Republicans and the Minimum Wage

Some Republicans in Congress are apparently worried about the midterm elections. They are so worried, they are starting to vote like Democrats.

According to today's Wall Street Journal,

Breaking with its Republican leadership, the House Appropriations Committee approved a $2.10-an-hour increase in the minimum wage as part of a budget bill that adds $4 billion to President Bush's requests for domestic programs.

The 32-27 vote is certain to be challenged when the $596.5 billion measure comes to the House floor. But the seven Republican defections underscored the growing prominence of the wage issue going into the November elections.

The minimum wage is, I admit, controversial among economists. But many economists, and surely most allied with the Republican party, take the view that Linda Gorman expressed so succinctly:

Unfortunately, neither laudable intentions nor widespread support can alter one simple fact: although minimum wage laws can set wages, they cannot guarantee jobs. In reality, minimum wage laws place additional obstacles in the path of the most unskilled workers who are struggling to reach the lowest rungs of the economic ladder.

Consistent with this assessment, here the abstract of a NBER study by David Neumark and Olena Nizalovaof on the long-run effects of the minimum wage:

Exposure to minimum wages at young ages may lead to longer-run effects. Among the possible adverse longer-run effects are decreased labor market experience and accumulation of tenure, lower current labor supply because of lower wages, and diminished training and skill acquisition. Beneficial longer-run effects could arise if minimum wages increase skill acquisition, or if short-term wage increases are long-lasting.

We estimate the longer-run effects of minimum wages by using information on the minimum wage history that workers have faced since potentially entering the labor market. The evidence indicates that even as individuals reach their late 20's, they work less and earn less the longer they were exposed to a higher minimum wage, especially as a teenager. The adverse longer-run effects of facing high minimum wages as a teenager are stronger for blacks. From a policy perspective, these longer-run effects of minimum wages are likely more significant than the contemporaneous effects of minimum wages on youths that are the focus of most research and policy debate.

Neumark on the Minimum Wage

A prominent critic of the minimum wage as an anti-poverty tool is David Neumark, an economics professor at UC Irvine and a graduate of the Harvard econ PhD program. Here is an excerpt from Neumark's latest summary (brief version) of the relevant research:

The central goal of raising the minimum wage is to raise incomes of low-income families and reduce poverty. There are three reasons why raising the minimum may not help to achieve this goal. First, a higher minimum wage may discourage employers from using the very low-wage, low-skill workers that minimum wages are intended to help. Second, a higher minimum wage may hurt poor and low-income families rather than help them, if the disemployment effects are concentrated among workers in low-income families. And third, a higher minimum wage may reduce training, schooling, and work experience—all of which are important sources of higher wages—and hence make it harder for workers to attain the higher-wage jobs that may be the best means to an acceptable level of family income.

The evidence from a large body of existing research suggests that minimum wage increases do more harm than good. Minimum wages reduce employment of young and less-skilled workers. Minimum wages deliver no net benefits to poor or low-income families, and if anything make them worse off, increasing poverty. Finally, there is some evidence that minimum wages have longer-run adverse effects, lowering the acquisition of skills and therefore lowering wages and earnings even beyond the age when individuals are most directly affected by a higher minimum....

Those interested in using economic policy levers to redistribute income to lower-income families should instead push for policy options that encourage work, that better target poor and low-income families, and that have a proven record of reducing poverty. The Earned Income Tax Credit, which is implemented at the federal level and supplemented by many states, appears to satisfy all of these criteria and thus is a better redistributive policy.

If you click on the link, you can also read Neumark's assessment of the famous Card-Krueger study, which is often cited by minimum-wage advocates.

Some Observations on Minimum Wages

John Cochrane has a nice post on minimum wages.

I was recently discussing the topic of minimum wages with a friend who favors them.  (He is a prominent economist, whose name you would surely recognize, but conversations with friends are off the record).  As justification for his view, he pointed me to this paper by Lee and Saez, called "Optimal minimum wage policy in competitive labor market."

What was notable to me about this paper is the incredibly strong assumptions they need to make their case.  In particular,

Assumption 1. Efficient rationing: Workers who involuntarily lose their low-skilled jobs due to the minimum wage are those with the least surplus from working in the low-skilled sector.

 Later they point out:

Finally, the desirability of the minimum wage hinges again crucially on the “efficient rationing” assumption. Under “uniform rationing”, where unemployment strikes independently of surplus, the minimum wage cannot improve upon the optimal tax allocation, a point formally proven in Lee and Saez (2008). Indeed, with efficient rationing, a minimum wage effectively reveals the marginal workers to the government. Since costs of work are unobservable, this is valuable because it allows the government to sort workers into a more socially (albeit not privately) efficient set of occupations, making the minimum wage desirable. In contrast, with uniform rationing, as unemployment strikes randomly, a minimum wage does not reveal anything about costs of work. As a result, it only creates (privately) inefficient sorting across occupations without revealing anything of value to the government. It is not surprising that minimum wages would not be desirable in this context.

