Economy & Business

Magical Thinking about Minimum Wages

Labor activists attend at a Seattle City Council meeting in 2014. (Reuters photo: David Ryder)
The laws of supply and demand apply to labor, too.

Thanks to a new study from economists at the University of Washington, American progressives have learned that the laws of supply and demand apply to the labor market. Everybody already knew that, except for professional economists.

The study, commissioned by the city government of Seattle and published by the National Bureau of Economic Research, found that Seattle’s law incrementally raising its minimum wage — to $13 an hour last year, en route to $15 — resulted in low-wage workers’ earning less money rather than more. This surprised many in Seattle, who had been assured by all the best economists, including Paul Krugman, that such a thing would not come to pass.

So, what happened?

The short version is: You can pass a law saying you have to pay low-wage workers more, but you cannot pass a law that says you have to hire them in the first place, or that you cannot cut back on hours when the price of hourly labor goes up. As businesses responded to the new higher labor costs by reorganizing their processes in less labor-intensive ways (the classic examples here are the replacement of wait staff with computer screens in restaurants and the replacement of bank clerks with more sophisticated ATMs), the law that was supposed to increase low-wage workers’ incomes actually reduced them — substantially, by an average of $125 a month.

The first lecture in Economics 101 is that supply and demand interact through prices. (And a wage is a price — the price of labor.) Producers will produce more of any given product at a higher price, and consumers will consume less of it at a higher price. At some point, producers’ preferences coincide with those of consumers, and that is the market price that emerges. That’s a rough model, of course, but it describes the basic reality of how commercial transactions actually happen.

When Economics 101 tells you something you don’t want to hear, the thing to do is to commission a study. As Ronald Coase observed: If you torture the data enough, it will confess to almost anything. For progressives desiring to raise the minimum wage in spite of the consequences predicted by basic economics, that study came from two Princeton economists, David Card and Alan Krueger, who in 1994 compared employment at fast-food restaurants in New Jersey to that of their counterparts across the river in Pennsylvania after New Jersey enacted a relatively modest increase in the minimum wage. The Card-Krueger study found that raising the minimum wage had not cost jobs in New Jersey. There were many problems with the study: It used fast-food employment as a proxy for minimum wage even though most fast-food workers do not make the minimum wage; it ignored workers in other industries, such as hospitality, that might have been more strongly affected; it covered a relatively short period of time; it relied on telephone surveys of restaurant managers rather than on hard employment data.

The Card-Krueger study included only a few months’ worth of data from after the time the minimum-wage hike went into effect. Some economists suspected that while fast-food operators were unlikely to simply start hacking away at their staffs in the months following an increase in the minimum wage (which, again, would not affect the wages of most fast-food workers), they would instead change their medium- and long-term plans, choosing less labor-intensive modes of production, substituting capital for labor through automation, reducing hours to make their labor consumption more efficient, etc. And that is, in fact, what subsequent studies found: Restaurants didn’t just start firing people after the minimum wage went up, but the wage hike did significantly reduce future job growth and labor consumption. As Preston Cooper of e21 put it:

This suggests that in a short-term response to the minimum wage hike, few businesses fired anyone. Instead, they raised their prices — something Card and Krueger found — to cover their extra labor costs, and left employment where it was. It makes sense, as employers might not want to immediately, significantly alter their business plans in response to a small increase in the minimum wage.

In the medium to long term, though, a different picture emerges. Higher minimum wages mean fewer businesses will open, and struggling ones will close more quickly. Instead of affecting the number of jobs in an economy, minimum wage hikes affect the rate of job growth.

Diana Furchtgott-Roth, formerly the chief economist at the Labor Department, offered a different criticism: “The regression statistics explain little variance, and practically none of the coefficients are significant. Card and Krueger infer that minimum-wage policy makes no difference. A more likely interpretation is that the equation excludes important variables.” In short, Card and Kruger mistook an absence of evidence of a minimum-wage effect for evidence of the absence of a minimum-wage effect.

