Wednesday, November 29, 2006

The Minimum Wage Controversy

My recent post on economic creationism drew a brisk response, including some offline debates about the validity of raising the minimum wage.

Now I am not an economist. I never took any economics classes in college, so all my economic knowledge comes from either HBS (where we didn't do much theoretical work) or my ancient Econ class with the icepick-wielding Mr. Richards (a great story for another time).

As a result, when I take a stance that raising the minimum wage is probably an unwise move, it comes from little more than reading The Economist in the bathroom. Not a strong leg to stand on.

On the other hand, I do know delegation, so I will cheerfully turn the debating over to Nobel-prizewinning economist Gary Becker and Judge Richard Posner (one of the founders of the law and economics movement).

Posner's Take:
As a means of raising people from poverty or near poverty, the minimum wage is distinctly inferior to the Earned Income Tax Credit, which compensates for low wages without interfering with the labor market. EITC is of course not devoid of allocative effect, because like any other government spending it is defrayed out of taxes; but it is probably a less inefficient tax than the minimum wage. And it is a more efficient device for spreading the wealth, since many, perhaps most, minimum-wage workers are not poor.

So why are the Democrats pushing to increase the minimum wage rather than to make EITC more generous? Three reasons can be conjectured. First, unions, which are an important part of the Democratic Party's coalition, favor the minimum wage because it reduces competition from low-wage workers and thus enhances the unions' bargaining power and so their appeal to workers. This would not be as serious a problem for unions if minimum-wage workers were organized. But the fact that most minimum-wage workers are part time makes them uninterested in joining unions. Second, increasing the EITC would mean an increase in government spending and hence in pressure to increase taxes, and the Democrats wish to avoid being labeled tax-and-spend liberals. And third, genuinely poor people vote little. The number of nonpoor who would be benefited by an increase in the minimum wage, when combined with the number of nonpoor workers whose incomes will rise as a result of reducing competition from minimum-wage workers, probably exceeds the number of nonpoor who will be laid off as a result of an increase in the minimum wage. Teenagers, moreover, will be among the groups hardest hit, and most of them do not vote.

Becker's Take:
Most knowledgeable supporters of a higher minimum wage do not believe it is an effective way to reduce the poverty rate. Poorer workers who are lucky enough to retain their jobs at a higher wage obviously do better, but the poorer workers who are priced out of the above ground economy are made worse off. Moreover, many of those who receive higher wages are not poor, but are teenagers and other secondary workers in middle class and rather rich families. Poor families are also disproportionately hurt by the rise in the cost of fast foods and other goods produced with the higher priced low-skilled labor since these families spend a relatively large fraction of their incomes on such goods.

A recent petition by over 600 economists, including 5 Nobel Laureates in Economics, advocated a phased-in rise in the federal minimum wage to a much higher $7.25 per hour from the present $5.15 per hour. This petition received much attention, and the number of economists signing is impressive (and depressing). Still, the American Economic Association has over 20,000 members, and I suspect that a clear majority of these members would have refused to sign that petition if they had been asked. They believe, as I do, that the negative effects of a higher minimum wage would outweigh any positive effects. That is one reason I would surmise why only a fraction of the 35 living economists who received the Nobel Prize signed on to the petition--I believe all were asked to sign.

My Take:
Obviously, I can't add much to the discussion other than this: These two very smart economists believe that the ostensible reasons offered in support of the minimum wage increase are either a) false, or b) inefficient in comparison to other options.

I realize that authorities are often wrong, but in the absence of a compelling alternative, I'm happy to throw my lot in with these two.


Foobarista said...

One of the nasty rules of economics is what I call the "feel-good rule": the option that makes you feel good is almost always the option that hurts the economy the most. The option that seems harsh and uncaring is often the one that works the best for all concerned. Exceptions to this rule are extremely rare.

This is why populist politicians uniformly wreck economies, and why economics education at an early age is crucial.

jhaus said...

I'm no expert, although, I do have a B.S. in Economics and currently work as a tax consultant, so I figured I'd throw in my 2 cents...

This newly impassioned debate has come as the result of widespread acknowledgement that there is growing gap between the rich and poor. To that end, I am glad this debate is taking place.

I am also in agreement that increasing the minimum wage is an inefficient tool to close this gap, but I would like to offer a few alternatives:

1) Eliminate taxes on the first 20K earned by everyone (Robert Reich -Clinton's Secretary of Labor- proposed this on Kudlow & Company)

2) Exempt teens under any proposed min. wage increase

3) Increase the EITC
- This would actually decrease gov't revenues, not increase spending; and if you buy into the idea that tax cuts stimulate the economy, you should be in favor of this...higher business revenues would theoretically increase tax revenues

Thanks for keeping the debate alive Chris!

Chris said...


Thanks for weighing in. There definitely seems to be a strong argument for using the EITC...unfortunately, the minimum wage increase has become for the Democrats what gay marriage for the Republicans: An election tool that they use to fire up the base despite dubious value.