TCS Daily


Minimum Behavior

By Stephen Bainbridge - April 20, 2006 12:00 AM

California is considering raising its state minimum wage. Bills under consideration would raise the wage by as much as a dollar and call for subsequent indexing of the wage, so that it will increase automatically along with inflation. According to press reports, Governor Schwarzenegger will not oppose a hike in the minimum wage, but is resisting indexing.

Assuming California ought to have a statutory minimum wage, which admittedly is a contested proposition, Schwarzenegger has it exactly backwards -- at least as far as an important segment of the relevant population is concerned.

The standard arguments over increasing the minimum wage are all focused on the effect of such a hike on the supply of jobs by employers. Basic price theory from Econ 101 tells us that employers faced with higher wage bills will hire fewer workers. Proponents of higher minimum wages counter with various empirical studies purporting to find no loss of jobs and various theoretical explanations for why standard price theory might not apply to this market. Opponents of wage hikes counter with their own studies and theories. And so the weary day wears on.

To be sure, the argument over job supply is an important one. Yet, in focusing on that issue, we overlook an equally important question; namely, what effect does a minimum wage hike have on the demand for jobs by potential employees?

At the outset, it is critical to recognize that the minimum wage debate is mainly a debate about how much working teenagers and twenty-somethings in their first job ought to make. The federal Bureau of Labor Statistics reports that (in 2002):

"Minimum wage workers tend to be young. About half of workers earning $5.15 or less were under age 25, and slightly more than one-fourth were age 16-19."

Let's focus specifically on the latter group. Imagine you're a 17 year-old junior in high school with a part-time job paying the minimum wage. You're eager to get started with life. You want to get a car, a place of your own, and maybe even get married. You're bored with high school and don't expect to go to college.

If you stay in school, you sacrifice current wages for higher future income. If you drop out, you likely will have a lower lifetime income, but start making money immediately.

Although you likely wouldn't articulate the problem in these terms, you're faced with a capital budgeting problem. Should you invest in your human capital by staying in school or should you drop out and go to work full time?

Although there are several ways for a business to make capital budgeting decisions, the simplest and most relevant to our hypothetical teenager is net present value. You therefore should discount to present value the net stream of income that would be generated by each of your choices.

The problem is that research in behavioral economics suggests that young people tend systematically to err in assigning discount rates; specifically, because they tend to be systematically biased in favor of current consumption, they tend to use too high a discount rate in making such calculations. As a result, the prospect of an immediate income will be given too much weight in their calculus and the prospect of higher lifetime earnings in the future too little weight and, when deciding between work and a present paycheck versus staying in school and deferral of income, they will tend to err towards the former.

Although relatively little empirical research has been done on the effect of a minimum wage hike on the demand for work by teenagers, one study does find results consistent with the foregoing analysis:

"Minimum wages increase the probability that teenagers leave school to become employed or work more hours, and increase the probability that they leave school and become non-enrolled and non-employed. Minimum wages also increase the probability that lower-wage employed teenagers become non-enrolled and non-employed." (Link)

Increasing the minimum wage is thus problematic because it makes the choice of work over school marginally more attractive.

For America to be competitive in a global marketplace, it needs an educated workforce. Minimum wage policy therefore must take into account the impact of changes in the minimum wage on the choice the youngest workers make between school and work.

The foregoing analysis has two specific implications for minimum wage policy. First, a differential lower minimum wage for those who have not completed a high school degree should result in a lower dropout rate.

Second, and here is where I think Schwarzenegger is wrong, the minimum wage ought to be indexed. Under current law, we get episodic large hikes in the minimum wage. In the interim between hikes, inflation tends to erode the value of the minimum wage, which will encourage teenagers to stay in school. In the year that a large hike occurs, however, the growth in the minimum wage far outstrips inflation, which tips the balance in favor of work. An indexed minimum wage, which grew steadily and no faster than inflation, would avoid the potential for biasing the choice between work and school.

The author is a law professor at UCLA and writes a weekly column for TCS Daily.

