Originally published on LinkedIn on March 8, 2021
The Raise the Wage Act has been introduced in each US congress since 2017 by Bobby Scott in the House and Bernie Sanders in the Senate. It is back on the table in the 117th Congress. In their analysis, the Congressional Budget Office tells us that the increase of the minimum wage to $15 will raise 900,000 people out of poverty in exchange for a reduction of 1.4 million jobs. Tradeoffs are typical of all government interventions, some people gain, and some people lose. Whether you are in favor of a minimum wage increase comes down to how you weigh these two outcomes.
To quote the CBO report, under the Raise the Wage Act of 2021 by 2025 we will see:
Employment would be reduced by 1.4 million workers, and
The number of people in poverty would be reduced by 0.9 million.
CBO (https://www.cbo.gov/publication/56975)
[COVID concerns are discussed below, not all data include the years 2020 and the early months of 2021. Also, the report just cited suggests the deficit will increase by $54 billion, raise prices to all, including the federal government, and would change the distribution of spending. All fascinating aspects I do not talk about in this article.]
The minimum wage decreases employment
Employment effects: Economists have long known that there are negative effects of an increase in a minimum wage when set above the market wage in a labor market. When a minimum wage is effective (above market-level wages), both demanders and suppliers (employers and workers) adapt.
On the demand side, the rise of cost to employers will cause the employer to seek to (1) shift the cost onto consumers in the forms of higher prices (2) shift from dependency on low-wage workers (of lower productivity) into more skilled workers, (3) move away from low productivity labor towards automation and capital, or (4) scale back their production, or to some measure bits of all four possibilities. All four steps result in fewer minimum wage workers being demanded and hired.
On the supply side, those who do not work or who work at lower than minimum wages are more likely to seek a minimum wage job since it is more rewarding. This incentive effect pulls in more workers seeking the now more rewarding minimum wage jobs. Consider a thought experiment: What if there is a student in college who finds that the $7.25 minimum is not enough to compensate for her time away from studying? She essentially goes to college full-time from both a class and a study perspective. When the wage is raised from $7.25 to $15, this becomes more tempting, and she is more likely to enter the labor market and defer other uses of her time, possibly leading to less class or study time or both. She enters the labor market, drawn by the higher reward. An employer now has a richer pool of applicants to choose from now that she and others like her, who have more education and more productivity, are competing for the same jobs that dropouts are competing for. The employer will always hire the most (potentially) productive candidate in the pool of applicants. If she is selected, who is hurt? Answer: the least productive, for example, the dropout with no work experience, who already has a much tougher time getting a job.
What does the literature say about employment effects? Some say that economists have changed their thinking on the employment effects based on studies that show no negative employment impact. One economist remarks thusly and says they are reacting based on the entire literature.
David Newmark and Peter Shirley speak to the disagreement.
What is … puzzling, is the absence of agreement on what the research literature says – that is, how economists even summarize the body of evidence on the employment effects of minimum wages. Summaries range from “it is now well-established that higher minimum wages do not reduce employment,” to “the evidence is very mixed with effects centered on zero so there is no basis for a strong conclusion one way or the other,” to “most evidence points to adverse employment effects.”
David Newmark and Peter Shirley NBER working paper issued in January 2021, and revised in March 2021.
In the study, Myth or Measurement: What Does the New Minimum Wage Research Say about Minimum Wages and Job Loss in the United States? Newmark and Shirley say
… we assembled the entire set of published studies in this literature and identified the core estimates that support the conclusions from each study, in most cases relying on responses from the researchers who wrote these papers.
And their conclusions?
Our key conclusions are: (i) there is a clear preponderance of negative estimates in the literature; (ii) this evidence is stronger for teens and young adults as well as the less-educated; (iii) the evidence from studies of directly-affected workers points even more strongly to negative employment effects; and (iv) the evidence from studies of low-wage industries is less one-sided.
David Newmark and Peter Shirley NBER working paper issued in January 2021, and revised in March 2021.
The Minimum wage increase will decrease Poverty
Ok, but what about poverty? How much will it decrease and is it effective?
The CBO says 0.9 million workers will be raised from poverty. Isn’t that worth the losses in employment?
Semega, et al. write:
The 2019 real median incomes of family households and nonfamily households increased 7.3 percent and 6.2 percent from their respective 2018 estimates (Figure 1 and Table A-1). This is the fifth consecutive annual increase in median household income for family households, and the second consecutive increase for nonfamily households.
The official poverty rate in 2019 was 10.5 percent, down 1.3 percentage points from 11.8 percent in 2018. This is the fifth consecutive annual decline in poverty. Since 2014, the poverty rate has fallen 4.3 percentage points, from 14.8 percent to 10.5 percent (Figure 7 and Table B-5).
Semega, et al. “Income and Poverty in the United States, 2019” US Census (report p60-270) September 15, 2020.
This means before we consider the increase in the minimum wage, that poverty has declined, and median household income has risen in each of the last five years. Incomes are on the rise, and poverty is in decline. The need for the increase in the minimum wage to reduce poverty, while laudable, will only add to the current decline. That is, it is easy to think that poverty is rising and we have to do something, while what we have been doing sees poverty diminishing and income rising.
But 0.9 million workers will be freed from poverty! Most of the minimum wage workers are young, 48 percent of the minimum wage workers are under the age of 25. And poverty amount the youth is already in decline since 2010 as can be seen in Table 11 from the Census report. The market without the minimum wage rise to $15 is already reducing poverty.
The CBO report says that the increase to $15 will decrease 0.9 million from poverty roles. Table 7 puts this in perspective as 0.9 million is about 2.6 % of the total persons in poverty based on the 2019 level. Clearly, the minimum wage is not a significant poverty reduction program for the US. That is, if the argument is that the rise in the minimum wage reduces poverty, the tradeoff is that a two-and-a-half percent reduction is worth the loss of employment and all other disruptions in the marketplace, such as rising prices of goods and services.
COVID ruins everything.
I saw that on a t-shirt, and it certainly offers much truth. Covid also changes the conversation above. Poverty rates may have risen, incomes may have fallen, and unemployment rates are much lower now, but not yet back to the levels of 2019. So COVID ruins this tale in part.
However, the COVID recession is passing; whether this quarter or a couple of quarters from now, it will end, and the recovery that has already begun will return us to the earlier paths or to some slightly adjusted paths. (Update: The NBER Business Cycle Dating Committee has officially declared the COVID recession started in March 2020 and ended in April 2020. )
We know that working from home will not end as workers, and some companies highly prefer this new structural setting. Some goods and services are likely gone not to return because of this structural change, but I imagine that it only hastened the pace of change and not completely bent trends in very opposite directions. Of course, time will tell, and that is what makes this time fascinating from an economy-watch perspective.
Conclusion
I end this with not only my opposition to any increase in the minimum wage but with three things that we tend to do that distort our sense of what action is important in the economy:
- We overreact with pessimism. We think things are always worse than they are. Much of this is fostered because bad news gets our attention faster.
- Even when the current trend is negative, we are often ignorant of what the long-term trend has been. Poverty may be temporarily turning up, but look at how much better we are now compared to decades ago. Transitory changes are sometimes painful, but ignorance of the size and direction of long-term trends may make us choose ill-advised policy prescriptions today.
- Economic principles never change; how we apply them does. Demand curves always slope downward, meaning when prices are higher, we will buy less. When wages are higher, we will employ less (how much less is the real question).