8.2- Minimum Wages

The minimum wage is a hotly debated policy issue and it's also an example of a price floor. Let's graph it out to see what basic economic theory predicts the effects will be. On the x-axis we've got the quantity of labor, and on the y-axis we've got the price of labor, which we usually just call wages. So we've got downward sloping demand and upward sloping supply. Keep in mind in this case, demand is coming from companies that are looking to hire workers and supply is coming from the workers themselves who are selling their labor on the market. And so here we've got an equilibrium level of labor, I'm going to call it Q0, and an equilibrium wage rate, I'm going to call it W0, W for wages. What if a high minimum wage is set above the equilibrium wage for these workers? Right over here, a minimum wage. The consequences are predictable. The quantity supplied by workers will be higher, QS. More workers want to work at these artificially higher wages. The quantity demanded will be lower. because employers don't want to hire as many workers at those wages. There's a surplus of workers right here, supply exceeding demand, or as we might call it, unemployment. As before, there'll be some winners here, workers who get to keep their jobs at the higher wage. Some surplus will be transferred from employers to those workers. But there will be productive, desirable exchanges that don't happen. Someone who wants a job at a wage below the legal minimum and there's an employer who wants to give them a job, the government regulation says that's illegal so the job never gets created. The minimum wage is a particularly controversial topic because there's been empirical research using data and real policy changes that showed little or no decrease in employment from minimum wage increases. Those findings embolden advocates for high minimum wages who argue that the basic principles of economics don't apply in the case of the market for low-skill labor. Now, without getting too deep into the weeds, there's a few reasons to think why they're wrong. First, the types of minimum wage changes that we've had in the United States over the past few decades have, until recently, tended to be relatively small, 50 cents a year here and there. They don't bind on a large portion of the population. From the 1980s through the mid-2000 teens, About 3-5% of workers were paid the minimum wage. So you have small increases that might not have a huge effect binding on just a small part of the labor force. It's hard to pick out an impact in the data. Second, almost all of this research focuses on the number of jobs and the cash value of wages. So why might that be a problem? We've got Q labor right here, but jobs can have the number of hours cut back, and that won't show up in the statistics used by these researchers. because they're looking just at the number of jobs, not the total hours worked. And cash wages, the amount that's in your actual paycheck, is only part of compensation. Employers can do things like make you pay for your own uniform, or parking, or other things that used to be free. They can decline to provide you with on-the-job training. As with all price controls, some other aspect of the market will have to adjust if prices can't. But most importantly, the real world is more complicated than our simple model, which predicts that when the minimum wage goes up, we'll see a rapid adjustment to a new world with a surplus of workers. So over here, I'm going to draw a really simple graph with time on the x-axis. So we're starting off over here, and as time moves on, we're moving across the graph. And over here, I've got the level of employment. just the number of workers. We're moving along at a certain level of employment and then the minimum wage changes. It goes up at this date right here. The level of employment, as predicted by these simple models, would drop pretty much instantly. There'd be a big change right here, let's call this time t. But there are good reasons to think that the adjustment would take some time, rather than seeing a snap to the new state of the world. It would be a gradual change. For example, it takes time for a restaurant to switch to digital menus and cut back on waitstaff. And it turns out that the sorts of empirical models used in the research that didn't find negative effects of the minimum wage were looking for a rapid adjustment, and they would miss a more gradual adjustment that perhaps looks something more like this. They would then mistakenly conclude that there was no adjustment at all. This was the issue that I tackled in a paper with Jeremy West, my former graduate student who earned both his undergraduate and graduate degrees in economics at Texas A&M. Our work, which was published in one of the top journals in labor economics, looked for changes in employment growth, this gradual adjustment to a new world. And that's what we found. High minimum wages lead to slower job growth. It's not that people are fired necessarily, it's that they're never hired in the first place. And that's particularly problematic because low-wage jobs, while generally not very fun, allow workers to gain valuable experience, skills, and reputations that allow them to move up the job ladder. to higher paying jobs. The minimum wage destroys those first rungs of the job ladder. Finally, let's think about who's affected by increases in the minimum wage. Advocates believe, genuinely I think, that they want to help low-income, low-skilled people. But it turns out that many minimum wage workers are the teenage children of middle and upper class families, not exactly the people who we want to target anti-poverty policies at. The minimum wage is a blunt instrument. It doesn't distinguish between a teenager getting a summer job to pay for video games and a single mom trying to provide for her family. The law binds on both of them the same way. And with hundreds of people vying for each job at the artificially higher wage, employers can afford to be very choosy about who they hire. So who's going to get left behind? Recent research shows that the negative employment effects are concentrated among high school dropouts, especially minorities. People who are already on the margins of the labor force are those who are most likely to be negatively affected by this policy. It's true that the world is more complicated than our simple model. But the principles of economics hold, no matter whether we want them to or not, and wishful thinking doesn't make good policy. If you're interested in this issue, the supplemental material for this topic includes a video of a debate between James Galbraith of the University of Texas and me on whether a $15 an hour minimum wage would be good policy for the state of Texas. I think it's pretty interesting and I recommend it highly.