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43 Comments

Facts about federal minimum wage
Increase? The federal minimum wage has actually been dropping. Since 1979 the value of $5.15 has dropped to under four dollars. Even that is a conservative estimate, as our yardstick for inflation has been skewed to mask its severity. Gas is now three dollars, vegetables in the market are two dollars... everything but cheap consumer crap from China is now greatly higher than it used to be.

A single working mom earning the minimum is said by many people to be self supporting, and thus in no need of supplemental payments. So by the 30% rule, what kind of rent can she qualify to pay?

$268 a month. Know of any apartments in that price range?

For more facts about the federal minimum, read this:

http://www.epinet.org/content.cfm/issueguides_minwage_minwagefaq

Re: Facts about federal minimum wage
>> $268 a month. Know of any apartments in that price range?

Yes, actually. It's not impossible to find rents like that in Ohio. But, in any case, that's why roommates were invented. Two or three roommates can afford what one alone cannot. People do it all the time.

Far better would be to abolish the minimum wage altogether. Government is a very poor judge of what people "ought" to be earning. The market itself would probably do a better job setting the rate. Note that many, many companies set starting entry-level employees at far above the minimum wage. $8/hour jobs in fast food are not uncommon around here.

Who is the minimum wage for?
Every time I see people whining over the minimum wage they talk about 'A single mother with two kids' or 'A family of four'.

A couple days ago Oprah had a show about the minimum wage featuring families making in the $9/hr range. Not sure if she thinks we need to raise the minimum wage to $10/hr or more, but the overall emoting seemed to be that the government needed to do something so they would get paid more.

The minimum wage is supposed to be the absolute bottom of the pay scale. First job, 16 year old kids, no skills. Yet every time somebody argues about raising it the bring up the specter of a family of four being that just can't make it on minimum wage.

Mobile homes eom

'family of four being that just can't make it on minimum wage' Negative income tax would be better e

All poverty programs encourge less education and work. The question is how much.
All poverty programs encourage less education and work and as we get richer more and more people should be expected to drop out because X level of living is enough. The question is really how big is this effect. Democrats would say very small. Of course there is another side to this: If a kid is not learning much in school (many just go and pay no attention). Might he be better off working. I often wonder if our delaying of adulthood to 18 years old contributes to gangs and delinquency. Would it not be better for those who are not at all academically inclined to be working long hard hours rather than on the street making mischief.

Also:

Many people’s behavior seems to demonstrate that they think they can live pretty well without education or savings or whatever perhaps as lean as ghetto life looks to us that it looks rich enough to those in it?


Not with you on this one buddy
I'm usually on Roys side but on this one I'll differ. yes its true the set min wage is constantly reduced (in real terms) by the actual inflation rate (not the bogus CPI number), however, I think yhe min wage rules should be taken off the books all together. People should be free to work for whatever they feel is enough.

I hadn't considered the effect that the article brought up, that being that high enough min wage seems like a lot of money to high school kid, so they spend those important early years doing repetitive crap work instead of adding knowledge to their brains that they'll be able to use the rest of their lives.

A lot of the people talking about min wage are talking about people trying to create and support families (many illegals) doing the kind of work meant for teenagers. The goverment shouldn't tell you when you're economicly fit to have children, and the neither should they attempt to establish what a fair or "living wage" is.

Hey, an up side of reduced wages are reduced prices for many things that consumers compete for. Maybe you would be able to find an apartment (or at least roomate situation) for $268/month if the government wasn't constantly inflating the currency and hence prices of everything.

Good post but…
Your example is proof of what the minimum wage should be; not evidence that we should not have a minimum wage. I would submit that competition for workers combined with the minimum standard, is why those jobs are starting that high.

Washington State
As I recall, Washington State has the highest minimum wage and close to the lowest unemployment rate.

That is because the ideal and the reality differ a lot
First off, you are right to complain about Oprah making this kind of comparison; the minimum wage isn't $8 or $9 an hour anywhere I know of.

Second, you are also right; the minimum wage is supposed to be just that; the bottom the least that can be paid. It should be reserved for high school kids working summer jobs or drop-outs in their first job.