Rather than providing a justification for minimum wages, the paper seems to do just the opposite. It shows that you need implausibly strong assumptions, such as efficient rationing, to make the case.  I cannot see any compelling reason to believe that in the presence of excess supply of workers, the market will somehow manage to efficiently ration the scarce jobs.

The Minimum Wage Debate

A student calls to my attention a recent release from Senator Hillary Clinton's office, which says "Senator Clinton is a strong advocate of increasing the minimum wage." It also says "she will introduce legislation when Congress returns to link Congressional pay increases to increases in the federal minimum wage."

It looks like the minimum wage is shaping up to be an issue in the 2008 Presidential election.

To read conventional analyses of the economics of minimum wages, click here and here. For Steven Landsburg's always provocative take on things, click here.

Finally, I cannot resist offering an excerpt from my favorite textbook:

The minimum wage has its greatest impact on the market for teenage labor. The equilibrium wages of teenagers are low because teenagers are among the least skilled and least experienced members of the labor force. In addition, teenagers are often willing to accept a lower wage in exchange for on‑the‑job training. (Some teenagers are willing to work as "interns" for no pay at all. Because internships pay nothing, however, the minimum wage does not apply to them. If it did, these jobs might not exist.) As a result, the minimum wage is more often binding for teenagers than for other members of the labor force.

Many economists have studied how minimum-wage laws affect the teenage labor market. These researchers compare the changes in the minimum wage over time with the changes in teenage employment. Although there is some debate about how much the minimum wage affects employment, the typical study finds that a 10 percent increase in the minimum wage depresses teenage employment between 1 and 3 percent. In interpreting this estimate, note that a 10 percent increase in the minimum wage does not raise the average wage of teenagers by 10 percent. A change in the law does not directly affect those teenagers who are already paid well above the minimum, and enforcement of minimum-wage laws is not perfect. Thus, the estimated drop in employment of 1 to 3 percent is significant.

In addition to altering the quantity of labor demanded, the minimum wage also alters the quantity supplied. Because the minimum wage raises the wage that teenagers can earn, it increases the number of teenagers who choose to look for jobs. Studies have found that a higher minimum wage influences which teenagers are employed. When the minimum wage rises, some teenagers who are still attending school choose to drop out and take jobs. These new dropouts displace other teenagers who had already dropped out of school and who now become unemployed.

The minimum wage is a frequent topic of political debate. Advocates of the minimum wage view the policy as one way to raise the income of the working poor. They correctly point out that workers who earn the minimum wage can afford only a meager standard of living. In 2005, for instance, when the minimum wage was $5.15 per hour, two adults working 40 hours a week for every week of the year at minimum-wage jobs had a total annual income of only $21,424, which was less than half of the median family income. Many advocates of the minimum wage admit that it has some adverse effects, including unemployment, but they believe that these effects are small and that, all things considered, a higher minimum wage makes the poor better off.

Opponents of the minimum wage contend that it is not the best way to combat poverty. They note that a high minimum wage causes unemployment, encourages teenagers to drop out of school, and prevents some unskilled workers from getting the on-the-job training they need. Moreover, opponents of the minimum wage point out that the minimum wage is a poorly targeted policy. Not all minimum-wage workers are heads of households trying to help their families escape poverty. In fact, fewer than a third of minimum-wage earners are in families with incomes below the poverty line. Many are teenagers from middle‑class homes working at part-time jobs for extra spending money.

Krugman on the Minimum Wage

An old article by Paul Krugman is relevant for the current policy debate. An excerpt:

So what are the effects of increasing minimum wages? Any Econ 101 student can tell you the answer: The higher wage reduces the quantity of labor demanded, and hence leads to unemployment. This theoretical prediction has, however, been hard to confirm with actual data. Indeed, much-cited studies by two well-regarded labor economists, David Card and Alan Krueger, find that where there have been more or less controlled experiments, for example when New Jersey raised minimum wages but Pennsylvania did not, the effects of the increase on employment have been negligible or even positive. Exactly what to make of this result is a source of great dispute. Card and Krueger offered some complex theoretical rationales, but most of their colleagues are unconvinced; the centrist view is probably that minimum wages "do," in fact, reduce employment, but that the effects are small and swamped by other forces. What is remarkable, however, is how this rather iffy result has been seized upon by some liberals as a rationale for making large minimum wage increases a core component of the liberal agenda.

Thanks to Mark Thoma for the pointer.