It is not entirely surprising that a more dramatic effect was seen in Seattle: New Jersey hiked its minimum wage by only 80 cents an hour, or by 19 percent, from $4.25 to $5.05 an hour. Seattle will raise its minimum wage $9.47 to $15, an increase of nearly 60 percent. The law increases the statutory minimum in stages — with different schedules for large and small employers, and for those who do and do not provide medical benefits — but will be at least $15 for everyone by 2021. Also, the New Jersey minimum-wage hike happened in the booming 1990s, not in the current conditions of economic stagnation for relatively low-skill and low-wage workers. A little irony, there: The economy was booming in the 1990s in part because the young, high-earning workers of Generation X were inventing a great deal of the technology that would replace so many of the young, low-wage workers of the coming generations.

(You’re welcome, Millennials.)

Our progressive friends like to talk about how much they love science, because there is a great deal of prestige attached to science, and that prestige is relatively easy to misappropriate for progressive political ends. For example, the question of what to do about climate change is not really a scientific question at all — it is to a certain degree an economic question and to a much greater degree a political question. But deputizing “science” in support of one’s positions, and lampooning the opposition as knuckle-dragging flat-earthers, is rhetorically effective. But sometimes science, and the social sciences, aren’t on progressives’ side, especially when the dismal science is called into service. Economics tells the Left that its big ideas have big costs, that there are real limitations on what can be done by government, and that tradeoffs are not optional. So when a study comes up that seems to relieve progressives of the burdens of the science they don’t want to talk about, you can be sure that the study will be heralded as an “intellectual revolution,” which is what Professor Krugman called the Card-Krueger study in his influential New York Times column. Genuine intellectual revolutions are few and far between.

This is not to say that the Card-Krueger study was untrue, exactly, or that it was conducted in anything less than good faith. (And surely there will be shortcomings in the Seattle study.) It may very well be the case that you could increase the minimum wage by 80 cents an hour in New Jersey in 1994 without seeing dramatic short-term effects on the headcounts of fast-food operations in the Garden State. But you cannot conclude from that that larger wage hikes, or wage hikes undertaken in different kinds of economic circumstances, will not have an effect. That big jump in the Seattle minimum wage seems to have had a fairly dramatic one.

A great deal of economic policy is marred by magical thinking.

A great deal of economic policy is marred by magical thinking. The Left has its supernatural Keynesian multiplier effect, the Right has its self-financing tax cuts, and everybody clings to the myth about Henry Ford bootstrapping his business into greater profitability by paying his factory workers enough to buy his cars, which is a complete fiction. The truth is that demand curves slope downward: If you raise the price of something, including an hour of fry-guy labor, buyers will want less of it.

But magical thinking is much easier, and much more amenable to the political cast of mind, than undertaking the very hard, thankless, and uncertain work of doing the things necessary to turn low-skilled, low-earning workers into more productive and prosperous workers. Magical thinking is how you get a major political party and its hothouse intellectuals seriously convinced that the way to make health care more affordable is to pass a law called the Affordable Care Act. It is how you get Republican budget proposals that involve jacking up spending on the military, keeping Social Security and Medicare on their current stratospheric trajectories, cutting taxes, and . . . balancing the budget in ten years. (“But we’ll cut foreign aid!”) It’s how you decide to fix the problem of illegal immigration with a wall on the southern border when most illegal immigrants do not enter by sneaking over the border. It is how you spend 60 years thinking your prissy little moral declarations about the necessity of good public education for every child will result in a good public education for every child, how you come to believe that shouting “Health care is a human right!” will somehow summon general practitioners from the vasty deep and exnihilate hospital beds into existence.

But the next time you are tempted to indulge in that sort of intellectual laziness, consider that a lot of poor people in Seattle are going to have trouble paying their rents or feeding their children because policymakers who did not want to face the economic facts allowed themselves to be led astray by Professor Krugman, a first-rate economist who devolved into a second-rate newspaper columnist, who lent the considerable prestige of his Nobel prize to a policy proposal many of his fellow progressive economists knew to be defective even as they refused to criticize it in public. The poor people in Seattle know that there is no such thing as a free lunch. If only the economists did, too.

READ MORE:

Minimum-Wage Arguments: Emotional Appeals and Distortions of Economic Reality

The Insidious Political Power of Minimum-Wage Laws

An Alternative to Increasing the Minimum Wage