Minimum Wedge

On January 10th, the new Democratic Congress passed a bill to raise the minimum wage from $5.15 to $7.25 and hour, on a 315-116 vote. For the Democrats, politically, this was a no-brainer. Polls show that roughly 76% to 85% of the general public favor raising the minimum wage. Among registered Democrats, the support is around 94%.

Not surprisingly, all House Democrats voted for the bill, with none raising any concerns about its implications. Moreover, 82 Republicans, or just over 40% of House GOPers supported the hike as well. It’s an article of faith, not just amongst the progressive left, but broad segments of the public, that one of the greatest mechanisms for improving the living standards of the working poor is through government legislation of a wage floor.

Unfortunately, it is also long-standing conventional wisdom among the broad majority of economists that minimum wage laws can result in structural unemployment.

When wage floors are set below what low-wage workers already earn, they have no real consequence one way or the other. They cause no harm, but also provide no real benefits, either. When wages are set above what low-wage earners, however, then the minimum wage starts to make a difference, for better or for worse. Some clearly benefit from the higher salary. For other workers, however, there can be unintended consequences, as standard economic theory suggests that jobs at the low end are ultimately shed when mandated wages exceed market wages.

In 1997, however, two economists David Card and Andrew Kruger, questioned this aforementioned basic economic conventional wisdom in Myth and Measurement: The New Economics of the Minimum Wage. They suggested that in their New Jersey case study, a higher minimum wage did not lead to an increase in unemployment.

Since then, their work has been criticized, but also routinely cited by wage hike advocates. Some activists have gone so far in their advocacy of intervention in labor markets as to suggest that it is “proven” that minimum wage laws can be raised ever upward with no negative consequences. In a recent radio interview, Senator Bernie Sanders (D-VT), without citing Card-Kruger, argued that minimum wages are a scientifically proven, unalloyed good.

This optimistic notion, however, was slammed by Paul Krugman in 1998, who countered that at high enough levels wage floors are certain to do damage. He even scrutinized and questioned their rationale altogether. Meanwhile, economist Brad DeLong walks the fence. He supports minimum wage laws, but simultaneously acknowledges their potential to hinder employment. In a blog post last Sunday, he argued approvingly for the minimum wage hike but suggested that policy makers, “Try not to push it to the point where its drawbacks grow too large.” Unfortunately, DeLong offers no advice or guidance on how much is too much. Most economists, meanwhile, are with Krugman.

A recent story in the Washington Post, for example, noted that Congress, “brushed aside some corporate concerns” to pass the new minimum wage. The inference here is that only behemoth corporations had anything to lose from wage hikes, and that only elites at behemoth corporations have raised any intellectual objections.

Coverage like this helps to convince activists that government economic controls come free of side effects, and also nutures the image of a zero sum game battle between the working public and “corporations” over wages, work hours, sick leave, vacations, medical leave, heathcare benefits and pensions.

So why don’t we see even higher minimum wages? Steven Slivinski of the Cato Institute has an interesting and plausible theory as to why policy makers widely favor minimum wage floors, but stop at say, $7.25 per hour rather than going up to $20 an hour. He speculates that minimum wages only make politicians wary when they start to approach the market wages in their own Districts. When tiny hikes are proposed, only a few politicians in low cost of living areas object. As the rate moves higher, however, more and more object until a near majority feel threatened by the rate, and the proposed hike goes no higher.

Slivinksi suggests that if politicians were required to index the minimum wage to the cost of living in their own district, they’d be far less enthusiastic. For example a minimum wage of $7.25 in Kansas City might translate to $14 per hour in New York City.

The theory helps to explain how wage hikes, while highly popular with the public, always tend to stay within some reasonable bounds. While not in favor of such hikes, Slivinski nonetheless implies that politicians are clued in to the deleterious economic consequences of these wage hikes. This argument is comforting, but it does ignore some considerations.

States vary in their costs of living just like Congressional Districts. And, states pass their own minimum wage laws just like the Federal government. If Slivinksi is right, we would expect the minimum wage rates in states to correlate with their costs of living. But they don’t, or at least not very closely.

For example, according to a comparative salary calculator, a 72K salary in West Virginia is equivalent to a 100K salary in New Hampshire. Cost of living indexes show that West Virgina is about 25% less expensive than New Hampshire. Clearly, the cost of living in Mountain State is lower than in that of the Granite State. And yet, West Virginia passed a minimum wage of $7.25, effective in 2008. Meanwhile, New Hampshire’s is $5.15.

Policy makers may not be quite so illuminated on the subject of minimum wages after all. Their behavior seems to depend as much on the social and political attitudes in their particular district and states, as much as is does on market wages or costs-of-living. Ideas matter, and in particular ideas that are held by voters.

Unless free marketeers can convince many more Americans of the harm of wage controls to the overall economy, any big changes in public opinion are unlikely. I’m not holding my breath. The economics are complicated enough for the lay person, and academic dissent further muddies the waters. My guess is that as long as most Americans are sellers of labor, and not either self-employed or employers themselves, then support for labor price floors will be high. Only some wild changes in the economy with a radical downward shift in the average size of firms, and an explosion in the number of of entrepreneurs and employers would likely make any difference.

And, it doesn’t really matter which political party is in power. When Republican controlled Congress, they kept the issue off the table. However, they never really tried to educate the public, or challenge its conventional wisdom. And, since party control of the government is bound to fluctuate in a democracy, once Democrats regained power, they were sure to make up for lost time in their wage increase.

As a result, an alignment of libertarian minded voters, free marketeers and employers with the Republican party won’t make much difference for minimum wages over the long haul. Alignment with the Democrats probably won’t either. But the latter could gradually foster a more open minded attitude in the Democratic party towards to those who worry sincerely about the perverse consequences of labor market interventions. It could also encourage free marketeers to get more serious about ideas for helping the working poor, something they’ve been long divorced from in their relationship with the GOP.