Sperling on the Minimum Wage

Gene Sperling, former economic adviser to Bill Clinton, tries to get President Bush to endorse a minimum-wage increase. Gene dismisses worries about adverse effects on employment. He writes:

No one has yet rebutted convincingly David Card and Alan Krueger's study that compared fast-food jobs on the border of New Jersey and Pennsylvania, and found no decrease in lower-wage jobs after New Jersey raised its state minimum wage.

The key word here is "convincingly." Gene is, apparently, not convinced by the Neumark-Wascher study that reevaluated the Card-Krueger work:

estimates of the employment effect of the New Jersey minimum wage increase from the payroll data lead to the opposite conclusion from that reached by CK.

Nor is he convinced by another Neumark-Wascher study that found

"no compelling evidence" that minimum wages help in the fight against poverty. A higher minimum wage...generates tradeoffs with respect to the incomes of poor and low-income families. Some families gain and others lose.

Nor is he convinced by the Neumark-Nizalova study that found adverse long-run effects of the minimum wage:

The evidence indicates that even as individuals reach their late 20's, they work less and earn less the longer they were exposed to a higher minimum wage, especially as a teenager.

Nor is he convinced by the Abowd-Kramarz-Margolis study that reported

movements in both French and American real minimum wages are associated with mild employment effects in general and very strong effects on workers employed at the minimum wage.

To me, Gene looks like a doctor prescribing a drug relying on a single controversial study that finds no adverse side effects, while ignoring the many reports of debilitating results.

Mayor Daley on the Living Wage

Here is a good decision, but politically a tough one for any elected official, as reported in USA Today:

Mayor vetoes Chicago's 'living wage' ordinance aimed at big retailers

Mayor Richard Daley vetoed an ordinance Monday that would have required mega-retailers to pay their workers more than other employers after some of the nation's largest stores including Wal-Mart Stores warned that the measure would keep them from opening their doors within the city's limits.

Supporters said the measure would guarantee employees a "living wage," but in a letter to City Council members released Monday, Daley said the ordinance would drive businesses from Chicago.

"I understand and share a desire to ensure that everyone who works in the city of Chicago earns a decent wage," Daley wrote. "But I do not believe that this ordinance, well intentioned as it may be, would achieve that end." The veto was Daley's first in 17 years in office, and will likely set up a showdown during Wednesday's council meeting.

Here is an old piece I wrote on the topic, when Harvard students were protesting for a living wage at the university.

The Cost of a "Living Wage"

By N. Gregory Mankiw
Boston Globe, 6/24/2001

If student movements are a leading indicator of social trends, and they often are, then the recent student takeover of the administration building at Harvard University is a troubling sign.

The students wanted a ''living wage'' ($10.25 a hour, plus benefits) for all Harvard workers. Like the broader living wage campaign, which could culminate in a much higher national minimum wage, the students were laudable in their intentions but deficient in their analysis.

The appeal of the living wage is obvious. Life is hard for workers trying to support families on $7 or $8 an hour. If we could wave a magic wand and help those at the bottom of the economic ladder move up a rung or two, we should do it.

But enacting a social reform is not like waving a magic wand. It is more like prescribing a drug with a long list of side effects. Sometimes the side effects are worse than the disease.

Like most other prices, wages are set by the market forces of supply and demand. The major difference between high-wage workers and low-wage workers is not that the former are better organized or better liked by their employers -- it's that their higher productivity enhances the demand for their services. Workers earning only $7 or $8 a hour are typically those with the fewest years of education and the least experience, which depresses the demand for their labor.

The living wage campaign wants to repeal the law of supply and demand and raise wages by fiat. The goal is to help low-wage workers. Unfortunately, it wouldn't work out that way. One effect of a higher wage is a reduction in the amount of labor that employers demand.

Take Harvard, for instance. How often does it need its janitorial staff to vacuum the classrooms and wash the blackboards? It's a judgment call. An increase in the wage from $8 to $10 a hour raises the cost of labor by 25 percent. It is wishful thinking to suggest that this won't affect the number of workers hired.

Living wage proponents say that Harvard, with its huge endowment, can afford to pay higher wages. Yes, that's true, but that's not the point. Like all employers, Harvard is always making cost-benefit calculations, weighing the benefits of one project (hiring more janitors to clean blackboards more often) against others (hiring more professors to reduce class sizes). By raising the relative price of unskilled workers, the passage of a living wage shifts the tradeoffs in a way that means fewer of those workers will be hired.

Living wage advocates often point to a study by economists David Card and Alan Krueger, which claims that raising the minimum wage does not reduce employment. This research became prominent during the Clinton years, in part because Krueger was once chief economist in Clinton's Labor Department.

