Fred Thompson on the Minimum Wage

Editor's Note: A thousand thanks to Fred Thompson and his contributions to this blog during a time when I have been unable to provide much content. Fred promises to take a breather for a while and, based on this contribution especially, I hope he doesn't really mean it. For what it is worth, I think this post pretty accurately describes mine and many other economists preference for extra-market transfers in lieu of market distorting taxes and rigidities (see: my rants abut the prohibition on self-service gas). Take it away Fred...

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Last week, at Blue Oregon, Chuck Shekatoff of the Oregon Center for Public Policy (OCPP) accused the communications and lobbying firm Conkling Fiskum & McCormick (CFM) of slipping into “into Political BS (Bogus Statement) mode. The CFM article asserted ‘[h]owever, for the majority of that time [since 2002] the state unemployment rate has remained higher than the national average.’ The suggestion by CFM and business groups that a relatively high minimum wage and higher-than-average unemployment levels are related is Political BS.”

Shekatoff asserts that Oregon’s typically higher-than-national-average unemployment is due to population growth and the structure of our economy and cites an OCPP report and economists at the Oregon Employment Department in support of this claim. When, however, one checks the OCPP report (Who’s Getting Ahead) the evidence cited is short discussion of the issues by an Oregon Employment Department economist, Art Ayre, “Why Does Oregon Have a High Unemployment Rate?” published April 27, 2005. This is, indeed, a very nice discussion of the issues. It correctly observes that “economists usually speak of unemployment as having three components: frictional, cyclical, and structural. All three contribute to Oregon's higher-than-national rate.” However, while it is clear that Ayre has a keen grasp of the issues and the Oregon labor market. The evidentiary basis for his claims is simply not reported.

Indeed, it is hard to see how two of the factors he cites, the structure of the economy and population growth could explain Oregon’s RELATIVE unemployment when compared with the rest of the United States. The structure of Oregon’s economy is essentially a constant. It is axiomatic that a variable that doesn’t vary cannot explain any variance, although it might explain the intercept in an empirical model (which is how I understand Ayre’s claim, although I would stress that ‘might’ leaves a powerful lot of wiggle room). But if you take population growth as the independent variable in an empirical model and relative unemployment (or employment growth) as the dependent variable, one actually obtains a negative relationship. Now I don’t believe for a moment that population growth really causes unemployment to fall (or employment to grow). My hunch is that the causal arrow goes in the opposite direction.

The main driver of unemployment in Oregon is America’s business cycle. America’s booms and busts are also Oregon’s. But what explains Oregon’s RELATIVE unemployment. As a classroom exercise, I have had my students look at this issue several times over the past decade or so, using monthly data, the difference in unemployment (or employment growth) between Oregon and the US as the dependent variable and anything they could think of as independent (or causal) variables. The two variables that seem to explain Oregon’s relative unemployment best are the dollar’s exchange rate with other currencies and the state government's stop and start spending behavior.

The fact is that Oregon industry and agriculture are highly affected by foreign trade. When the dollar is low, they do well, at least so long as the rest of the world isn't in the tank. When it is high, they don't. This is a structural factor that varies measurably over time. Moreover, the state relies on a highly progressive tax structure. Progressive taxes are necessarily volatile revenue sources. Revenue volatility encourages spending volatility, making our booms and busts bigger than elsewhere. This is a cyclical factor unique to Oregon.

Early this year, I took a spreadsheet from the work of one of my better students and tossed a dummy variable representing Oregon’s adoption of a premium minimum wage into her model. The effect was statistically significant, as was the increase in the adjusted coefficient of determination. However, from the standpoint of relative unemployment (or the relative change in total employment), the negative effect was very small. This isn’t a very good test. It’s not a good econometric model. Moreover, using the change in Oregon’s minimum wage relative to the national average would have been better. But when I did the analysis, I lacked that data. Nevertheless, I think its results are likely to be correct. Oregon’s high minimum wage almost certainly makes relative unemployment worse, but the effect is probably not very big, at least not compared to other significant factors.

The reason I believe this is because it is consistent with what most other economists, who have looked closely and carefully at this issue, have found. My reading of contemporary research that the effect of high minimum wages on low-income employment is far more likely to be negative than neutral. Of course, employers can increase prices. But, other things equal, increased prices mean lower sales volume and fewer employees (otherwise, presumably, those employers would have already raised prices). High minimum wages also lead to rationing inefficiencies, which are probably more important than the job losses, but that is another story. One can recognize that high minimum wages have adverse effects and still support minimum wages, even high minimum wages. The consensus among labor economists is that minimum wages help many more low-wage workers than they hurt.

But its supporters shouldn't fool themselves that its effects are entirely benign. If anything is political BS, that is.

Obama proposes to raise the national minimum wage to $9.50 per hour in 2011 and index it to inflation. He also wants to increase the Earned Income Tax Credit (EITC) for working Americans with no children and for those with three or more children and a tax credit of up to $500 per person or $1,000 per couple. This would be a rebate of the worker’s Social Security contribution on the first $8,100 of earnings. Like the EITC, this helps low-income working families without creating employment disincentives.

Most economists believe that we could get more equality at a lower cost by focusing on bottom-end personal income tax brackets and expanding the EITC than by raising minimum wages. Consequently, I’d prefer it if Obama were less enthusiastic about increasing minimum wages and more committed to across-the-board increases in the EITC. Here in Oregon, one thing that we could do is to eliminate the first two brackets of the state personal income tax. Failing the better, however, we should probably, as Chuck Shekatoff proposes, celebrate the pretty good.

Disclosure, Gary Conkling of FSM is my colleague at the Atkinson Graduate School of Management.