The current federal minimum wage is $7.25. A person working 40 hours per week on that wage would earn $14,500 per year, which actually puts them above the
official U.S. poverty line for a 1-person household. But still, that's a pretty paltry amount for a full year's work, and Obama has made it a central goal this year to raise that minimum wage level. In fact, a couple of weeks ago he signed an executive order raising the minimum wage for federal contract workers to $10.10 per hour--a whopping 40% raise for these workers!
But should we raise the minimum wage? How much would it help?
Who would it help? And, how much would it cost?
The Econ 101 Story
Economics 101 says that price controls always cause what economists call
deadweight loss--they destroy economic value. Minimum wages could do this in the following way: Suppose that there is a worker, Bill, who can produce $8 of value per hour for a company. Suppose also that Bill knows that he is worth $8 an hour, so he is willing to work for nothing less. Luckily, the company is just willing to hire him at this wage, so he gets hired and takes home $16,000 in pay per year. To liven up the example, let's say he works for Wal-Mart, a company that took in $16 billion in profits last year.
It's easy to look at this and say, "Wal-Mart
so much money!
Bill worked hard! He deserves more!"
But, what would happen if we raised the minimum wage to $10.10, as Obama proposes? Bill would lose his job, because he only creates $8 of value for Wal-Mart per hour. If Wal-Mart continued to employ Bill, they would lose $2.10 every hour that he spent at work! Wal-Mart actually has a legal obligation
not to employ Bill at $10.10, since they have a fiduciary duty to create as much value for their shareholders as possible. Hiring Bill is essentially stealing $2.10 from shareholders for every hour that Bill works.
Here's a nice picture of the effect:
The
deadweight loss comes from the fact that Bill is now unemployed, and Wal-Mart will not hire someone to replace him. The economy as a whole shrinks as a result.
That's the Econ 101 story, and it would prescribe that we shouldn't have a minimum wage at all, because it hurts everyone involved.
The Econ 201 Story
But here's the Econ 201 story: What if an employer has some kind of market power? Let's modify my example above a bit: What if there are 1,000 people identical to Bill out there, and the only company they can work for is Wal-Mart? In this case, Bill knows that he creates $8 of value for Wal-Mart, but he can't insist on getting $8 per hour because there are 999 other unemployed Bills out there who would happily take his job for $7.99 per hour. And, if Bill loses his job he can't get hired elsewhere, and earning $7.99 an hour is better than getting nothing, right?
Of course, if you follow this logic, you can see that Bill will end up working for something far less than $7.99, because of course all of those other workers are willing to work for something a lot lower than $7.99. His wage will end up getting pushed much lower because Wal-Mart has all of the bargaining power, since they're a
monopsonist--the only place where people can work.
But, if there is a minimum wage, Bill knows that at least his wage won't fall below $7.25. In this way, the minimum wage takes away some of Wal-Mart's power, and saves Bill by putting a floor on his wage. In this way, the minimum wage is actually
value-creating, because Wal-Mart will end up hiring Bill for $7.25, and for some other reasons (that aren't really necessary for me to cover here) it will also be more willing to hire some of Bill's friends as well.
Of course, if the minimum wage is raised to $10.10, Bill will still lose his job, because he only creates $8 of value per hour. But, now imagine that there is also a worker named Sally who works at Wal-Mart. She creates $10.25 of value per hour, but has been getting paid far less than that because Wal-Mart has market power. Raising the minimum wage is great for Sally, because she'll earn far more and it takes away Wal-Mart's ability to underpay her. So, at the end of the day, when we raise the minimum wage it hurts Bill, and helps Sally. Whether the overall effect is positive or negative is hard to pin down--and it depends on how many Bills and how many Sallys are in the economy, and what their options might be should they lose their jobs.
How many Bills and how many Sallys are there?
So, if you want to make an argument for raising the minimum wage, you have to argue that there are a lot of employers out there that are monopsonists who are underpaying their workers,
and that there are a lot more Sallys out there who are getting severely underpaid than there are Bills who would end up losing their jobs with a minimum wage increase.
And that's why the minimum wage issue is thorny. Obama can say things like, "
We are a nation that believes in rewarding honest work with honest wages," but the implicit argument he is making is that there are a lot of employers who are
not paying their workers "honest wages." Is that really the case? I don't know, but to me it certainly doesn't seem like there are too many companies out there that have complete market power over workers.
A
recent report by the Congressional Budget Office (CBO) tried to put some numbers on this. Under a scenario in which the federal minimum wage was increased to $10.10, they estimate that:
- 500,000 people would lose their jobs (these are the Bills in my example above). Keep in mind that this is an estimate and that it could easily be as many as a million, or as few as zero.
- 16.5 million people would see their wages increase (these are the Sallys in my example above)
- On net, 900,000 people would see their incomes rise above the poverty line
So, clearly a lot more people would see their wages increase that would lose their jobs. On net, then, would this be good? Should we do it?
Why I'm against raising the minimum wage
I say no, and there's three main reasons why:
- Losing your job is much more painful than getting paid a bit less than you actually should. While 16.5 million people would see their incomes rise, for most their income isn't going to go up by much, and at the same time you're going to have half a million people drop all the way to zero. I think it's especially important to think about what Bill might do when he loses his job. Remember that he was already the low-productivity worker, even compared with Sally. The people that will lose their jobs are precisely the most vulnerable--those with the lowest skills, and the least chance at finding an alternative profession where they can get hired. Sally, remember, is worth at least $10.10 per hour, and is much more likely to be able to switch jobs than Bill because she has some abilities that increase her productivity and probably make her more marketable.
- Raising the minimum wage is poorly targeted to help the poor. A recent paper shows that only 11.3% of workers who would see their wages increase due to a minimum wage hike live in poor households. Meanwhile, 63% of those that would see their income rise are second or third earners living in households with incomes at least three times above the poverty line. So, yes, we would see 16.5 million people have higher incomes, but most of those people are already living in households that aren't poor.
- It will cause deadweight loss. Not only is raising the minimum wage poorly targeted to help the poor, but raising it will slow growth in the economy, which also disproportionately hurts the poor. Put differently, this isn't just a transfer from employers to employees as they have to pay more wages, but actual value is just lost when the minimum wage rises. This effect isn't captured in the CBO estimates above, but some recent evidence suggests that in the long run rises in the minimum wage slow job growth significantly.
I'm all in favor of helping the poor, but raising the minimum wage just isn't the best way to do it. Why don't we focus our efforts on re-vamping the food stamps program, or creating a more effective way for unemployed people to get re-training? Or, in training people better in the first place?