Although Card and Krueger are reputable economists, equally reputable economists have attacked their data, methods, and results. Meanwhile, most research on the minimum wage finds that it reduces employment. Emphasizing the Card-Krueger evidence is like a doctor prescribing a drug relying on a single controversial study that finds no adverse side effects, while ignoring the many reports of debilitating results.

Moreover, the adverse effects of a high minimum wage go beyond its impact on total employment. In addition to reducing the amount of labor demanded, a high minimum wage compounds the problem by increasing the amount of labor supplied. In other words, not only are there fewer jobs available for unskilled workers, but more people apply for those jobs. Studies have found that increases in the minimum wage encourage some teenagers to drop out of school earlier than they otherwise would. These teenagers take jobs that would go to unskilled adults, making it harder for those adults to make the transition from welfare to work.

The case against a high minimum wage is even more compelling once one realizes that it is not the only way to address the hardship of the working poor. A better weapon to fight poverty is the Earned Income Tax Credit, a provision of the income tax system that supplements the income of low-wage workers. Like any spending program, this policy has the cost of higher taxes on everyone else. But those costs are smaller than the unemployment that results from high minimum wages.

Throughout history, students have been drawn to utopian social reforms. But history teaches that such social reforms often fail to yield what the reformers promised. The living wage campaign is the most recent example.

EITC is better than the Minimum Wage

From David Neumark:

Suggesting that federal policy addressing low-wage work and low-income families has somehow failed because the minimum wage has not kept pace with inflation ignores the fact that we have moved away from a focus on the minimum wage — a policy with many flaws — and toward the earned-income tax credit.  We shouldn’t be asking simply how much the real minimum wage has changed, but rather how much the combined income floor generated by the two policies has changed.

To provide an example, the blue line in the figure below shows the wages received by a single adult worker earning the minimum wage and working full time throughout the year. This can be interpreted as the income floor established by the minimum wage. The red line shows the level of family income when the earned-income tax credit for a family with two children is added (all in 2012 dollars). The lower line illustrates the income consequences of the real decline in the minimum wage. But the upper line shows that, because of the sharp increase in the generosity of the earned-income tax credit, the combined effect of the two policies is that the real income of this family is as high or higher than it was in past decades — when the real minimum wage was relatively high — and much higher than it was in most of the intervening years.

 

Nonetheless, there are important differences between the earned-income tax credit and the minimum wage. The fundamental difference is that the earned-income tax credit aims benefits at low-income families with children, rather than simply low-wage workers. This is in large part its virtue, and it makes a lot more sense than the minimum wage’s focus on low-wage workers. Do we really care if a low-wage teenager in a middle-class family makes an extra dollar an hour?  Economists of all persuasions in the minimum-wage debate agree that mandated wage floors do a bad job of directing benefits to low-income families.  This is confirmed in recent research by my graduate student Sam Lundstrom, calculating who would be affected by increasing the current federal minimum to $8.25 from $7.25.  He finds that only 21.3 percent of the affected workers would be in poor families, while 30.9 percent would be in families with incomes more than three times the poverty line.

Boudreaux on the Minimum Wage

GMU econ prof Donald Boudreaux writes about the minimum wage. His bottom line:

We don't know exactly how, or exactly by how much, employers as a group respond to higher minimum wages -- but the theoretical case that they do respond in ways unfavorable to low-skilled employees is too powerful to dismiss.

This sounds right to me.

But Boudreaux's arguments will not convince a hard-core egalitarian. Suppose these unfavorable responses are small in magnitude. Isn't it possible that the minimum wage on net helps poor families because the direct effect of higher wages more than offsets the adverse response from employers? Since Boudreaux is making a theoretical argument, he has to admit that it is possible. The minimum-wage debate will not be resolved with an appeal to theory alone.

In the end, there is no good substitute for an appeal to facts. What the facts show is that the minimum wage is poorly targeted as an anti-poverty program. Moreover, while the evidence is controversial, some studies find significant long-term adverse effects. As a result, most economists prefer more efficient and better targeted anti-poverty tools, such as the EITC, which has grown significantly over the past few decades.

Minimum Wage Redux

In his Times column today, Paul Krugman argues in favor of a higher minimum wage, suggesting that the adverse employment effects are trivial. Unfortunately, Paul presents a highly selective review of the literature. For example, this paper is relevant. From its abstract:

"new evidence based on methods that let the data identify the appropriate control groups leads to stronger evidence of disemployment effects, with teen employment elasticities near −0.3. We conclude that the evidence still shows that minimum wages pose a tradeoff of higher wages for some against job losses for others, and that policymakers need to bear this tradeoff in mind when making decisions about increasing the minimum wage."

