Paycheck Politics

Sunday, April 1, 2007
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The strong bipartisan support for increasing the federal minimum wage to $7.25 an hour from the current $5.15—a 41 percent increase—is a sad example of how interest-group politics and the public’s ignorance of economics can combine to give us laws that manage to be both inefficient and inegalitarian.

An increase in the minimum wage raises the costs of fast foods and other goods produced with large inputs of unskilled labor. Producers adjust both by substituting capital inputs and high-skilled labor for minimum-wage workers and, because the substitutes are more costly (otherwise, the substitutions would have already been made), by raising prices. The higher prices reduce the producers’ output and thus their demand for labor. The adjustments to the hike in the minimum wage are inefficient because they are motivated not by a higher real cost of low-skilled labor but by a government-mandated increase in the price of that labor. That increase has the same misallocative effect as monopoly pricing.

Although some workers benefit—those who were paid the old minimum wage but are worth the new, higher one to the employers—others are pushed into unemployment, the underground economy, or crime. The losers are therefore likely to lose more than the gainers gain; they are also likely to be poorer than the gainers. And poor families are disproportionately hurt by the rise in the price of fast foods and other goods produced with low-skilled labor because they spend a relatively large fraction of their incomes on such goods. And many, maybe most, of the gainers from a higher minimum wage are not poor. Most minimum-wage workers are part-time and supplement their minimum-wage income with other sources. Examples are retirees living on Social Security or private pensions who want to get out of the house part of the day and earn pin money, stay-at-home spouses who want to supplement their spouses’ earnings, and teenagers working after school. An increase in the minimum wage will thus provide a windfall to many workers who are not poor.

Teenagers and retirees who have trouble finding a job probably won’t realize that it’s because there are fewer jobs around for minimum-wage workers.

Some economists deny that a minimum wage reduces employment, though most disagree. And because most increases in the minimum wage have been slight, their effects are difficult to disentangle from other factors that affect employment. But a 40 percent increase would be too large to have no employment effect; about a tenth of the workforce makes less than $7.25 an hour. Even defenders of minimum-wage laws must believe that, beyond some point, a higher minimum would cause unemployment. Otherwise, why don’t they propose $10 or $15 or an even higher figure?

A number of countries, including France, have conducted such experiments; the ratio of the minimum wage to the average wage is much higher in these countries than in the United States. Economists Guy Laroque and Bernard Salanie find that the high minimum wage in France explains a significant part of the low employment rate of married women. Salanie has argued that the minimum wage also contributes to the dismal employment prospects of young people in France, including Muslim youths, an estimated 40 percent of whom are unemployed.

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As a means of raising people from poverty or near poverty, the minimum wage is inferior to the earned income tax credit (EITC), which compensates for low wages without interfering with the labor market or conferring windfalls on the nonpoor. The EITC is not completely devoid of effects on efficient resource allocation because, like any other government spending, it is defrayed out of taxes and has been abused by those underreporting income and overreporting dependents. But it is a more efficient tax than the minimum wage, as well as being more effective in redistributing income to the poor.

So why push to increase the minimum wage rather than the EITC? For one thing, unions strongly favor the minimum wage because it reduces competition from low-wage workers (who, partly because most of them work part time, tend not to be unionized) and thus enhances unions’ bargaining power and so their appeal to workers. For another, increasing the EITC would mean increasing government spending, which might require higher taxes; there is no public support for explicit tax increases, and most people don’t understand that regulatory laws can have the same effect as taxes.

Even defenders of minimum-wage laws must believe that, beyond some point, a higher minimum would cause unemployment. Otherwise why don’t they propose $10 an hour, $15 an hour, or even more?

Moreover, poor people tend not to vote; the number of nonpoor who would directly benefit from an increase in the minimum wage, when combined with the number of nonpoor workers whose incomes would rise because of reduced competition from minimum-wage workers, probably exceeds the number of nonpoor who would lose jobs. Teenagers would be among the hardest hit—and few of them are voters (if under 18, they’re ineligible). Although workers who receive a wage increase when the minimum wage is increased realize they’ve benefited from the hike, teenagers and retirees who have trouble finding a job are unlikely to realize that it’s because there are fewer jobs in the economy for minimum-wage workers.

Let’s hope that if Congress passes a stiff increase in the federal minimum wage, President Bush will emulate Mayor Richard Daley and veto it. Several months ago, the Chicago City Council, by a lopsided but not veto-proof vote, passed an ordinance requiring companies that have more than $1 billion in annual sales, and own stores in Chicago having at least 90,000 square feet of floor space, to pay Chicago employees a minimum wage of $9.25 an hour plus $1.50 an hour in fringe benefits, rising to $10 and $3, respectively, by 2010. About 40 stores would have been affected.

The ordinance was surpassingly foolish. The retailers that would have been most affected, such as Wal-Mart, Target, and Home Depot, are only marginally interested in placing stores in large cities because space for large stores and the parking they require is much more expensive than it is in suburbs and smaller towns. Moreover, these companies could offset much of the ordinance’s effect by opening more stores in suburbs within easy reach of Chicago or by holding their floor space to just below 90,000 square feet. Fewer jobs would be available to low-skilled workers in the city, and families with modest incomes who seek low prices rather than elaborate service would be hurt more than the affluent by the increase in prices and reduced availability of big-box outlets.

In France, the minimum wage is believed to contribute to the dismal employment prospects of young people, including Muslim youths, whose jobless rate is 40 percent.

Who would favor such a bad ordinance? Conventional supermarket chains and clothing stores, of course, and unions—the latter not only for the usual reasons but also because big-box companies oppose unions; the ordinance sent a signal that unions have enough political clout to make life difficult for large nonunion retailers. The absence of opposition to the ordinance from low-income consumers is not surprising because they are not organized to exert political pressure. The aggressive support for the ordinance by most of the council’s black members is more difficult to understand, but the explanation may be that they are allied with unions. They may have realized that their constituents would be harmed by the ordinance but believed that, in return for taking this hit, they would get the support of unions for measures that would help low-income families.

The failure of the Chicago ordinance and related local measures helps explain the push to raise the federal minimum wage. The ordinance would have been particularly destructive—hence Mayor Daley’s veto of it—because the smaller the scope of a minimum-wage increase, the more easily it is evaded, though possibly at great social cost. A federal increase would have a smaller social cost per worker covered but presumably a larger overall social cost. Chicago’s big-box ordinance is evidence, if any is needed, that politics can override economic sanity. One can only hope that this lesson will not be repeated on the national stage.