This excellent book surveys virtually all of the published research on the minimum wage since1938. Parts of it will be pretty heavy sledding for those of us not trained in econometrics, because it’s littered with mathematical formulas that not one person in a thousand could understand. However, the authors do a good job of explaining their science, methodologies and conclusions in words as well. A listing of the chapters shows the questions being addressed:
1 Introduction.
2 The History of the Minimum Wage in the United States.
3 The Effects of Minimum Wages on Employment.
4 Minimum Wage Effects on the Distribution of Wages and Earnings.
5 The Effects of Minimum Wages on the Distribution of Incomes.
6 The Effects of Minimum Wages on Skills.
7 The Effects of Minimum Wages on Prices and Profits.
8 The Political Economy of Minimum Wages.
9 Summary and Conclusions.
The most obvious question is, if we don’t like the authors’ conclusions, why should we believe them? Well, it seems that the impact of Minimum Wages has been heavily studied since its inception, and while the authors describe their own research, they also rigorously present the research and conclusions of others. In fact, the extensive coverage of existing literature is one of the reasons this book is challenging. The list of references alone is about 24 pages with over 400 separate citations.
Another obvious question is whether it’s even possible to figure out the effects of a change in the minimum wage. After all, many things affect the labor market, so how can we isolate out the effects of a change in just one variable? For example, in July 2007, just as the U.S. economy was beginning to tank, the federal minimum wage was increased 13.6% from $5.15 to $5.85. Then, when the economy was clearly in free fall and unemployment skyrocketing a year later, the minimum wage was increased another 12% to $6.55. So can we say that a compounded 27% increase in the minimum wage within a one-year period caused the second-biggest economic crisis in U.S. history? No, nobody thinks that.
Fortunately for these analysts, not only has the federal minimum wage changed numerous times over the last 75 years, but most of the states have implemented widely varying minimum wages that have changed even more frequently. As a result, econometricians have access to sufficient data to distill out the effects of the minimum wage against the background of countless unrelated changes in the national and regional economies. Moreover, the granularity of the data by region, demographics, and wage levels is astonishing. I’ll leave it to the authors to persuade you of their science, but I came away persuaded.
As for the conclusion (insert spoiler alert here) it seems that the minimum wage achieves virtually none of the goals advanced by its proponents. In fact, in many cases it hurts the very populations it is intended to help. The authors do a good job of explaining the linkage between their studies, their data, and their conclusions, so I won’t attempt to repeat it here, except to mention one of the causalities that wouldn’t be obvious someone that stopped with Economics 101.
It goes like this: The iron law of neoclassical economics is supply and demand. If you raise the price of something, the demand is assumed to fall. And because of this, even the most ardent proponent of raising the minimum wage would have to sense that he’s feeding into the forces of automation and outsourcing when he wants to raise the price of labor. But it turns out reduced aggregate demand isn’t the most significant problem. Quite to the contrary, it seems that raising the price of the lowest tier of the labor pool causes a shift in demand, not up but down – to even more expensive workers. The authors call this phenomenon “spillover,” which I’ll try to explain.
To understand spillover (shifting of demand to higher-priced items), we have to recognize that prices force shoppers to choose. All economic goods can be rank ordered, but knowing which is the “best” isn’t a good predictor of what’s going to sell. For easy example, if you look for men’s watches on Amazon, you’ll find an assortment of popular brands, including Timex, Casio, Seiko, Citizen and Tag Heuer. Currently, Tag Heuer lists for about 50-times the price of Timex, and we don’t have to know anything about watches to know that, confronted with such vast price differentials, some will choose Tag Heuer, but more will settle for one of the less expensive brands.
Labor is subject to the same market forces. It’s not just manufactured goods – everything with a price goes through this filter. My local market sells regular tomatoes for around $2.49/lb and “organic” tomatoes for $3.49/lb. Without the little sticker you couldn’t tell them apart, but somebody obviously thinks there’s a difference because people are willing to pay 40% more for organic. What’s less obvious is that the market rank orders two human beings the way it orders watches and tomatoes – by price. And the reason “cheaper” labor gets selected is because, even though employers may perceive one worker as less productive than another, the less productive ones are also less expensive.
Enter price controls and resulting spillover. What happens to Timex if you legislate a “Minimum Watch Price?” What happens to regular tomatoes if you establish a “Minimum Tomato Price?” Now everything is more expensive, but if it’s true that purchasers only choose the lesser good because it’s cheaper, then as the price gap narrows, the benefit of choosing cheaper diminishes. Suddenly, what was an unreachable distance up the price curve is now much closer, albeit only because the bottom of the curve has been legislatively raised and all goods are more expensive.
A shallow view of supply and demand imagines that the response to rising prices is not to consume. But in the case of business that require significant human labor, this generally not an option. What is an option, however, is to take advantage of the narrowing price gap between lower-skilled and higher skilled labor to spend more to get more – and this is exactly what the data show. When the minimum wage rises, the low-skilled population loses work hours as employers utilize higher-skilled workers that now are more cost effective. But because it’s a “spillover” between labor categories, the aggregate employment data don’t show the decline that would tip off Minimum Wage proponents that their strategies are not having the desired outcome.
In summary, this book will open your eyes to non-obvious issues surrounding the Minimum Wage. Most of the conclusions run counter to our intuitions, so for some it will be hard to swallow. Basically, increases in the Minimum Wage end up being generally harmful to the populations they’re intended to benefit, and as the authors point out, there are better alternatives. One of them, the Earned Income Tax Credit apparently does a much better job of targeting those in need (despite some well published failures of IRS monitoring). So if you’re interested in the plight of the poor and want to understand the options, this is an excellent place to start.
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Ruosi Lu
Quick parcel and good book
Reviewed in the United Kingdom on December 13, 2013Frank Reibold
Mindestlöhne sind kein Mittel gegen Armut
Reviewed in Germany on August 24, 2010