Bad Economic Policy from a Lefty Economist and Blogger

This takes a look at one of the ideas of the “Netroots Policy Platform” that James pointed too. Specifically the idea of raising the minimum wage and indexing it to the CPI.

There are at least two problems with this policy. The first is that it is a bad way to help young workers. The minimum wage is also known in economics as a price floor. For those who don’t know a price floor is a price that a given good (in this case unskilled labor) can’t go below. The idea behind the minimum wage is that raising it will help those who are unskilled earn a decent wage. Nice sentiments, but bad policy. As with a price ceiling, this can cause distortions in the market. If the market clearing wage is say $5/hour and the minimum wage is $6/hour then we’ll have what is called excess supply. That is more people looking for those $6/hour jobs than there are $6/hour jobs.

Further, the minimum wage is basically a tax on the employer and the consumer. Often the consumer are the very same people that the minimum wage is trying to help. Not exactly good policy when you stick it to those you are trying to help. A better way to do this would be to expand the earned income tax credit. This works by giving low income individuals (households/families really) tax credits, but at the same time structures the credits so that there is always an incentive to work. For example, suppose a household is earning $5,000/year and gets a tax credit of $5,000/year. Now, if a member of that household gets a better paying job, say it pays $8,000/year instead of reducing the tax credit to $2,000 it is cut to say $3,500 which means that the households income is $11,500 vs. $10,000. It pays to take the better paying job.

Now obviously the tax credit would have to be financed via a tax, but it could be a tax on incomes above a certain level (i.e., there isn’t a direct tax on the people to pay for the program the program is trying to help). While such a tax could eventually have indirect negative impacts on those who receive the tax credits it isn’t as direct nor likely as large as raising the minimum wage. Further, there wouldn’t be the problem of excess supply which means that more people would have jobs. Granted the wage would be lower, but this would be offset by the earned income tax credit.

Another problem is a bit more technical. The CPI is known to be upwardly biased. That is, the way the CPI is calculated makes it somewhat higher than the actual change in the cost-of-living. There have been some improvements to minimize this, but last I checked (and admittedly it was awhile ago) some of the problems were difficult to quantify. For example, how do you take into account bulk discount buying. Suppose there is a sale on tuna fish and one goes out and buys up a good amount of it, and when the sale is over one draws down over time the stock of tuna that was purchased at a discount? Yeah, it is a rather arcane point, but it is still a valid problem none-the-less. So indexing the minimum wage to the CPI wouldn’t merely assure us that the minimum wage was keeping pace with the cost-of-living, but was actually growing faster than it.

Duncan “Atrios” Black is an economist and he likely knows about all these objections. But this kind of simpleton policy is bad policy and shouldn’t be part of the platform. It is the kind of thing that makes me wonder whether people like Black, who is probably quite well off, actually wants to help those who are that lower end of the economic spectrum.

FILED UNDER: Economics and Business, ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Tano says:

    I think you miss an important point. There is the world of economic theory. And then there is the political world. We all would love to have policies that make optimal sense in terms of economic theory, but we will only ever get policies that make sense in the political world.

    Your ideas about the EIC seem to make good economic sense (I’ll say so provisionally prior to thinking them through completely). But all you need do is focus on that one sentence of yours “Now obviously the tax credit would have to be financed via a tax..” and you can see what will happen to the political debate once your idea is raised.

    It is far easier politically (though not easy) to raise the minimum wage. And if you really care about the plight of the working poor, you have to go with what can actually be accomplished.

    Do your part to make this world a better place. Fight with the republicans over their instinct to automatically shut down whenever the word “tax” is mentioned, unless it is immediatly followed by the word “cut”. If you have some success there, then we would have the necessary political environment to solve this problem in an economically-sensible manner.

  2. Boyd says:

    And if you really care about the plight of the working poor, you have to go with what can actually be accomplished.

    I think this misses the point, Tano. What good is “accomplishment” if it doesn’t improve the lot of those it’s intended to help? One of Steve’s points was that raising the minimum wage is, at best, neutral for those it’s intended to help, and more likely a negative for them, at least as a group.

    I don’t have any noteworthy experience or knowledge in economics, so I’m not competent to debate the validity of Steve’s point. But I know that “if we do this, at least we accomplish something.” misses the point. You must be sure that you can accomplish something worth accomplishing. Otherwise, you’re just rearranging chairs on the deck of the Titanic.

    Or something like that.

  3. You can’t help the working poor by throwing them out of work. This is what a minimum wage does. If it’s so low that it has no impact on the labor market, then it’s just political window dressing. If it’s any higher, it raises an economic barrier to small business creation and job creation.

    We should continue to fight Democrats who think that a nation can tax its way to prosperity.

  4. Dave Schuler says:

    The first is that it is a bad way to help young workers.