That, unfortunately, isn't the case in too many instances. There are a lot of people in this country working for minimum wage or some percentage above that. I think we could all agree that a family of four is going to have a tough time living on one job at even 175% of federal minimum wage (less than $8 an hour).

Generally, it is expected that when you raise the minimum wage, the wage scale will follow suite across the board fairly soon. Unfortunately, the last raise showed that it can take quite a while for wages much above minimum to catch up to the minimum wage increase.

Personally, I'm on the fence on this one. I both like and hate the idea of a minimum wage increase for a number of reasons.

But the authors idea that the increase will increase drop-out rates by any notable amount is rediculous. The few drop-outs I know never considered such a thing. They either had a pregnant girlfirend they felt obligated to take care of, had a home life they consider unliveable, were on drugs, or lived in abject poverty and see working as a way out.

A very high percentage of drop-outs don't even consider looking for a job. They're just screwed up teens.

the minimum wage should be dropped to zero.
As the article pointed out, most of the people who earn minimum wage are under 17. A sizeble percentage of the remainder are college students. The next largest chunk are retirees.

As to the single mother. If roy is so gosh darned eager to pass out charity, why doesn't he use his own money for a change?

minimum wage
Considering the damage the minimum wage has done to the working poor, it should be gotten rid of entirely, as soon as possible.

your error
is in thinking that raising the minimum wage will help the working poor. It won't. It just gets them fired. Every single study ever done on the issue (save one, Krueger/Card, and it was so badly flawed to be laughable) has reached the same conclusion.

Businesses are not in business to create jobs, they are in business to sell product, so that the owner can make a profit. Each job in a company has a certain value to the owner. When the govt mandates a minimum wage that exceeds the value of the job. The job goes unfilled.

valid considerations
This would be a valid comparison, if and only if, the minimum wage was the only difference between Washington state and all the other states.

On the other hand, every controlled study ever done has found that raising the minimum wage low skill employment.

What damage?
I'm not sure whether I agree or disagree. I have heard a lot of rhetoric but I've never seen any real evidence of damage. In fact, from what I've seen it is a pretty benign deal. Doesn't really help much and doesn't do any real harm.

That's BS and you and I both know it
If a company is lean, mean and competitive it doesn't have too many "spare" jobs to cut. Raising the minimum wage even 50% isn't likely to result in many job cuts. This same bull arguement was used last time there was a minimum wage hike and it proved to be totally false. Unemployment didn't even show a blip of a raise because of it.

i understand why this concept looks good on paper, and your post explained it well. But the business world doesn't work that way.

However, I would agree that a 100% increase would probably result in some companies shutting down and/or moving out of the country. If that company is scrapping by and is already cut to the bone, then they are already in trouble. If that company has an average wage of, say, $9 an hour and a starting wage of $7 then a minimum wage increase to $10 would break them. They have to move to China or go under.

You are right about the mechanics
I worked for years in restaurants and they pay as low as any business outside of farming but they do not replace labor with capital when wage rates rise. What happens is some go out of business. There are always some restaurants that are losing money. A little push will put some out of business. This gives the other restaurants more customers and ability to raise prices and new equilibrium will be reached. I believe at very slightly lower rate of employment.

Otherwise why not a $50/hour minimum wage.

BTW high rents are often a function of local slow/controled growth policies

BTW high rents are often a function of local slow/controlled growth policies and the rat race to get away from the poor. More liberal county growth plans could help with the former and better policing could help with the latter.

It is easier to see…
in small businesses like that, harder to see in bigger companies. But it does happen.

Paying for poverty
I've heard and considered the arguments you raise, zizzy (how do you pronounce that?). And I'm even inclined to go along with them. But I would invite you to consider the Stanford-Binet IQ test.

It's a bell curve, with 100 at the middle. Thus for every 120 IQ, which most of the people we know might probably consider "average", there is someone out there with an eighty. That's a lot of eighties.

