DRI-259 for week of 2-10-13: Coverage of President Obama’s SOTU Minimum-Wage Proposal

An Access Advertising EconBrief:

Coverage of President Obama’s SOTU Minimum-Wage Proposal

As advertised, President Barack Obama’s 2013 State of the Union (SOTU) address outlined the economic agenda for his second term in office. Among its planks was a proposal to raise the minimum wage to $9.00 an hour from its current $7.25. The reputation of economics as “the dismal science” is vindicated by the coverage of this proposal in the news media, which is indeed nothing short of dismal.

The Wall Street Journal‘s Coverage of Obama’s Minimum-Wage Proposal

The Wall Street Journal is the leading financial publication in America – indeed, in the world. On page four of its morning-after coverage of Obama’s SOTU message, the Journal provided a five-column box headlined “Bid on Minimum Wage Revives Issue That Has Divided Economists,” written by reporters Damian Palette and Jon Hilsenrath. The pair predicts that “President Obama’s proposal… is likely to rekindle debates over whether the measure helps or hurts low-income workers.” And the debates will be between “White House officials” who “say the move …is aimed at addressing poverty and helping low-income Americans” and “Republicans and business groups, which have traditionally said raising the minimum wage discourages companies from hiring low-skilled workers.”

The article rehearses the specifics of the President’s proposal, which raise the minimum wage in stages to $9.00 per hour by 2015, after which it would be indexed to the rate of inflation. It reminds readers that Mr. Obama originally proposed to raise the minimum to $9.50 by 2011. It reports confident projections by “Administration officials” that at least 15 million Americans would directly benefit from the increase by 2015, not counting those now earning above the minimum whose wages would be driven higher by the measure.

Three paragraphs in the middle of the piece gloss over the views of “economists and politicians [who] are divided over the issue.” These consist of two economists, one proponent and one opponent, and one central banker. David Neumark of the University of California Irvine unequivocally maintains that “the effects of the minimum wage are declines in employment for the very least skilled workers,” while “a lot of the benefits …leak out to families way above the poverty line.” Alan Krueger from PrincetonUniversity, currently Chairman of the President’s Council of Economic Advisors, “found positive effects” from the minimum wage on fast-food workers in New Jersey. The authors do not remark the apparent coincidence that Neumark and Krueger studied precisely the same group of workers in reaching their conclusions. Janet Yellen, Vice-Chairman of the Federal Reserve, was quoted as refusing to endorse the minimum-wage increase on grounds of its irrelevance to current conditions, while admitting its adverse effects would probably be small.

The authors close out by summarizing the political strategies of the White House and Republicans in proposing and opposing the measure. The authors toss in a few numbers of general economic significance – surging stock market, recent increase in hiring, persistently slow economic growth, nagging high unemployment, decline in median real income since 2000. They cite the most recent minimum-wage increase in 2009 and note that 19 states already have statewide minima in excess of the current federal minimum.

The reader will notice that the Journal‘s headline refers to a revival of a debate between economists. Yet the article only cites two economists and the debate consists of approximately five lines out of five columns of prose – just over 4% of the article’s 120 lines. A reader who isn’t already thoroughly familiar with the issue will learn virtually nothing at all about why the minimum wage is bad or – for that matter – why its proponents think it is good. The closest thing to analysis are cryptic references to “discourages companies from hiring,” “declines in employment” and – most mysterious of all – “benefits” that “leak out to families way above the poverty line.”

Between 90% and 95% of the article is devoted to politics. And that is utterly superficial. The world’s leading financial publication has devoted substantial space to a Presidential proposal of economic significance, yet its readers would never suspect that the subject is one of the most highly research, well-considered and settled in all of economics. The minimum wage has been a staple application in microeconomics textbooks for over a half-century. Along with policy measures like free international trade and rent control, the minimum wage has generated the most lopsided responses in opinion surveys taken of economists. In percentages ranging from 75% to 90%, economists have resoundingly affirmed their belief that minimum wages promote higher unemployment among low-skilled workers – among their many undesirable effects.

Yet today Wall Street Journal reporters imply that it’s a 50-50 proposition. Or rather, they imply that economists are evenly divided on the merits of the measure. The article mentions a revival of a debate without explaining the terms of the debate or its previous resolution. Indeed, even the arguments of the proponent economist – the Chairman of the CEA, no less! – go unmentioned.

Something more than mere journalistic incompetence is on display here. The WSJ reporters are showing contempt for the discipline of economics. The only significant thing about economists, they imply, is that they are “divided.” The economics itself is hardly worth our attention.

Economists have only themselves to blame for their low repute. But readers deserve a truthful and complete understanding of the minimum wage.

The Minimum Wage As Seen by Economics – and Economists

The minimum wage is a species of the economic genus known as the “minimum price.” Other species include agricultural price supports, imposed for the ostensible purpose of increasing the incomes of family farmers. The idea behind all minimum prices is to make the price of something higher than it would otherwise be. The alternative embodies in “otherwise” is to allow the price of human labor to find its own level in a free labor market. That level is the point at which the amount of labor workers wish to supply is equal to the amount that businesses want to hire. Economists call the wage that equalizes the quantity of labor supplied with the quantity demanded the equilibrium wage.

