The Minimum Wage isn't The Worst Idea in the World, But...

Mario Pisani joins the anti-minimum wage bandwagon in today’s FT (subscription required). The theoretical case outlined in his essay is standard, namely that the imposition of a minimum wage prevents employers from hiring workers whose productivity levels are beneath the wage floor. The minimum wage then acts as a tax on the hiring of employees whose productivity levels are between $0 per hour and the level of the minimum wage. Taxing work is not a good idea if one believes that work has positive externalities like Pisani does. For Pisani, taxes should be imposed on activities with ugly social consequences, such as drinking and smoking, and should subsidize activities that result in positive benefits for society (charitable giving, working). Pisani could also have mentioned that it is plausible that employers will respond to the minimum wage hike by allowing work conditions to deteriorate, a reasonable assumption if bargaining power within low-skilled labor markets is weak, and evidence suggests it is.

If the minimum wage is so bad, why have 650 economists, including several Nobel Prize winners, expressed their support for it? Well, a cynic might say that given the minimum wage is the only source of aid to low income workers being seriously considered by the 110th Congress, it was nothing or the 10th best alternative that this group was advocating. The truth is that the real effects of minimum wage hikes are obscure, difficult to measure, and in the end, relatively small. As Megan McCardle argues, low-skilled labor markets are relatively volatile, making it difficult to disentangle multiple effects moving in opposite directions on the employment of low-skilled workers. Most economists would agree that the effects of a minimum wage increase such as the level passed in the House earlier this year would have very minor, negative effects on employment---the negative effects are mitigated by the positive effects in the form of a sturdier balance sheet for those benefiting from the hike (the winners spend more). But the fear is not so much that unemployment will increase, but that overtime, the increasing cost of labor will lead to input substitutions away from labor, toward labor saving machines. There is also the concern that a minimum wage hike will hurt the most vulnerable in the low-income distribution, namely individuals with criminal records or those workers who have been out of the labor market for an extended period. Employers will be unlikely to hire those workers who they were disinclined to hire at the previous wage floor.

What struck me most about this essay is what Pisani chooses not to include from his laundry list of minimum wage critiques. Here's the real issue: If a minimum wage hike is designed to help the workers at the very bottom rungs of society’s income ladder, it does not do a particularly good job of hitting its target. Of the 2.5 million full and part-time workers earning the minimum wage, 53 percent fall in between the ages of 16 and 24, and within this age group, average household income tops $64,000. Older minimum wage earners (25+) are not nearly as well off, with average household income hovering around $33,000. But still, $33,000 is $14,000 above the poverty level.

It is wrong to say that the minimum wage completely misses the mark: 19 percent of minimum wage earners are living in poverty, and these workers would benefit from the hike. Further, the increase in minimum wages should also boost the wages of those earning just above the minimum wage today, as their employers need to pay more to prevent these workers from working in occupations that require less skill, but pay the same amount. However, the point is that hourly wages are not the best statistic to look at when determining social welfare policy. Policymakers should avoid mistakenly aiding a 20 year old worker living in a $64,000 household while leaving the family of four to make ends meet at $20,000. The fact that the minimum wage doesn’t do that bad, isn’t of great consolation to the lowest skilled workers who lose their job because of its passage, nor does it help the family to whom the benefits of the minimum wage pass by.

If the minimum wage is not the answer, what is? Pisani advocates one sensible alternative, the earned income tax credit (EITC) paid to low-income workers (low income as measured by household income). The EITC acts as a subsidy to work as opposed to a tax on it. Greg Mankiw has argued that the minimum wage “is a tax on low-skilled workers paid for by low-skilled workers”. The EITC can be financed more broadly, and more progressively, enabling policymakers to spread the costs of the tax across the population. The EITC is not a permanent fix to the problems encountered by low-skilled workers in today’s economy, but the incentives to work embedded in that program are sensible and the effects on the household incomes of the poorest are more positive. In conclusion, the minimum wage isn't the worst thing we can do, but it falls just short of being adequate.