They're only worth so much. I've employed plenty of them in minimum wage work, so I know. Back when the minimum was $4.25 I had people who were only worth three. So raising the minimum would have posed a hardship on me, to find personnel worth their salt.

But I now think it's a price society has to pay-- to give those people incomes that will allow them to be merely low-rent poor instead of desperate poor. Society pays for them in other, less pleasant ways when we don't psay them just to keep out of trouble.

We can pay them now, in the form of having $1.25 stores instead of dollar stores manned by such employees, or we can pay them later, in the form of a clogged judicial system, the costs of paying health care for indigent patients, and the cost of housing two million excess souls in expensive prisons. Just my opinion, of course, but roll it around in your mind.

No Subject
I'm a Washingtonian, and the reason we have low unemployment at our high minimum wage is that we have a high education rate. If I recall correctly, Seattle is the most educated city in America, according to some surveys. We have low unemployment because there are fewer workers competing for the lower-paying jobs. In fact, a lot of would-be minimum wage jobs pay a bit over the minimum wage, since there is competition for workers at that level. If we lose some more of our more educated industries (which we might, considering we love to tax them), there is a real possibility that our highly educated workers would drive the less educated out of the workforce.

Education
The largest factor in our high minimum wage not adversely affecting employment in WA is education. We have a highly educated workforce (Seattle is the "most educated" city in America, according to many studies). Because of our education levels, there are fewer workers competing for the minimum wage jobs. In fact, many unskilled positions are at even higher wages, simply because we have too few unskilled laborers.
It does, however, sometimes have the effect that this article describes. I grew up in a logging town, and a lot of the kids got jobs in the mill just after graduation, since around $10/hr looked better to them than going to college and making more later. Of course, that just serves to balance it later. Some classes had larger percentages go to college because the mills were full.
If Washington's minimum wage were at the federal level, we'd still have wages starting at around $8, though, because we simply don't have enough unskilled laborers to drive the wage any lower.

I want $50/hr, too.
" For that matter, why not raise it to $50 an hour, assuring every working Californian a comfortable living?"

http://www.latimes.com/news/opinion/commentary/la-oe-mcclintock11apr11,0,4317694.story?coll=la-news-comment-opinions

People wonder why we have an illegal immigration issue.
None of the pro-increase the minimum wage folks points out the increase in incentives for employers to hire and undocumented workers to seek employement.

This is easy:
Make documented labor more expensive and you get more undocumented labor.

you don't think getting laid off is damaging?
.

if it's bull
how come every single study done on the subject has found that higher minimum wages result in higher unemployment.

A simple thought experiment. If raising the minimum wage by $1/hr can't possibly hurt, why not raise it $10/hr, or $50/hr?

If you admit that huge increases result in unemployment, why can't you admit that small increases do as well?

As to your example, you should know how weak that correlation is. That's like fortunato pointing out that since it's gotten warmer over the last 40 years, and btw, CO2 has been rising during the same time, this proves that we are all going to die if we don't cut CO2 emissions. You know as well as I do, that you have to control for all the variables, not just the ones you are interested in.

Finally, I didn't say the jobs were spare. If they were, they wouldn't be there in the first place.

Didn't you notice that right after the last big federal minimum wage hike, fast food stores turned their drink machines around and started letting the customers fill their own cups? What happened to the people who used to fill the cups?

There are many low value jobs in a company. They can empty the trash twice a week instead of three times. They can vacuum the floors once a month instead of once a week.

Your smart, you've proven that time and time again. Use that intelligence to examine the real world, and how things really work.

pretty typical of roy
he loves to be generous, it's just that he's generous with other people's money, not his own.

a seconday affect
Higher wages mean that the company has to charge more.
Higher prices mean lower volume.
Lower volume means that fewer workers are needed.

Yes, and i repeat "what damage"?
Sorry, but that arguement flies in the face of the statistics from the last minimum wage increase. Something i believe I noted above.

Makes sense…
But the actuality of a minimum wage increase has shown it to be true.

As I said, we seem to look at economics…
from a slightly different perspective and it can create some big differences.

