, Jeff Faux, wrote this article back in 2005 as a devastating critique of the book The World is Flat, by The New York Times's Ron Friedman. The money quote is near the end:

"Friedman is blind to the class structure that inevitably grows out of this horizontal flatten- ing. Ex-Mexican president Ernesto Zedillo, who oversaw the destruction of Mexico’s small farmers and domestic industries by the North American Free Trade Agreement, complains to him that Mexico needs more infrastructure. “The only way for government to serve is to get people to pay higher taxes [but] then populism comes up and kills it.” It is the rich and powerful who don’t pay taxes in Mexico. Instead of taxing the oligarchs, Mexican “reformers” like Zedillo raised taxes on food and medicine in a country where almost half the people live on less than $2 a day. Then he complains about the nerve of populists who resist having their real wages lowered further.

But the reader senses that Friedman suspects that most Americans will not make it. That’s why he hedges his bets by suggesting a realignment of American political parties, with the business wing of the Republican Party and the affluent East Coast and Hollywood social liberals joining together to resist the “populist” demands of increasingly disgruntled working people in both blue states and red. "

The reason this happened, of course, is that the executives and the rich wanted a Free Lunch: we can shift all our production and our cost structure to the Third World, and continue to sell to the developed world at regular prices, by encouraging them to buy on credit. Now that the credit bubble has burst, there is nobody with money to purchase at the higher prices, and there has been no true large-scale middle class in the developing countries which could take up the slack. The Left wanted their Free Lunch of endless entitlements, on the back of the middle classes of the developed world. But demographics and offshoring together are putting an end to that. The real solution is not that of turning on the printing presses, as Obama wants to do, but of forgetting the principle of the Free Lunch altogether. The only way to make sure both the poor and rich have enough, is not to quibble over how to divide the pie, but to *bake more pie*. It's not sexy, and it won't make any Ivy League MBA types rich quickly -- but it will make everyone wealthy (compared to ten years ago, or twenty, or a generation ago) slowly.

And it will do it sustainably, which is a buzzword which seems to be all the rage among the annointed these days.

Peter Schiff and the Austrian School fundamentalists make claims without regard for the actual facts.

http://www.miseryindex.us/urbymonth.asp

As a case study, lets go from the beginning of 1950, where the minimum wage was 75 cents, to October of 1997 where minimum wage was 5.15. Unemployment went down from 6.5% to 4.7%. And the places in between where unemployment above above the 6.5% figure were not correlated to a minimum wage increase, but to other economic events.

What the heck, make it $20 per hour.

At that level, I would go back to work.

There was a time when I would have KILLED to have gotten $7.25 an hour.

Back when I was getting $1.25 an hour.

It is simply a fact of physics that if a product costs more, there will be downward pressure on the demand for that product, no matter what it is. If you argue this isn’t the case for labor, then you have to argue the possibility that nothing in the economy makes sense. Hopefully you aren’t arguing that there is zero correlation between the minimum wage and the employment of teenagers, are you? Because that would be ludicrous.

Thanks, grey_whiskers.

Now that the credit bubble has burst, there is nobody with money to purchase at the higher prices, and there has been no true large-scale middle class in the developing countries which could take up the slack.

The Left wanted their Free Lunch of endless entitlements, on the back of the middle classes of the developed world. But demographics and offshoring together are putting an end to that.

The real solution is not that of turning on the printing presses, as Obama wants to do, but of forgetting the principle of the Free Lunch altogether. The only way to make sure both the poor and rich have enough, is not to quibble over how to divide the pie, but to *bake more pie*.

Look, you can keep spouting your nonsense, but it simply doesn’t correlate to unemployment numbers of the last half century. I have two good friends working for minimum wage right now, I have been employed for more than minimum wage, so you are wrong on a second count as well. A business should always be able to pay a decent wage to employees.

What creates a sustainable increase in low-skill wages is a continuing increase in technology.

It is not worthwhile to pay somebody $5/hr to produce $4.50 worth of product, but it IS viable to pay somebody $8/hr to babysit a machine that cranks out $20 worth of product.

Teh increase in unemployment is precisely what tehy intend. Taht makes for more dependent people, thus more "need" for government programs, thus more power for them. And mor epower is the ONLY thing these people care about. They're totalitarians at heart.

I think one perhaps unintended consequence of this increasing minimum wage will be an increase in under the table or “private contractor” work. Which would of course decrease the amount of taxes the government collects.

Homemade pie can't be beat. In my neighborhood wild blackberries, free for the taking, are just now getting ripe. They make an outstanding pie.

I never knew how good fresh peach pie could be until I made one myself. I try to use 3 lbs. of fresh fruit per pie (10" deep dish).

“A business should always be able to pay a decent wage to employees.”

I hear you, but a man should be able to work for what he is willing to accept. He should not be forbidden to get a job for less than $7.25 per hour or what have you. I want that freedom.

My teenage sons want that freedom! My 18 year old had a terrible time getting a min wage job, and he has a good work history and no problems! He finally had to move out of town to get, for real, a job grilling hamburgers at McD’s.

[Look, you can keep spouting your nonsense,]

Okay, you tell us EXACTLY what the minimum wage should be, the exact clearing prce, since you are so smart. And then tell us how you calculated that exact point.

The minimum wage should be what an illegal makes and double it. The fact is, you have abandoned your absurd claim that minimum wage causes unemployment, and are trying to shift topic stop what I think minimum wage should be, which has nothing to do with the premise of your OP.

>> A business should always be able to pay a decent wage to employees.

Yeah, what the hell - I made $150 a flight hour as an airline captain. Why not pay everybody that? ANSWER: The marketplace will only pay you $150 or $7.50 or whatever an hour IF you can generate MORE than that amount of goods and services. For that kind of money, I had to make life and death decisions for the 254 people I had strapped to my a$$. The net result of minimum wage laws is that they restrict entry of young and/or unskilled workers into the marketplace. The unions love it!

“My teenage sons want that freedom! My 18 year old had a terrible time getting a min wage job, and he has a good work history and no problems! He finally had to move out of town to get, for real, a job grilling hamburgers at McD’s.”

I agree with you. In fact, I don’t believe that a minimum wage is even necessary. Here in the Dallas metroplex the market minimum wage is around $8 or $9. I too have teenage kids who have part time jobs and as do their friends. None of them have started their jobs at less than what I stated above.

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