The wage is too damn high?

I don’t think so. But first, some background.

President Obama proposed raising the minimum wage in his State of the Union address. Specifically he called for it to go up to $9 an hour by the end of 2015, up from $7.25 now, and then to index it to the rate of inflation in subsequent years. Is this a good idea?

Economists are famous for being against the minimum wage, with introductory microeconomics textbooks typically using it as an example of a price floor that creates a surplus of the good in question – in this case, a surplus of labor, or unemployment. And that is valid if the market for labor is perfectly competitive and if the rest of the economy is held constant. (Two rather big ifs, yes.) Economists call this “partial equilibrium analysis,” as opposed to “general equilibrium analysis,” which looks at the repercussions in all markets. In the economy as a whole, firms can’t always sell all they want to at the going price, and too-high wages are not the only source of unemployment – recessions cause unemployment, and so does falling demand in specific sectors of the economy. It’s also possible that higher minimum wages could increase the total income of the lowest-paid workers, resulting in more demand for goods and services in general and a higher level of employment. The White House clearly believes that last part (more about that here).

Who’s right? It all depends on which effect is stronger – the micro effect (higher wages mean less output and employment) or the macro effect (higher wages mean higher incomes and higher aggregate demand). And that is an empirical question. For decades, most economic studies found that minimum wages reduced employment among the least educated, least skilled workers, i.e., the people most likely to be working at low wages. But an influential study by economists David Card & Alan Krueger in the 1990s found either no effect or, surprisingly, a positive effect of higher minimum wages on low-skill or teenage employment. In their 1995 book, Card & Krueger further found that the earlier studies omitted important variables, like teenage high school attendance rates, and that controlling for those variables caused the minimum wage’s estimated effect to be insignificant. Their work has had its own critics and would-be debunkers, but it remains influential.

I figured it was time to take my own look, however superficial (I got no time for regressions) at the available data. First, why $9 an hour? Does that amount make sense when compared to other years and their price levels? Based on the Consumer Price Index (CPI) data from the Bureau of Labor Statistics (BLS), the answer is yes. A $9 minimum wage for right now equates to a minimum wage of $1.24 in 1965, when the actual minimum wage was $1.25. For all fifteen years from 1965 to 1979, the equivalent back then of a $9 minimum wage today was within a dime of the actual minimum wage in all but three of those years. After 1979, the minimum wage started to lose ground relative to inflation; for example, it stayed at $3.35 for the next 11 years and was at $5.15 for all of 1997-2006. So if 1965-1979 is a reasonable benchmark, then $9 makes sense. And indexing it to inflation makes sense both from the point of view of the buying power of the minimum wage and minimizing the disruption on labor markets. If the minimum wage had been adjusted for inflation every year since 1979, we wouldn’t be debating whether to raise it by $1.25 over two years – the yearly increases would be much more gradual.

(The rest of the data cited come from the latest BLS employment report, historical tables A2, A3, and A4).

First, how have the least-skilled workers fared over time, under different minimum wages? These BLS tables don’t classify workers according to skill per se, but they do classify workers age 25+ according to education level, and those with less than a high school diploma and those with only a high school diploma would seem to be the least skilled. It looks like their unemployment rates are most sensitive to the overall state of the economy – their unemployment was 10 – 12% in 1992 through early 1994, in the wake of the early 1990s recession and has been 10 – 16% (now 12%) during and in the wake of the 2007 – 2009 recession. When the minimum wage was raised in 1996 and 1997, this unemployment rate actually fell, probably because the economy was powering along on its own. In the nine years from 1998 through 2006, when the minimum wage fell after adjusting for inflation, this unemployment rate followed the business cycle (up in the 2001 recession and its aftermath, e.g.) but otherwise was about the same at the end as at the beginning.

The BLS also keeps track of unemployment rates for teenagers. Their tables show current unemployment rates of 16-19 year olds to be 21, 26, and 38% for whites, Hispanics, and blacks, respectively. These numbers are very high and usually are Exhibit A in arguments as to why the minimum wage is bad for the employment prospects of low-skill workers. As high as those numbers are, they are high even in good times — at the cyclical peak of December 2007, they were 14, 18, and 33% — which would tend to reinforce the argument. But it should be noted that the labor force participation rates for teens are low to begin with and follow a downward secular trend (about a 5-point drop in 2003 – 2007 for whites, for example), so these teen unemployment rates likely have a very different meaning than adult unemployment rates do. In the vast majority of cases, it’s almost surely nowhere near the same degree of hardship as for an unemployed adult.

Many economists and policy types have proposed a sub-minimum “training wage” for teenagers, and I can see the logic of that proposal. (It could run into problems of displacing older workers, but it’s still worth investigating.) Teen unemployment rates are very high at all times, and the minimum wage could well play a role. But teens themselves, and low-wage/skill workers in general, seem to strongly favor a higher minimum wage, and I don’t think ignorance of the law of demand is why. I’m guessing they feel better knowing that decent-paying jobs are out there, even if they’re hard to get, then knowing that crappy-paying jobs are plentiful.

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7 Responses to “The wage is too damn high?”

  1. Ranjit Says:

    Hat tip to my colleague John Kane, whose excellent 1997 review of Card & Krueger’s book saved me the trouble of finding and wading through their 422-page book.

  2. jeremyland Says:

    Informative post Ranjit, but what are your thoughts on part-time work by itself? Should we still allow anything less than full-time jobs? Would we need such dramatic hikes in minimum wage if everyone was guaranteed a full week of hours? Granted this goes beyond your post, sort of. But beyond seasonal and day labor, I cannot find a good, and efficient reason for not having full-time hourly workers. For example, would restaurants need to have scores of workers? If they had a solid, reliable workforce, wouldn’t it be a better restaurant?

  3. democommie Says:

    But, but, buuuuuuuuuuuuuuuuuuuuut…

    If poor people get more money they’ll just “squander” it on stuff like clothes and food and movies and cars and, and, and…

  4. democommie Says:

    Informative post Ranjit, but what are your thoughts on part-time work by itself?

    Restaurant and retail companies rely on not having to pay any healthcare costs by hiring 2-3 people instead of 1. Remove the cost of healthcare from the equation with some sort of legislation (hint: it sounds like “:single payer”) and they would still want to have flex-time staffing but they might have to offer their employees a premium to work split shifts.

  5. Ranjit Says:

    I have to think that part-time work is a good thing, having once been a teenager, and now teaching and knowing people who don’t have time to work full time but still need some extra cash.

    But I see your point that under current conditions, companies will choose to work a bunch of people part time instead of a few people full time with full benefits. Yes, single-payer health insurance would go a long way toward solving that problem. In its absence, I really don’t know what the best policy option is.

    PS All I do know at this moment is that Tammy Wynette was one hell of a singer back in the day. Who else could get so much out of “Honey I miss you”?

  6. Mark E. Says:

    Another case of a band-aid to try and circumvent a bigger problem no lawmaker wants to address. i.e. the increasingly two-class system in the U.S. and elsewhere. Raising the minimum wage wouldn’t hurt small businesses so much if there were more than scraps for them to feed off of in the first place. Raising the minimum wage to me works best as a spread the wealth technique, but fails at least in part if it just moves money from one segment of the 99% to another.

    Yes, something needs to be done, but the money somehow needs to be extracted from the 1% or it’s just a game of political football.

  7. Mark E. Says:

    As Democommie mentions, Single Payer is a good example of “Socialism” that could actually work toward what I mentioned above.

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