Econ 539 - Public Policy Analysis: Minimum Wages, Part 2

Quite a while ago now, a 'friend-of-the-blog' in the restaurant industry e-mailed to ask about what I thought of the relatively high minimum wage in Oregon and the additional aspect of Oregon's minimum wage that it cannot be reduced for those that earn tips.  California and Washington also have high minimum wages and do not allow for a 'tip credit,' of this sort so we are not alone, but these are three of eight total states (that I was able to determine) that do not allow credit for tips.

The question was essentially, what did I think of the effect on unemployment in Oregon and what did I think of the specific impact on the restaurant industry?  I punted on the question at the time as it required too much time to read up on the literature just for the purposes of the blog which is, after all, not my real job.  But happily my real job has converged with the blog and doing a week on minimum wages in Public Policy Analysis required my familiarity with the literature and I have learned a few things.  Not enough to synthesize into a strong opinion, but enough to list some empirical evidence of the impact of minimum wages:

1.  Minimum wages, if they are designed to combat poverty are a pretty poor way to do so.

This table, from a Congressional Budget Office report on the effectiveness of the minimum wage relative to an expansion of the Earned Income Tax Credit (EITC), shows that just $1.6 billion of almost $11 billion would go to households classified as below the poverty line.

To get virtually the same amount of money going to impoverished households, you could do a $2.4 billion expansion of the EITC.

Why is it so bad as an anti-poverty measure?  Well, it didn't used to be, but it turns out that a very small fraction of impoverished households (or those within double the poverty line) actually work for the minimum wage.

Here is a table from a report done by Burkhauser and others in 2005:

From this table you can see how the persons making the minimum wage have evolved through time and now (or by 2003 at least) few of the households in or near poverty rely on a minimum wage job.  More and more, minimum wage earners are teenagers and part-timers. Which brings me to my next observation:

2. Minimum wages may distort the incentives for kids to invest in education.  By raising the opportunity cost of schooling, kids may be induced to leave school and not continue their education.  In fact Neumark and Wascher (AER 1995) have found such effects.  They find that minimum wages "...increase the probability that teenagers leave school to become employed or work more hours, and they increase the probability that teenagers leave school to become non-employed or non-enrolled."

3. But what about the big question of minimum wages and unemployment?  The evidence is decidedly mixed and the effects appear to be small, with a preponderance of the evidence suggesting an elasticity of teen workers at about -0.2 (though some notable studies even find positive employment effects, like the famous Card and Krueger 1994 AER paper).  However, many have pointed out that studies that fail to find any effect are unlikely to be published leading to a type of bias.  Given this, most studies of the effectiveness of the minimum wage (like the CBO one above) go with the zero employment affect assumption.

4. As for restaurants and the minimum wage: Oregon is already the second highest minimum wage state in the nation and added to that we have a no tip allowance so it is likely that we pay more for our restaurant food and that we have fewer restaurants than we would have in absence of a minimum wage.  Empirical evidence has found the minimum wage-price link to be strong.  This, of course (from the law of demand), means that we probably have fewer restaurant jobs than we would have in the absence of a minimum wage, but it does not mean we have lower employment overall, as well-paid restaurant employees spend their income as well and the net effect is, as mentioned above, a matter of some debate.

5. The last observation I have is that the big question to which their seems to be no good evidence is if states with relatively high minimum wages suffer higher unemployment and lower growth because of their minimum wages.  This is a very tricky empirical puzzle to solve so it does not surprise me that there is a lack of convincing evidence, but it would be extremely useful to know.  In other words, the graph I made for my last minimum wage post is really totally meaningless as far as a causal link goes.

My conclusion is that for me the main rationale for a minimum wage is to provide a 'living wage' - meaning to fight poverty - and that I think it is not a particularly effective way to do so, the EITC is much better, for example.  The minimum wage does, however, have the advantage of being practically costless to administer, while the EITC does not.  Still, from my perspective, if I were to think about further expansion, I would go for the EITC before the minimum wage.

Econ 539-Public Policy Analysis: Minimum Wage

For the last week of classes before our series of rapid-fire in-class presentations (my there are a lot of you) we will study the minimum wage using the methods and ideas presented in class.  We will study the standard neo-classical theory of labor markets and how minimum wages affect labor markets, and then think about how realistic the neo-classical model is and what kinds of other complexity we might add and how this might alter how we view minimum wages.

We will then proceed to think about how one might test for the effects of minimum wages using real-world data.  We will think about the causality and identification problems and how these might be overcome.  We will than proceed to examine a series of studies to attempt to get a sense of where the literature stands on the issue.

After this, on Wednesday, we will think about minimum wages in policy terms: what is the market failure we are trying to correct and is it the best was to do so.  We will compare alternatives to minimum wages, most notably the Earned Income Tax Credit.  Finally we will think about the appropriate pieces of a cost-benefit analysis of the Oregon minimum wage and the lack of an exemption for tips.  We will finish with a specific examination of the Oregon restaurant industry: how is it probably affected by the state minimum wage law.

To begin, here is a provocative graph I threw together last night using BLS data on state unemployment rates and US Department of Labor data on state minimum wages:

Is this graph meaningful?

The Governors Make-Work Plan and the Minimum Wage

I have been asked by a couple of readers for my take on the governors plan to temporarily employ 12,000 people who are currently unemployed. The short answer is (Grinch that I am): I am not sure I get it. Presumably many/most of the people employed by this plan will be ones that are currently getting unemployment insurance and who have time to look for work, try and get training for new marketable skills, and can cut child care costs by taking care of their children themselves. When jobs become available the best matches for each opportunity will be hired and the job market will unravel itself efficiently.

What this system creates is a system of 'winners' who will get more than the unemployment insurance benefit, but who will have less time to look for permanent jobs, may have to get additional child care and will not be available for new, better matched opportunities; and 'losers' who will get the standard unemployment insurance (until it runs out).

Why should 12,000 of the 250,000 unemployed in Oregon get lucky? What about the rest? And is this the best way to spend unemployment insurance money? I think the answers are that the system should not be altered to create winners and losers and that it is not an efficient use of unemployment insurance money. In short, this smacks of a policy completely devised for political aims not one for economic progress.

With all that said, I am not insensitive to the plight of distressed Oregon families and I understand that those that would get these jobs would be made better off. But if you are going to spend extra money, why not spend it on education and retraining so that these workers can have better job prospects int he future? Or extend unemployment insurance for folks who find themselves in long-term jobless spells? Or even increase the average payment?

And by the way, we can't escape the elephant in the room: Oregon has a relatively high minimum wage. This also creates winners and losers. We can expect that, relative to having a lower minimum wage, fewer people will be employed in Oregon, but those that are will do better. Economic estimates in the past have shown very small effects on unemployment from minimum wages, but in such a distressed economy, there are probably many people willing to work for, say, $6 and perhaps many places that would employ them at that wage. So I imagine that in times such as these the minimum wage actually bites off many more jobs than in a 'normal' economy. Is is right to deny these struggling people the right to work at this wage? I mention this because too often I think we conveniently forget about the trade-offs, especially when times are good and these trade-offs are small or virtually non-existent. But times are bad, unemployment is rampant, and this plan and the minimum wage creates distortions that make the labor market less efficient and this will likely lead to more suffering

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.