The Minimum Wage Quandary

By Robert Hahn and Peter Passell

The minimum wage issue – a hardy perennial one dividing liberals and conservatives – is once again bubbling. In his State of the Union speech, President Obama called for a hike from $7.25 to $9.00 an hour, arguing that “in the wealthiest nation on Earth, no one who works full-time should have to live in poverty.” And this week Costco’s CEO Craig Jelinek upped the ante, calling for a $10 minimum – a bold move made only slightly less bold by the fact that Costco’s starting wage is $11.50.

The argument between those who say a higher minimum is only a matter of justice and those who counter that it would destroy jobs seems to have been caught in an endless loop ever since 1938, when New Dealers rammed through a minimum wage (25 cents an hour, or roughly $4 in today’s money). Indeed, the only folks who have apparently wavered in their opinion are the alleged experts (us economists). And that’s only because Washington’s rhetoric about raising the living standards of the working poor by other means has never rung more hollow.

Pros vs. Cons

Back up a moment: The case against minimum wages is pretty obvious, even to those who slept through Econ 101. If the legal minimum wage exceeds the wage determined by the supply and demand in a competitive market for labor, somebody who is willing to work won’t be able to find it.

But it isn’t quite that simple: If the labor market isn’t competitive, a hike in the minimum wage may actually increase hires. In fact, there’s real-world evidence that, in some instances, a raise in the minimum wage has created jobs. In a now-classic study, David Card and Alan Krueger (then, at Princeton) compared employment in the fast-food industry after New Jersey upped its minimum wage in 1992 and Pennsylvania, across the river, didn’t. Contrary to expectations, employment rose in New Jersey relative to Pennsylvania. Since then, a host of other studies comparing states have also found that higher minimums led to more employment – or not less, anyway.

The last word on the subject? No way. Indeed, the Card-Krueger result triggered a flood of rebuttals, some of which were based on respectable research. One distinguished economist, David Neumark (University of California, Irvine), has spent much of his career retracing Card-Krueger’s footsteps and coming to the opposite conclusion.

This Isn't About Poverty

So who’s right? Darned if we know. The answer probably varies with place and time since it depends on the competitiveness of the labor market. But it’s striking how far the conventional wisdom has drifted to the left on this issue. The Economist, which often defines the establishment view on economic policy, recently concluded that a “carefully imposed minimum wage ... can raise incomes at the bottom of the wage spectrum without much reducing employment.”

What we do know, though, is that an increase in the minimum wage is a poor excuse for an anti-poverty program.

For one thing, increases surely do affect productivity, in some cases reducing job opportunities, in others reducing employers’ incentives to take chances on iffy applicants or to offer on-the-job training. For another, the hike in the minimum that would push most working households above the poverty threshold – we’re talking $10-12/hour – would likely accelerate structural changes in the economy we’re ill-prepared for. Robots are fast becoming practical substitutes for unskilled labor in a wide variety of tasks. And a higher minimum would certainly perk up business interest in, say, automating simple tasks like bussing restaurant tables and packing mail order parcels.

An Impossible Dream?

All that said, it really would be possible to have it both ways. In fact, we already have the scaffolding of a reasonably efficient policy in place to make low-wage work pay better without reducing employment: the Earned Income Tax Credit, which morphed from Milton Friedman’s path-breaking, analytically purer negative income tax. The EITC sends checks to low-income tax filers according to a complex formula based on earnings, deductions and numbers of children. Thus in 2012, a family of four with two kids and an adjusted gross income of $15,000 got back $5,230.

That’s nothing to sneeze at. But a total income of $20,230 for a working family of four seems mighty ungenerous in a country where the median personal income per capita was twice that figure in 2011. Of course, an increase in the EITC would cost money. Bear in mind, though, that the minimum wage is no freebee, either: The cost of raising it would almost certainly be passed on to consumers in the form of higher prices for everything from burritos to nursing homes. Moreover, unlike the minimum wage, the EITC can be fine-tuned to reflect the earnings of a second worker and the number of kids in each household.

An impossible dream, you say, in the era of trillion-dollar deficits? Maybe – but that’s another story.

Robert Hahn is director of economics and professor at Oxford's Smith School and a senior fellow at the Georgetown Center for Business and Public Policy. Peter Passell is a senior fellow at the Milken Institute and the editor of its quarterly economic policy journal, The Milken Institute Review. They co-founded Regulation2point0.org, a web portal on economic regulation.