I would say that your theory, in light of the unemployment facts from the last minimum wage increase, is like fortunato's holding on to Mann's hockey stick in spite of all the evidence you showed him that it was debunked.

The facts don't fit the theory.

Also, if you don't see the difference in effect from a $1 raise to a $4 or $45 raise than I'm at a loss to explain it to you.

Here's one thing to ponder; how many people do you know of that make the minimum wage? I don't know one and I live in a poor state (average wage is 45th in the nation). The average starting wage here is about $6.50/hr. The average working wage is under $10. A raise in the minimum wage here would effect few initially, and would help drive up wages slightly over the next few years.

This was not the case when I first started working as a kid in the late 60s in early 70s. I knew a lot of people making between the minimum and 125% of the minimum ($1.00/hr and $1.25/hr). It was enough to live on in most cases and the average wage was, maybe, $1.25-1.40/hr. Then came the inflationary years of the mid and late 70s and early 80s. (Thank you Gerald Ford and, mostly, Jimmy Carter) In this area we actually benefitted as wages outstripped the minimum and inflation. In 1978 I was working a summer job (going to college) and made $3.50 an hour (minimum wage I believe was around $2 at that time). It was good times for a youngster!

Wages here average $6 an hour from around that time (actually about 1981-83) to to the last minimum wage raise, then slowly went up to around $7.50-$8 until 2001-02. Very flat with less than a 25% raise in nearly 2 decades.

Finally, in 2002, things started to improve a bit; there has been an increase of nearly 25% in that time due to various factors; Oh, and unemployment is at an all time low here. Higher wages = higher unemployment? Doesn't seem so now does it.?

I don't know any more real world than personal experience and observation combined with real world numbers from around the country.

As for the fast-food drink machines, huh? Do you know of anyone who got fired where they did this? I don't. A lot of that was a change in job descriptions and a re-ordering of the work. Perhaps they didn't hire someone else to empty the garbages, but that slack was taken up in other areas in a big hurry. When the last minimum wage increase went in, most people I knew working at McDonalds were already making $5-$5.50 an hour.

Again, there was little effect, if any, from the minimum wage increase; and this was a big one. When the first increment went into effect the minimum was, I believe, $3.85/hr. Over two years they pushed it up to $5.15/hr.; a nearly 35% increase.

I would question this, from my experiences and what i've read. The last minimum wage increase may be partly responsible for the flat middle-class wages over the past decade plus. If companies needed to keep those low-wage workers, and keep expenses in check, the money came from somewhere.

and I have noted why your example carries no water.

hmm
why is it that your personal experience trumps every scientific study ever done on the subject. Not to mention basic economic theory. Not to mention the opinion of almost every economists to voice their opinion on the subject?

the difference between a $1 raise and a $4 raise
is a difference in size, but not of kind.
A $1 dollar raise will have a smaller affect, but it will still have an affect.

When something costs more, people buy less.
When a job costs more than a businessman wants to pay, the job goes unfilled.
Those are basic facts of economics, I don't know why you insist on pretending they don't exist?

econ vs. climate
All things being equal, a rise in CO2 will cause a rise in temperature. The reason why the rise is less than the alarmist predict is that there are strong negative feedbacks that damp the affect of CO2.

All things being equal, a rise in cost of anything, means less of that thing will be bought. You are claiming that this econ 101 fact doesn't apply to wages. Why?
What are the negative feedbacks that you believe negate this basic fact?

Your one example is worthless, because you haven't controlled for all of the potential variables.
For example, if unemployment for the country as a whole is going down at the time that your state raised the minimum wage, its quite possible that the unemployment rate did not rise in your state, instead it fell less than it would have absent the rate increase. Also there's a lag in these things. Businessmen are not heartless automatons. They rarely fire immediately. What they do instead is cut back everyone's hours, until somebody quits, then his hours are divided up amongst the remaining staff.

As I pointed out before, there are hundreds of ways that businessmen can cut back on low value tasks.

another fact
prior to the introduction of the minimum wage, there was very little difference in the unemployment rate for teenagers and young adults, and adults. As soon as the minimum wage was introduced, the unemployment rate for the young (and least experienced workers) started rising. The gap between the two has reflected the minimum wage rate ever since.

