On the minimum wage Part I: an effective tool for poverty reduction?

As reports of the recently crafted deal in California come out conversations at the dinner table will inevitably turn to the minimum wage (MW) this week.

As an economist, this is a topic I’m often asked about and it is a topic that I have written about in the past both in my academic writing [1] and in an article that was picked up by the local press a couple of years ago.

I care about people who live in poverty. The poverty that exists in our society and abroad is something that we should care about and we should seek to eliminate. I also believe that this is the well-intentioned goal of those who advocate raising the MW. On these things, it is my hope that we can all agree.

The next step is then to ask ourselves the question: Will raising the MW increase the wages of lower income families boosting them out of poverty? It turns out the answer to this question has some nuances.

First, who will the raised MW affect? It will affect those with (potential) wages which fall below or at the increased rate and to a limited degree will also affect those with wages slightly above the minimum. But how will it affect them? Even holding an analysis to the increases proposed by the Obama administration and scored by the Congressional Budget Office at $9.00 and $10.10 per hour the effects are not at all entirely positive. In fact, concentrating the analysis even further on the young high school educated population, the effects can be quite negative.

The MW does clearly help some. Those who are able to obtain work with a higher wage rate due to the MW are clearly better off. However, not everyone who wants to work at the now higher MW is likely to be able to find it. Economists have established that the MW causes unemployment.
Neumark and Wascher [2] state (page 121) that "when researchers focus on the least-skilled groups most likely to be adversely affected by MW, the evidence for disemployment effects seems especially strong. In contrast, we see very few—if any—cases where a study provides convincing evidence of positive employment effects of minimum wages".

There are those that use anecdotal evidence from case studies on businesses such as Costco and Trader Joe’s to show that it can be profitable to offer a wage higher than the minimum as workers work harder and turnover is lower when wages are higher. However, such examples are fundamentally flawed as the returns to higher wages are dependent on offering a wage rate consistently above that available in the market in general. If every firm offers “Costco wages” then Costco will no longer be able to hire and retain only the most productive workers.

Many companies (even the much maligned Walmart) are voluntarily increasing the wages they offer to entry level employees. While it is true that not everyone is fortunate enough to be employed by Costco or one of its peers, it is also true that mandated increases in the MW will hurt those whose jobs no longer exist. A MW hike will help some but will also cause others to fall deeper into poverty as they now contend with the unemployment line.

It is often said that this unemployment doesn’t matter because it only effects kids who don’t really need a job to survive but are just earning extra spending money. Those displaced by the MW aren’t supporting a family. While I don’t believe the data supports that statement, even if true the effects are alarming.

In our paper recently accepted for publication (and available in published form online) at Contemporary Economic Policy [1], my coauthor and I found that the effects of the increases scored by the CBO (to $9.00 and $10.10) would have drastic and lasting effects on young high school educated workers. We find that the impact of raising the MW to $9.00 on the youth unemployment rate will be quite large (in the neighborhood of 11 percentage points) with effects an order of magnitude larger for an increase to $10.10. For workers with a low education the benefits to experience gained at an entry-level job are quite large. Thus, the effects of unemployment for the young permeate throughout the lifecycle as young workers are denied the ability to gain experience causing such workers to suffer persistently low wages and unemployment on into the future. This finding is especially troubling as today’s youth become the heads of tomorrow’s households.

The effects of an increase to the now proposed $15 level would be catastrophic. Most estimated effects of MW increases assume linearity in the statistical relationships that were uncovered using data during a relatively well performing economy and with small to moderately sized increases. An increase from the current $7.25 to $15 is historically unprecedented causing any estimated effects from linear extrapolation to severely underestimate the impacts.

Before we go about increasing the MW we need to come to grips with one of its realities. Raising the MW does not reduce poverty for all. In fact, the MW creates and exacerbates the poverty of some. The current MW proposals generate a living wage for some but no wages and increased poverty for others.

Because I started this post by stating that I care about the blight of those who live in poverty and I am writing against one of the key policy proposals meant to reduce it, I end with what I view should be investigated as a potential policy replacement for the MW and in fact for all current welfare programs. I advocate further exploration into the Basic Income Guarantee (BIG) [3].

1. Gorry, Aspen. and Jackson, Jeremy J. (2016), “A note on the nonlinear effect of minimum wage increases.” Contemporary Economic Policy. doi: 10.1111/coep.12175
2. Neumark, David, and William Wascher. (2006), “Minimum wages and employment: A review of evidence from the new minimum wage research.” No. w12663. National Bureau of Economic Research.
3. For commentary from the Cato Institute regarding the BIG. An excellent video from pbs on the support of a BIG from both the left and right.