Addendum: This old post by Steve Landsburg on the unfairness of the minimum wage is worth rereading.

Two Ways to Tell the Story

 From Paul Krugman today:

The most famous example is the research that Card conducted along with the late Alan Krueger on the effects of minimum wage. Most economists used to believe that raising the minimum wage reduces employment. But is this true? In 1992 the state of New Jersey increased its minimum wage while neighboring Pennsylvania didn’t. Card and Krueger realized that they could assess the effect of this policy change by comparing employment growth in the two states after the wage hike, essentially using Pennsylvania as the control for New Jersey’s experiment.

What they found was that the increased minimum wage had very little if any negative effect on the number of jobs....

So the empirical revolution in economics undermines the right-leaning conventional wisdom that had dominated discourse.

From David Henderson today:

Messrs. Card and Krueger conducted a famous natural experiment by studying employment at fast-food restaurants in New Jersey and Pennsylvania before and after New Jersey raised the minimum wage while Pennsylvania didn’t. Contrary to what one might expect, employment in New Jersey’s fast-food restaurants rose slightly relative to employment in Pennsylvania’s. On this basis, they challenged standard supply-and-demand models of the effects of minimum wages. Unfortunately, Messrs. Card and Krueger’s data weren’t so great—they gathered it by phoning restaurants.

University of California Irvine economist David Neumark and Federal Reserve economist William L. Wascher, using the restaurants’ payroll data, found what most economists would have expected: The minimum wage increase in New Jersey caused employment to fall in the New Jersey restaurants relative to Pennsylvania restaurants’ employment.

A Question from France

The Wall Street Journal (subscription required) describes a recent policy idea from France:

The government's latest proposal is to reduce the amount companies contribute to the state-run health-care and pension systems, which is based on the size of their work forces. To make up for the lost income, it would raise France's value-added tax.

Here is a good question for discussion: If a government reduces a payroll tax and raises a consumption tax, how does the tax shift affect the economy?

Here are my tentative answers:

1. The Labor-Leisure Decision. The shift does not alter the tax distortion between leisure and consumption. Both consumption taxes and payroll taxes distort that margin. The tax is collected at a different place (at the store rather than at work), but the disincentive to work is roughly the same.

2. The Saving Decision. Neither tax distorts the decision about consuming today versus consuming in the future. So the tax shift does not affect the incentive to save.

3. Distributional Effects. The shift may have some distributional effects--in particular, on the old versus the young. The old have already paid taxes on their wage income and now will have to pay taxes again when they consume out of savings. The young would seem to benefit by this shift of the tax burden to older generations. If the young have higher propensities to save than the old, this distributional effect could raise aggregate saving.

4. Short-run Macro Disequilibrium. Assuming the pretax price of goods is given by world prices, the after-tax price of goods in France will rise with the new sales tax. Nominal wages will rise as well, so that the after-tax real wage will be approximately unaffected. The transition to higher prices and higher nominal wages may not be instantaneous, so there may be some short-run macroeconomic effects (as was studied in this 1986 paper by Poterba, Rotemberg, and Summers). In particular, if nominal wages are slow to adjust to their higher level, the real wage will be temporarily lower than its equilibrium level, and this would tend to stimulate employment for a while.

Update: My colleague Emmanuel Farhi emails me:

I was reading your blog today. Encouraged by Olivier Blanchard, I actually wrote a note with Ivan Werning on the French reform under consideration. The note is attached, but is in French (we passed it on through Olivier to various people in the French government). We make all the points you are making, and a couple additional ones:

- A lot of non-traded goods and services are exempt from VAT. So the reform would [depress] consumption of traded goods and services relative to non-traded goods and services.

- Payroll taxes are highly progressive for wages between the minimum wage and 1.6 times the minimum wage. The reform would hurt those people, as the VAT is linear and not progressive.

- A lot of empirical studies find that a part of the VAT - up to 15% of the VAT - falls directly on firms and is not transmitted to consumer. This is called "VAT remanence" in French. Hence a VAT increase represents an increase in the tax on capital (investment).

- There is a lot of VAT fraud in Europe, that basically involves creating an ad-hoc firm that is supposed to go bankrupt with VAT liabilities.

- For many people, income comes from transfers from the government in one form or another. In France, this is true of pensions, unemployment benefits etc. Most of these transfers are indexed on inflation. So the reform would be neutral for them. A big question, given the importance of the public sector in France, is civil servant's wages.

Thanks, Emmanuel, for those insights.

I am puzzled by one thing: Why is a young, productive, untenured economist like you wasting time reading this blog?

A Comeback for Comparable Worth

In the first edition of my favorite economics textbook, there was a section on "comparable worth." Eventually, my editor suggested I take it out, on the grounds that economic logic had finally killed off this bad idea. But like Lord Voldemort in the first Harrry Potter book, the idea was weakened, but not dead.