As inflation reduces the value of the minimum wage, the gap has lessened. Everytime the minimum wage is increased, the gap widens again.

reducing labor
A manager can respond to an increase in the minimum wage by having the trash dumped twice a week instead of three times.
Or having the carpets vacuumed once a month instead of once a week.
Or having the floors waxed twice a year instead of twice a month.
Or no longer hiring people to pick up the trash around his store.

Did you not notice that it was right after the last federal minimum rate hike, that fast food companies turned around their drink machines and had the customers fill their own cups?

I'm not
What do you want me to say? Yes, there are effects?

Of course there are; but there aren't many people working anywhere for the present minimum. Because of that, it is doubtful that a large enough effect to be noticable would occur, even from a $2 raise.

I would submit that the worst case is a slight slow down in job creation.

Lean businesses cannot let a job go unfilled or it wasn't necessary in the first place; doesn't work that way. They may change the way the do things and not hire more for a while.

They may not give raises to the masses.

They may keep wages flat and stagnant.

but, no, unemployment in any noticable measure will not go up.

Yes, as I noted before, there are people affected. But, in the end, the overall economy will not suffer.

As i said, I'm on the fence on this issue. Few people work for the minimum wage here so a raise is pretty much irrelevant. But an MW raise usually does trickle up some. That can be a good thing and it can cause more problems.

You haven't convinced me; I remain on the fence.

No arguement with this
It, in fact, is the point.

necessary jobs
How necessary is vacuuming the carpet? And how often should it be done.
While it may be true that because of current economic conditions, there are few people who make minimum wage. But what happens on the next economic down cycle?

Secondly, as wage increases force price increases, sales go down. This also causes employment reductions.

rehash
We've been here before.
You will vaccuum the carpet as much as needed; if you do it more you are creating work where it isn't needed.

Few make the minimum now and an economic downturn will not reduce wages; irrelevant.

Minimum wage increase will not increase prices as virtually no one (and certainly no one in manufacturing) makes the minimum. That means no decreased sales and no employment reductions.

Mark, I agree that a minimum wage increase is real trouble when a majority of entry level jobs are paid at minimum wage and even some low-skilled long-term employees make little more than the minimum. That is simply not the case right now. Part of the reason is competition for employees and part of it is people's reluctance to work for "minimum wage".

The minimum entry level pay in my small and poor hometown is $6/hr and I only know of one place paying under $6.50 (the local restaurant; which isn't a fair comparison as waitresses there earn tips and make a minimum of $2/hr over their pay. With that in mind, they are actually making more than many skilled laborers.).

As I said, I'm on the fence this time around. If the wage scales were lower I would be firmly against it; if they were any higher at all I would be for it. They way things are, I'm inbetween.

Sorry Pauled
You will vacuum the carpet as much as you can afford to.
You will mop the linoleum as much as you can afford to.

When the cost of cleanliness goes up, the amount of cleanliness the boss is willing to pay for goes down.
When I was a teenager, between the rushes, the boss would send us outside to pick up trash. That doesn't happen anymore.

I've detailed the dozens of ways bosses find to use less labor, when the cost of labor goes up.

Have you noticed how much automation exists behind the counter at your average fast food place these days. The bosses didn't buy that stuff because they like to play with gadgets. They bought that stuff because it replaced labor. The reason it replaced labor, was because labor was more expensive.

I've stated it before, with one excpeption, (I can detail the many reason's why the one exception is invalid) every single study done, has shown that increasing minimum wage increases unemployment, and the hit is hardest amongst the young and unskilled.

You can allow your emotions to keep you on the fence, if that's what you want, but there is no science that backs up your position.

Uh, crushed by the no science arguement
LOL. I get your drift and understand why your rehashing; this gets frustrating, probably more because we are not dead against each other. I will leave it at we agree to disagree.

(No science!! you've been argueing with Fagotnuto too much, it's rubbing off!!)

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