TCS Daily

Cut the Minimum Wage With Ockham's Razor

By Donald Boudreaux - July 28, 2006 12:00 AM

Do we know with certainty what effect raising the minimum wage will have? Maybe not. But even if we don't, that doesn't mean we can't take a position on the matter.

Consider a recent post on the economics blog, Marginal Revolution, by my colleague Tyler Cowen. He weighed in on the debate over the merits of recent empirical studies of the effects of minimum-wage legislation:

"I'm willing to admit, unabashedly, that I form my judgments on this matter by theory more than 'raw evidence.' When the evidence is unclear, or points in multiple directions, I favor the most plausible explanation."

The evidence is indeed imprecise. Some empirical studies -- most famously one published in 1994 in the prestigious American Economic Review by David Card and Alan Krueger -- find that on at least some occasions raising the minimum wage might actually increase employment of low-skilled workers. Other studies -- for example, this 2004 one by David Neumark and Olena Nizalova -- find that the higher the real minimum wage, the worse are the employment prospects of low-skilled workers.

Empirical research in economics is notoriously difficult because wages, prices, unemployment rates, product qualities, and all other data of the social sciences are, as Friedrich Hayek said, "complex phenomena." Having so very much constantly going on in the real world, having no laboratory in which reliably to isolate more than a handful of these phenomena at any one time, and unable to read directly the minds of the many persons whose perceptions and choices combine to generate social outcomes, empirical researchers can easily overlook or misread important variables.

This situation distinguishes the social sciences from the physical sciences in two notable ways. First, a higher proportion of empirical research in the social sciences is subject to legitimate -- oftentimes irresolvable -- dispute. Second, as a consequence, in the social sciences theoretical considerations inevitably play a larger role in navigating around these disputes and in forming judgments about desirable public policies.

And so it is with the minimum wage. Almost any empirical study of this government mandate can be challenged for ignoring this variable, for mis-identifying that variable, for focusing on an inappropriate time period, or for countless other possible errors. Therefore, following Tyler Cowen, we are justified in being extraordinarily skeptical of empirical findings that are inconsistent with widely accepted theoretical foundations.

Minimum-wage studies that find no negative effects on the employment prospects of low-skilled workers are whoppingly inconsistent with basic economics -- a fact that means that they are probably inaccurate.

Basic economics tells us that the higher the cost of choosing X the less likely is X to be chosen. Economists call this relationship between cost and choice "the law of demand." Non-economists call it common sense. Does anyone really doubt that the law of demand is both true and robust? I think not -- even though persons who insist that a higher minimum wage is good for low-skilled workers carve out employer decisions on hiring workers as an inexplicable exception to this rule.

It's interesting to note what most people would likely say about other alleged possible exceptions to this rule. Suppose, for example, the government announces that it will slap high monetary penalties on any newspaper that it believes is reporting in ways that frustrate the government's war on terror. Would anyone doubt that this added cost of reporting on the government's conduct of its war on terror would reduce the quantity of such reports, or the quality of such reports, or both? If an empirical study were done showing, say, that the number of lines devoted to reporting on the war on terror actually increased following government's announcement of its policy, would sensible people scratch their heads and conclude "Hey, we were wrong. Government's threat to penalize unfavorable reporting on the war on terror increases newspapers' willingness to report on this war."

I think not.

So why do so many people doubt that employers' decisions conform to the law of demand? Businesses want to earn as much profit as possible, which means they seek to keep their costs of producing whatever it is they produce as low as possible. Such commercial decisions are especially unlikely to be influenced by emotional considerations or by psychological indifference to consequences. (Indeed, insofar as business people are the cold, calculating, mad-for-profit rascals that many on the left imagine them to be, decisions by business people will surely be the last to violate the law of demand.) Raise businesses' cost of hiring low-skilled workers and watch them creatively figure out ways to avoid -- or to compensate having to pay -- this higher cost.

The textbook explanation is that employers respond to a higher minimum wage by hiring fewer hours of low-skilled labor (which is usually taken to mean that fewer low-skilled workers find jobs). It is this textbook proposition that is empirically tested again and again without reaching any consensus today on the effect that minimum-wage legislation has on the unemployment rate of low-skilled workers.

But while hiring fewer hours of work from low-skilled workers is indeed one possible employer response to a hike in the minimum wage, it's not the only one. Another possible response is to extract more output per hour from each low-skilled employee -- for example, by increasing employees' work pace, by giving employees fewer breaks, or by being less-forgiving of employees who report to work late. And as difficult as it is to measure by how much an increase in the minimum wage reduces employment, it is vastly more difficult to measure these latter sorts of possible employer responses. (How do we quantify changes in employer strictness in dealing with employees who are late?)

We don't know exactly how, or exactly by how much, employers as a group respond to higher minimum wages -- but the theoretical case that they do respond in ways unfavorable to low-skilled employees is too powerful to dismiss.

Donald Boudreaux is Chair of the economics department at George Mason University.


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