Here is what Fortune is now reporting:

It's baaaack!! Yes, "comparable worth," which faded out around the same time the Bay City Rollers were disbanding, is making a comeback, under the euphemism "pay equity". To wit: the Fair Pay Act of 2007. Introduced by Tom Harkin (D-Iowa) in April (Illionois Sen. and Democratic presidential hopeful Barack Obama is one of 15 co-sponsors) the Act notes the existence of wage differentials between men and women.

This is true; according to the Bureau of Labor Statistics, in 2005 female full-time wage and salary workers made 81% of what men did. What is more dubious, though, is the assumption that is the heart of the Fair Pay Act: that discrimination is the reason for all or most of the difference. And the act's remedies are absurdly misguided, injecting the federal government into the most routine pay decisions.

And here is what I wrote about the topic ten years ago in that first edition:

The Debate over Comparable Worth

Should engineers get paid more than librarians? This question is at the heart of the debate over comparable worth, a doctrine according to which jobs deemed comparable should be paid the same wage.

Advocates of comparable worth point out that traditionally male occupations have higher wages than traditionally female occupations. They believe that these occupational differences are discriminatory against women. Even if women were paid the same as men for the same type of work, the gender gap in wages would persist until comparable occupations were paid similar wages. Comparable-worth advocates want jobs rated according to a set of impartial criteria--education, experience, responsibility, working conditions, and so on. Under this system, comparably rated jobs would pay the same wage. A librarian with a master's degree, ten years of experience, and a forty-hour workweek, for instance, would be paid the same as an engineer with a master's degree, ten years of experience, and a forty-hour workweek.

Most economists are critical of comparable-worth proposals. They argue that a competitive market is the best mechanism for setting wages. It would be nearly impossible, they claim, to measure all of the factors that are relevant for determining the right wage for any job. Moreover, the fact that traditionally female occupations pay less than traditionally male occupations is not by itself evidence of discrimination. Women have in the past spent more time than men raising children. Women are, therefore, more likely to choose occupations that offer flexible hours and other working conditions compatible with childrearing. To some extent, the gender gap in wages is a compensating differential.

Economists also point out that comparable-worth proposals would have an important unintended side effect. Comparable-worth advocates want the wages in traditionally female occupations to be raised by legal decree. Such a policy would have many of the effects of a minimum wage, which we first discussed in Chapter 6. In particular, when the wage is forced to rise above the equilibrium level, the quantity of labor supplied to these occupations would rise, and the quantity demanded would fall. The result would be higher unemployment in traditionally female occupations. In this way, a comparable-worth law could adversely affect some members of groups that the policy is aimed at helping.

The debate over comparable worth continues. The courts have usually rejected the claim that occupational wage differences are discriminatory. Nonetheless, the comparable-worth movement has had some political success. For example, in 1985, a government employees union sued the state of Washington for discrimination using a comparable-worth argument. The case came before Circuit Court Judge Anthony Kennedy, who later became a justice on the U.S. Supreme Court. Kennedy decided against comparable worth, writing that "neither law nor logic deems the free market system a suspect enterprise." Despite their defeat in the courts, however, the advocates of comparable worth ultimately got what they wanted. The state of Washington eventually succumbed to political pressure and adopted a comparable-worth system for paying state employees.

CBO on the Minimum Wage

NPR reports:

Raising the federal minimum wage to $15 an hour by 2025 would increase wages for at least 17 million people, but also put 1.4 million Americans out of work, according to a study by the Congressional Budget Office released on Monday.

A phase-in of a $15 minimum wage would also lift some 900,000 out of poverty, according to the nonpartisan CBO. This higher federal minimum could raise wages for an additional 10 million workers who would otherwise make sightly above that wage rate, the study found.

Potential job losses were estimated to affect 0.9 percent of workers, the CBO wrote, adding: "Young, less educated people would account for a disproportionate share of those reductions in employment."

Minimum wage vs EITC

The CBO today released a brief report comparing an increase in the minimum wage with an expansion in the Earned Income Tax Credit. The report shows that the EITC is far better targeted as an antipoverty policy.

Here is the summary:

On the basis of data from the March 2005 CPS, about 18 percent of the 12 million workers who were paid an hourly wage rate between the federal minimum wage of $5.15 and $7.24 were in families that had a total cash income below the federal poverty threshold in 2004. Had all of the workers in that wage range, instead, received $7.25 per hour, they would have gotten about $11 billion in additional wages in that year. About 15 percent of those additional wages ($1.6 billion) would have been received by workers in poor families.

