Illogic on the Minimum Wage

The Canadian Broadcasting Corporation (CBC) ran a piece promoting some supposed benefits to a minimum wage hike.  There are quite a few issues, both in the article and the study it cites.

Methodological Issues

The NELP study they cite is very poorly done.  I have written on the methodological and statistical issues with the report in the past.  The paper claims that minimum wage boosts employment.  However, most research shows minimum wage has a negative effect on low-skilled employment, especially over the long term,  But the NELP study is short term.  Maybe there are some short term gains?  Not likely.  My own research (forthcoming) shows minimum wage has no statistically significant effect on employment within the first 9 months of a hike.  Other studies have reached similar conclusions.  The NELP paper cited in this article has both methodological and empirical problems.

Theoretical Problems

The article addresses why minimum wage may increase employment:

Proponents of minimum wage hikes argue they are a net positive for the economy, as they give a large number of low-paid workers more money, which they are more likely to go out and spend. That, in turn, grows the economy enough to offset the added costs for businesses.

There are several problems with this argument.  First, the workers are not “given” more money.  That money is transferred from somewhere else: from consumers in the form of higher prices, from the owners in the form of lower profits, perhaps even from the workers themselves in the form of reduced hours, unemployment, or reduced benefits.  This means that the increase in spending or whatever that minimum wage workers do with their new pay must mean a decrease in spending the original “owners” of that money had.  It’s unlikely to amount to a net gain in the economy.*  Minimum wage is not a free lunch, and someone has to pay.

Secondly, this is not “a large number of workers.”  Workers on the minimum wage in the US account for about 2.5% of workers (5% if we count part timers, and chances are there is some double-counting going on here).  This is not a “large number of workers.”  It is quite small.  Any increase in spending is unlikely to have a major effect on the economy.

Thirdly, it rests on the assumption that the minimum wage workers spend their money back at their places of employment (or other low-skilled establishments).  This helps offset the costs.  However, if the people with the raises don’t do this (say, they save money, or they use it to pay down debts, or whatever), then this cycle gets broken and the firms are left with less profit than before.

Productivity Problems

Interviewing another economist, the article continues:

“You get very poor productivity when you can coast on the fumes of just hiring cheap labour,” Yalnizyan said. “Raise the cost of labour and you’ll suddenly see businesses trying to do more with less.”

Well, yes.  “Less” meaning fewer workers (which negates the NELP claim above, something the CBC may want to look into.  It’s generally not a good idea to have contradictions in the article you’re writing).  But there is no promise that higher costs of labor means an increase in productivity.  The idea that a minimum wage can increase productivity comes from the Efficient Wage Hypothesis (EWH.  For a detailed analysis of the EWH, see here).  Firms, if they think they can get productivity gains, will increase wages above market wage so they can essentially threaten with firing employees who don’t work hard.  In short, for these productivity gains to work, there must be unemployment!  So, the minimum-wage-as-an-efficiency-wage argument is incompatible with the minimum-wage-as-a-job-creator argument.

More importantly, it is reasonable to assume that firms have already maxed out productivity to the point they can; that is, they are operating where marginal benefits equals marginal costs.  In short, they are acting rational.  A minimum wage hike is unlikely to increase productivity more, and will likely harm the firms and workers.  One could object to this line of thinking and say that it’s possible the firms aren’t operating where marginal benefit equals marginal cost, and that a minimum wage could improve this situation.  I’ll grant that such a situation is possible, but it is not probable.  If all the firms in Canada or the US are unable to see this mistake, if they are all leaving money on the table, what makes it more likely that politicians far away and not involved in this business every day have more insight?  It’s your standard knowledge problem.

Profit Margins Matter

There is one final bit of illogic in this piece:

And in contrast to the apocryphal mom-and-pop shop forced to shut down and fire workers because of higher costs, more than half of the minimum wage workers in Ontario work for companies that employ more than 500 people.

Fine, but irrelevant.  The size of a company has nothing to do with their ability to handle an arbitrary cost increase.  What matters is profit margin.  If a firm like Wal-Mart, who currently only keeps $0.03 for every dollar revenue, faces a $0.05 per dollar revenue cost increase, they will have to cut back just to remain profitable.  Furthermore, if they are a firm that needs to maintain a certain profit margin to keep shareholders/owners happy, then even if they don’t go negative they may need to cut back.

Sins of Omission

There’s a lot in this article I did not cover for the sake of space (as it is, this post is approaching 1,000 words).  I invite any additions in the comments section.  However, I do want to briefly mention that neither one of the economists quoted in the article mention the unseen effects of minimum wage, that is how many people would have been employed should the wage not have been artificially risen.  This is a huge omission on both their parts.

*Sophisticated people will argue the marginal propensity to consume (MPC) for poor people is higher than the MPC for the wealthy, and that in turn leads to the money being “more stimulative” in the hands of the poor than the wealthy.  This is a wonky question that would require a wonky response, one which I will not bore my readers with here.

6 thoughts on “Illogic on the Minimum Wage

  1. ” But there is no promise that higher costs of labor means an increase in productivity. “

    I think the point is not that workers will worker harder if only you pay them more, it’s that firms have more of an incentive to invest capital in labor-saving devices if labor costs go up. A great example of this is the recent NBER paper on the old bracero program in the 1960s. When the program was cancelled and Mexican immigrant worker numbers were radically reduced, farmers reacted by increasing mechanized harvesting, resulting in an order of magnitude increase in productivity in tomato harvesting.

    Like

    • Investing in labor-saving devices will obviously have the effect of lowering employment – something the advocates of raising the minimum wage usually claim will not happen.

      Like

  2. Bob is an unskilled worker. He’s tired of the cold North and wants to move South. All the towns and cities in the South offer at least a minimum wage of $7.25 per hour. But does this mean that all these different places equally need Bob? Countless different places equally need Bob?

    People perceive wages as compensation rather than signals. This is the main problem. When we think of compensation we think of fair vs unfair… but when we think of signals we think of true vs false. In order for Bob to move to where he is most needed, wages must truly signal each place’s actual need for unskilled labor. The difference in signals would accurately reflect the difference in need for unskilled labor. The greater the disparity in signals, the greater the incentive for workers to move from where they are least needed to where they are most needed.

    The point of all resources is to be efficiently (optimally) distributed (allocated). Nobody benefits when steel, wheat or workers are inefficiently allocated. Nobody benefits from the misallocation of society’s limited resources. Nobody benefits from inaccurate treasure maps.

    Like

Comments are closed.