And so here we've got an equilibrium level of labor, I'm going to call it Q0, and an equilibrium wage rate, I'm going to call it W0, W for wages. What if a high minimum wage is set above the equilibrium wage for these workers? Right over here, a minimum wage.

The consequences are predictable. The quantity supplied by workers will be higher, QS. More workers want to work at these artificially higher wages. The quantity demanded will be lower. because employers don't want to hire as many workers at those wages.

There's a surplus of workers right here, supply exceeding demand, or as we might call it, unemployment. As before, there'll be some winners here, workers who get to keep their jobs at the higher wage. Some surplus will be transferred from employers to those workers.

But there will be productive, desirable exchanges that don't happen. Someone who wants a job at a wage below the legal minimum and there's an employer who wants to give them a job, the government regulation says that's illegal so the job never gets created. The minimum wage is a particularly controversial topic because there's been empirical research using data and real policy changes that showed little or no decrease in employment from minimum wage increases.

Those findings embolden advocates for high minimum wages who argue that the basic principles of economics don't apply in the case of the market for low-skill labor. Now, without getting too deep into the weeds, there's a few reasons to think why they're wrong. First, the types of minimum wage changes that we've had in the United States over the past few decades have, until recently, tended to be relatively small, 50 cents a year here and there.

They don't bind on a large portion of the population. From the 1980s through the mid-2000 teens, About 3-5% of workers were paid the minimum wage. So you have small increases that might not have a huge effect binding on just a small part of the labor force.

It's hard to pick out an impact in the data. Second, almost all of this research focuses on the number of jobs and the cash value of wages. So why might that be a problem? We've got Q labor right here, but jobs can have the number of hours cut back, and that won't show up in the statistics used by these researchers.

because they're looking just at the number of jobs, not the total hours worked. And cash wages, the amount that's in your actual paycheck, is only part of compensation. Employers can do things like make you pay for your own uniform, or parking, or other things that used to be free. They can decline to provide you with on-the-job training. As with all price controls, some other aspect of the market will have to adjust if prices can't.

But most importantly, the real world is more complicated than our simple model, which predicts that when the minimum wage goes up, we'll see a rapid adjustment to a new world with a surplus of workers. So over here, I'm going to draw a really simple graph with time on the x-axis. So we're starting off over here, and as time moves on, we're moving across the graph.

And over here, I've got the level of employment. just the number of workers. We're moving along at a certain level of employment and then the minimum wage changes. It goes up at this date right here.

The level of employment, as predicted by these simple models, would drop pretty much instantly. There'd be a big change right here, let's call this time t. But there are good reasons to think that the adjustment would take some time, rather than seeing a snap to the new state of the world.

It would be a gradual change. For example, it takes time for a restaurant to switch to digital menus and cut back on waitstaff. And it turns out that the sorts of empirical models used in the research that didn't find negative effects of the minimum wage were looking for a rapid adjustment, and they would miss a more gradual adjustment that perhaps looks something more like this. They would then mistakenly conclude that there was no adjustment at all. This was the issue that I tackled in a paper with Jeremy West, my former graduate student who earned both his undergraduate and graduate degrees in economics at Texas A&M.

Our work, which was published in one of the top journals in labor economics, looked for changes in employment growth, this gradual adjustment to a new world. And that's what we found. High minimum wages lead to slower job growth. It's not that people are fired necessarily, it's that they're never hired in the first place.

And that's particularly problematic because low-wage jobs, while generally not very fun, allow workers to gain valuable experience, skills, and reputations that allow them to move up the job ladder. to higher paying jobs. The minimum wage destroys those first rungs of the job ladder. Finally, let's think about who's affected by increases in the minimum wage. Advocates believe, genuinely I think, that they want to help low-income, low-skilled people.

But it turns out that many minimum wage workers are the teenage children of middle and upper class families, not exactly the people who we want to target anti-poverty policies at. The minimum wage is a blunt instrument. It doesn't distinguish between a teenager getting a summer job to pay for video games and a single mom trying to provide for her family. The law binds on both of them the same way. And with hundreds of people vying for each job at the artificially higher wage, employers can afford to be very choosy about who they hire.

So who's going to get left behind? Recent research shows that the negative employment effects are concentrated among high school dropouts, especially minorities. People who are already on the margins of the labor force are those who are most likely to be negatively affected by this policy.

It's true that the world is more complicated than our simple model. But the principles of economics hold, no matter whether we want them to or not, and wishful thinking doesn't make good policy. If you're interested in this issue, the supplemental material for this topic includes a video of a debate between James Galbraith of the University of Texas and me on whether a $15 an hour minimum wage would be good policy for the state of Texas. I think it's pretty interesting and I recommend it highly.

Transcript for:8.2- Minimum Wages

Transcript for:
8.2- Minimum Wages