In practice, the minimum wage is always legislatively pegged at a higher level than the current equilibrium wage. Otherwise there would be no point to it. And in practice, the minimum wage applies only to low-skilled labor. This is because wages reflect the value of labor’s productivity and low-skilled labor is the least productive kind. What is the effect of a higher-than-equilibrium wage for low-skilled labor?

Holding the price of anything above its equilibrium level produces a surplus of that thing. A surplus of human labor is called “unemployment” in layman’s terms. Thus, a minimum wage produces unemployment where there would otherwise be no (persistent) unemployment.

If this sounds pretty categorical, cut-and-dried and matter-of-fact, that’s because it is. Supply and demand are economics. More precisely, they are what we today label “microeconomics.” Since there is no macroeconomic theory left standing that is worthy of the name, that leaves us with supply and demand and very little else.

The federal minimum wage was first introduced in the Fair Labor Standards Act of 1938. It first began attracting attention from academic economists after World War II when George Stigler wrote a celebrated article outlining its basic effects in 1946. The first edition of Stigler’s legendary textbook on microeconomic price theory appeared in 1949. This may have been the debut of the minimum wage as a textbook application – a way of illustrating what happens when the principles of supply and demand are flouted by government.

Stigler may have been the first future Nobel Laureate to oppose the minimum wage, but he headed up what became a long procession with few absentees. Since then, it has been rare to find an intermediate (junior-senior level) micro textbook that didn’t feature an analysis of the minimum wage and the effects of the labor surplus it causes. This practice has crossed political lines. Liberal economists write textbooks, too, but they were pitiless in their view of the minimum wage – at least until recently, anyway. Alan Blinder, former CEA member under President Bill Clinton, was embarrassed by the revelation that his political support for a minimum wage conflicted with his textbook’s unsparing criticism of it.

The Effects of a Minimum Wage

The effects of a minimum wage are those of a minimum price generally, translated into the specific context of the market for low-skilled labor. The overarching effect, whose implications far exceed the obvious, is the surplus of labor created. The resulting unemployment, in and of itself, confounds the expectations of minimum-wage proponents. Their stated purpose is to increase the monetary incomes, hence real incomes, hence well-being of low-income workers. But you can only benefit from a higher wage if you have a job from which to earn that wage. The low-skilled workers whose jobs are lost because of the minimum wage are harmed by it, not helped. Moreover, they have nowhere to go except the unemployment line. Ordinarily, people who lose their job look for another job. But low-skilled workers are already scraping the bottom of the barrel – when that residue is suddenly denied them, they’re out of luck.

But what about the people who don’t lose their job? They benefit, don’t they? True enough, at least as a first approximation. The minimum wage should be viewed as transferring income from some low-skilled workers to other low-skilled workers. It is tempting to say it transfers income from some poor workers to other poor workers, but this is not always true. Sometimes it transfer income from poor people to rich people or, more precisely, to the offspring of rich people. That outcome will be explained below.

Wait a minute – what about employers? To hear the left wing talk, the problems of the poor are mostly the fault of greedy bosses who refuse to pay the poor what they’re worth. (The ever-popular formulation is that employers owe their workers a “living wage.”) At least the minimum wage sticks it to those greedy bastards, doesn’t it?

The answer is: Yes and no, but mostly no. In the short run, owners of businesses share the cost of the minimum wage with workers who are driven out of work. Business owners share that cost because higher wages mean higher costs, and higher costs will reduce revenues and profits and drive marginal businesses out of business. The reduced supply of goods will drive prices to consumers higher.

In the long run, though, the higher price gradually attained by the market in response to the higher costs will restore the business rate of return (i.e., profit) to its “normal” level. So, the remaining businesses in the market do not suffer long-run harm from the minimum wage. In the long run, the burden of the minimum wage is borne by consumers of the products produced using low-skilled labor and by low-skilled workers who remain out of work or whose prospects for work and productivity are permanently reduced by their sojourn into unemployment.

In other words, the minimum wage does not exact class revenge against evil, greedy businessmen. It harms poor, low-skilled workers and consumers – who are mostly ordinary people. Is it any wonder, then, that even liberal economists have traditionally refused to endorse the minimum wage as a means of transferring income to the poor?

Wait – There’s More. A LOT More

If John Paul Jones were an economist, he might interject at this point that we have not yet begun our analytical fight against popular misconceptions about the minimum wage. The artificial surplus created by the minimum wage has even more insidious implications.

In a competitive market, the tendency toward equality between quantity supplied and quantity demanded of the good or service being provided exerts a restraining influence on the actions of buyers and sellers. If you show up to rent an apartment or house and the landlord doesn’t like the color of your skin, he might decide to not to rent to you. But when there are exactly as many buyers as there are apartments and houses on the market, this will cost him money. The economic history of the world – and the history of discrimination in the American South and South Africa, among other places – very strongly confirms that competition and economic incentives are the best means of overcoming racial discrimination.