As requested, CBO examined the potential effects of hypothetical expansions in the EITC that would have provided additional payments to workers in poor families similar to the amount of additional earnings poor workers would have received by increasing the minimum wage rate to $7.25 per hour. One option was to increase the subsidy rate for childless workers by 50 percent. Another option was to increase the subsidy rate for workers with three or more children by 25 percent. On the basis of data from the CPS, combining those options would have increased total EITC payments by roughly $2.4 billion in 2004, with workers in poor families receiving $1.4 billion of that total.

Living Wage Redux

A group of ec 10 students asked me today about the hunger strike that some students have recently begun to protest the wages of Harvard security guards. A similar issue arose in 2001. Here is what I wrote back then in Harvard Magazine.

The Case against the Living Wage

When a group of students took over an administration building last spring to protest Harvard's wage policy, many people found it easy to sympathize with them. Without doubt, life is hard for workers getting by on $8 or $9 an hour. Moreover, the protest was a welcome relief from the relentless careerism that infects too many students today. The protesters were admirable in their desire to reach beyond their own fortunate cocoons and help those who are less lucky.

Despite the students' good intentions, I cannot support their cause. If any institution should think with its head as well as its heart, it is a university. In my view, there are compelling reasons to reject the students' pleas.

Like most of the prices in our economy, wages move to balance supply and demand. A high minimum wage set by fiat, either through legislation or student pressure, prevents this natural adjustment and hurts some of the people it is designed to help. It is a timeless economic lesson that when the price of something goes up, buyers usually buy less of it. If Harvard has to pay its unskilled workers a higher wage, it will hire fewer of them. Some workers earn more, but others end up unemployed.

Living-wage advocates say that Harvard with its huge endowment can afford to pay higher wages. That's true, but it misses the point. Like all employers, Harvard faces trade-offs. Should extra money be spent hiring more professors to reduce class sizes, or should it be spent hiring more janitors to vacuum classrooms more often? It's a judgment call. If the cost of unskilled labor rises, Harvard faces a new set of trade-offs. Over time, it will respond by hiring fewer of those workers.

A higher wage would also change the composition of Harvard's work force, for wages play a role in supply as well as demand. If the University posts a job opening at $10 an hour, it gets a larger and better mix of applicants than if it posts the same opening at $8 an hour. The person who would have gotten the job at the lower wage is now displaced by a more skilled worker. In the short run, a living wage might benefit those at the bottom of the economic ladder. In the long run, they would be replaced by those who are already a rung or two higher.

Finally, the living-wage protest raises the issue of Harvard's mission in society. The benefactors who give to the University do so to support education, not income redistribution. (And if Harvard were to take up the cause of income redistribution, it would have to acknowledge that even the poorest workers in Cambridge are rich by world standards.) Harvard needs to pay its workers--janitors and professors alike--enough to attract and motivate them. But it shouldn't pay more than it needs to, given the competitive labor markets in which it hires. To do so would compromise the University's commitment to the creation and dissemination of knowledge.

Don't 'Fight for Fifteen'

U Chicago's Allen Sanderson opines on the minimum wage.

Addendum: And here is an interesting new contribution to the empirical literature on minimum wages.

Working at Cross Purposes

Consider this policy aimed to help workers at the bottom of the income distribution:

1. A wage subsidy for unskilled workers, paid for by
2. A tax on employers who hire unskilled workers.

Now, if you think like an economist, you might wonder about the logic of part 2 of this proposal. You might say, "A tax on the hiring of unskilled workers would discourage their employment, offsetting some of the benefits they would get from the wage subsidy. It would be better to finance the wage subsidy with a more general tax, rather than with a tax targeted specifically on employers of unskilled workers."

I agree. So why did I bring up this proposal? Because a policy essentially the same looks likely to become law, having been advocated by Congressional leaders and, recently at his news conference, President Bush. Haven't heard of it? It is called an increase in the minimum wage.

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Update: A commenter asked about the technical equivalence of minimum wages with taxes and subsidies. I will leave this issue as an exercise for the reader, but here are some hints about how to think about it in a competitive labor market using supply and demand curves. Let w be the market wage, and let W be the target wage of policymakers. Draw supply and demand curves for labor such that the equilibrium wage in the absence of any policy is below W. Now suppose the government tells suppliers of labor: Whenever w is less than W, you are paid a subsidy equal to W-w. Similarly, it tells demanders of labor: Whenever w is less than W, you are charged a tax equal to W-w. Calculate quantity supplied and quantity demanded as a function of the market wage w. Graph the new supply and demand curves, and I believe the equivalence should be clear.

Nine Observations about Investment

1. Above is a chart of the growth rate, from four quarters earlier, of real investment in equipment and software.  Notice the left scale.  Investment spending is very volatile.  This is one of the standard stylized facts about the business cycle.