But when the market is in surplus, the picture changes dramatically. Now the landlord can afford to discriminate among would-be buyers by turning down one he doesn’t particularly like, because he knows that others are out there waiting for his unit.

The logic applies to buyers as well. Under competitive conditions, employers cannot afford to discriminate against workers for any reasons not related to productivity. They know only too well how hard it is to find good help when the market is tight. But when unemployment is high, an employer with a “taste for discrimination” can afford to indulge it. (It is idle to talk about whether that behavior is against the law or not. In practice, the case for discrimination cannot be proved; legal cases are won by imposing heavy costs on defendants until they give up and settle by admitting guilt whether true or not. And the cases are prosecuted in the first place for political or economic reasons, not to achieve justice for defendants.)

One of life’s supreme ironies is that the very people who cry the loudest for an end to racial discrimination and lament the injustice of our racist society are the same people who lobby in favor of the minimum wage. By creating a surplus of low-skilled labor and reducing the effective cost of discrimination to zero, the minimum wage surely makes it easy for employers to exercise whatever racist urges they might feel.

…And More

The minimum wage is anti-black in its effects not only because it promotes discrimination, but also because it places blacks at an objective disadvantage. One thing employers look for is experience. On average, blacks are younger than other ethnic groups and have less experience. Thus, they are less able to cope with the labor surplus created by the minimum wage.

Both minimum and maximum prices bring the issue of product quality to bear on the decisions of businesses. When businesses can’t raise prices due to maximum prices, or price controls, they try to reduce product quality instead. Similarly, when businesses suddenly face an increase in the minimum wage, they look to offset its effects by retaining only their highest-quality low-skilled workers. That is, they retain the best-dressed, most punctual, technologically adept workers rather than the shabbier, less reliable, socially and technically awkward workers. All too often, the workers let go are the ones who need the job the most – namely, low-income blacks picking up the necessary skills to succeed in the working world. Their places are taken by the sons and daughters of the well-to-do, whose cultural and economic advantages gave them an occupational leg up when they entered the labor market. This is what David Neumark meant by benefits leaking out to the well-to-do.

Black (illicit) markets are an inevitable by-product of minimum and maximum prices. In this case, the existence of a labor surplus means that there are people willing to work at a lower wage than the prevailing wage. By offering sub-standard working conditions and employment “off the books,” some employers can induce workers into work that they wouldn’t accept in a competitive labor market. This is still another ill effect of the minimum wage and another way in which low-skilled workers bear its brunt.

The late Milton Friedman was outraged by popular efforts to depict the minimum wage as the salvation of the poor and underprivileged. He called it the most anti-black law on the books.

The Card-Krueger Study

In 1993, two economists made a bid to overturn the decades-old economic consensus against the minimum wage. David Card and Alan Krueger conducted a phone survey of fast-food establishments in New Jersey and Pennsylvania. They chose these two adjoining states because New Jersey had raised its minimum wage prior to the study period, during which Pennsylvania’s law remained unchanged. Their study found that New Jersey’s employment of low-skilled labor increased by 13% relative to Pennsylvania’s. They ascribed this to the fact that the higher wage had certain desirable effects on the labor force.

Both the general public and the economics profession went gaga over this single result. Despite decades of studies and negative results by dozens of distinguished economists, this one study was said to have revolutionized thinking on the minimum wage. In reality, its effects were more political than economic.

An attempt to replicate the study by the National Bureau of Economic Research used payroll records from the businesses surveyed by Card and Krueger rather than relying on the phone surveys. Apparent anomalies had been found in both the New Jersey and Pennsylvania date using the phone surveys, so the payroll records were substituted as a check on the results. Sure enough, recalculation of the results using the payroll records reversed the results of the study – New Jersey employment was now found to have declined by about 4% relative to Pennsylvania’s.

Alan Krueger parlayed the popularity of his study into the Chairmanship of the President’s Council of Economic Advisors. David Card has recently written a book about the subject of the minimum wage. But there is little reason to accept the results of their original study at its face value.

The Political Purpose of the Minimum Wage

Economists have long known that the true purposes of the minimum wage are political rather than economic. Low-skilled labor is a substitute for unionized labor and higher-skilled labor. By making low-skilled labor less attractive to employers, the minimum wage makes union labor more attractive. That is why unions have supported a minimum wage since long before it was actually adopted, both in the U.S. and in places like South Africa.

Unions are one of the strongest and most numerous constituent groups of the Obama administration. That is why the President has now opted to advance this proposal to increase the minimum wage. Yet The Wall Street Journal‘s piece – which purported to describe the economics and politics of the measure – did not breathe a word of this.

Note: The first draft of this post erred by saying that the minimum wage was introduced in the Wagner Act of 1935, rather than the Fair Labor Standards Act of 1938.