2. Investment has been particularly weak during this economic downturn.  Weak residential investment is not a surprise, as the downturn was started by events in the housing market.  But as this graph shows, business investment has also been very weak.  Indeed, by the metric used in this graph, it is far weaker than in previous deep recessions, such as 1982.

3. Why is business investment so weak?  Part of the reason is that the downturn is severe and investment responds to the overall economy.  Part of the reason is that the credit crunch makes financing more difficult.  Part of the reason is that the policy environment seems adverse to business.  I am referring here to a group of policies that include higher minimum wages, the seeming retreat from free trade, proposed mandates to provide employees health insurance, higher prospective energy costs from climate change regulation, and the likelihood of higher future tax rates resulting from the huge fiscal imbalance we are now experiencing.  All of these factors have worked in concert to depress business investment.

4. The recent weakness of business investment was one of unstated reasons why, in my recent NY Times column, I suggested that an investment tax credit (ITC) might have been a better form of fiscal stimulus than what we in fact are getting.  Given the amount of money being spent on stimulus, the ITC could have been sizable.  The measure of investment used in the chart above is about $1 trillion per year.  So, to give a very rough example, if Congress had passed a 20 percent ITC in 2009, 10 percent in 2010, it would have cost the Treasury about $300 billion.  Essentially, the Treasury would have picked up 20 percent of the cost of all of these investments if done this past year, and half that amount next year.

5. Some readers might wonder if this policy would work in the presence of the zero lower bound on interest rates (aka the "liquidity trap").  The truth is that we don't fully understand the role of the zero lower bound, and most of what we do know is based on stylized theoretical models with scant evidence to back them up.  But those models suggest that an ITC would work just fine.  The zero-lower-bound whiz kid Gauti Eggertsson in fact endorses the ITC as a plausible policy in that environment.

6. In my most controversial NY Times column, I said that what the economy needed was negative real interest rates, which could be accomplished via inflation.  A temporary ITC does something similar.  By temporarily reducing the effective price of capital goods, it creates expected inflation in this particular price.  Under the numerical example above, the effective price of new capital would immediately fall by 20 percent, and expected inflation would rise by 10 percent.  If nominal rates stay at zero, the real interest rate measured in units of new capital goods would become negative 10 percent.  That is one way to view the way in which a temporary ITC stimulates investment spending.

7. So much for theory, but would it work?  The cash-for-clunkers program is thought by many to have promoted, or at least accelerated, car purchases.  An ITC would be similar, but it would apply to business investment rather than personal cars.  Instead of targeting a very narrow, politically favored industry, it encourages investment broadly.  It should have positive effects on aggregate demand in the short run and positive effects on aggregate supply in the medium and longer run.

8. Recall that an investment tax credit was part of the Kennedy plan to get the economy going again back in the early 1960s.  According to historical reports, Kennedy came to this idea of tax cuts with the advice of economist Paul Samuelson, who just passed away.  In memory of Professor Samuelson, if the Obama administration wants to switch gears and try a sizable investment tax credit, I propose that we call it the Paul Samuelson Memorial ITC.

9. Update: Intrigued by this idea? Try these further readings on the subject by Bruce Bartlett and Hal Varian.

Mallaby on Inequality and Taxes

In today's Washington Post, Sebastian Mallaby gives us his laundry list of proposals to reduce inequality. I disagree with a lot of it (such as Mallaby's generally positive assessment of higher minimum wages, greater unionization, and repealing saving incentives), but I would go along with some of the ideas. Here is the part I like best:

Many popular provisions in the tax code are both ineffective and regressive. Repealing them would liberate billions that could be used to help workers.

Take mortgage-interest relief, a policy that's supposed to boost home ownership. More than half of this subsidy flows to the top 12 percent of households with incomes over $100,000; the poor get very little. This absurdly regressive policy doesn't even promote its objective, since affluent families would own their own homes anyway. The U.S. home ownership rate is no higher than Britain's or Australia's, two countries that have no mortgage-interest tax relief....

The same argument holds for tax incentives to buy health insurance. Just over a quarter of this subsidy is swallowed by households in the $100,000-plus bracket; far from promoting the wider dissemination of health insurance, it may even reduce it. Affluent Americans use the subsidy to buy all-inclusive health plans, which in turn causes them to throw money at health services; health inflation goes up, making insurance too expensive for poor families. The Treasury estimates that the ranks of the uninsured could be reduced by at least 1 million if the tax deduction for health insurance were capped at a reasonable level.

Mallaby would use the revenue from eliminating these tax breaks to expand the EITC. I would use some of the extra revenue to help close the long-term fiscal gap.