    But it’s a great way to give a raise to union workers who are already making more significantly more than the minimum wage with contracts that call for them to be paid a multiple of the minimum wage. That’s what this issue is about not helping the working poor.

    As Steve points out, the problem with raising the minimum wage as a means to helping young workers is that it is inefficient in producing that end. Revising the EITC (sort of a reverse income tax) is a better means to the same end. But it wouldn’t give an automatic raise to union workers with minimum wage multiple contracts.

    Atrios knows that perfectly well.

    Steve, also take note that Atrios calls for “universal health care”. Not universal coverage or universal insurance. Did a consensus (that’s the claim of the post) emerge on that while I wasn’t looking?

  5. Steve Verdon says:

    Dave,

    Universal health care is a big issue. I was planning on covering it in another post.

    Tano,

    Oh I’m quite well aware of the “political reality” of the situation. But this is again part of my complaint about activist government policy. Instead of doing something that is efficient/makes sense we end doing something that benefits a group that isn’t really the target we intended.

    And the Republicans are no better, IMO. They talk about tax cuts, but forget about the other kind of cutting that needs to be done. I’m done with the Republicans, they are just as venal and corrupt at the Democrats.

  6. I was taught that when theory and practice diverge, it is time to check one’s assumptions. Pity, this occurs so rarely with the Angry Left.

  7. Christopher says:

    What did you expect from liberals? Intelligent thinking? Riiiggghhhttt…

  8. Hit The Bid says:

    Saying that increasing the minimum wage caused people to lose jobs is a typical GOP myth. When the minimum wage was raised in 1997, how many people lost their job–or even how many people were not hired that may have been if the Minimum wage had not been raised?

    Oh you don’t know? I’d like to see any link to a study that shows that negative effect.

    In your article you allude to a “market clearing” price for labor. Since the minimum wage is a politically arbitrary wage, why do you assume it is the equilib?

    Oh wait straight thinking from a Conservative economist? Riiiiigghhhhht. Doesn’t happen.

  9. Hit The Bid says:

    Additionally, doesn’t paying someone too little for their labor also result in a market distortion? Ie..we need to spend too much on public programs to make up for the economic rents businesses are pocketing by paying folks too little?

    Man you guys are can’t think straight. How about some demand side economics? its gotta be more effective than supply side economics at increasing AG and helping the middle class.

  10. tom says:

    Hit The Bid,

    You are a special person!

    Click the link.

    http://www.house.gov/jec/cost-gov/regs/minimum/50years.htm

  11. ICallMasICM says:

    ‘Additionally, doesnâ??t paying someone too little for their labor also result in a market distortion?’

    ????????????????How can you pay below market value if someone is willing to work for it?

  12. Tano says:

    I disagree with the claim that raising the minimum wage would actually hurt those who are the recipients.

    It is a direct wage increase. It is not taken away by higher taxes, since those at that level are not paying much in taxes at all. And if it causes incremental increases in prices for the products that they consume, such an effect is not going to come close to erasing the benefit that the wage increase gives, at least not in the short to medium term.

    So, for the actual recipients, I do think it is better than nothing.

    There is a larger macro issue here as well. Poor people are underachieving consumers. Increasing the money that they have to spend is a benefit to the economy – especially small businesses like mom and pop shops. Injecting money into the base of the economy, even if it is not “deserved” in terms of whether the work could be done at a lower wage level, benefits the system as a whole.

    Yet another chapter in the long thesis regarding how pure market forces, the optimally clean theoretical basis of capitalism, needs to have its edges rounded in order to work in the real world where human beings are not idealized factors.

  13. Mr. Econotarian says:

    The loss of employment due to the minimum wage does not show up across the board.

    As in France, in the U.S. job losses due to the minimum wage are concentrated in the young and ethnic minorities. U.S. black youth unemployment (18-25 years old) has now risen to 26.6%.

    Don’t take my word for it:

    Minimum Wage Teen-age Job Killer

  14. Declarative statements are to be taken as fact for those whose hearts are pure.

  15. physics geek says:

    I disagree with the claim that raising the minimum wage would actually hurt those who are the recipients.

    I was going for something pitying, but Charles’ comment will suffice.

  16. Steve Verdon says:

    In your article you allude to a â??market clearingâ?? price for labor. Since the minimum wage is a politically arbitrary wage, why do you assume it is the equilib?

    I didn’t, read it again.

    Additionally, doesnâ??t paying someone too little for their labor also result in a market distortion? Ie..we need to spend too much on public programs to make up for the economic rents businesses are pocketing by paying folks too little?

    And pray tell how exactly does this happen?

    Man you guys are canâ??t think straight. How about some demand side economics? its gotta be more effective than supply side economics at increasing AG and helping the middle class.

    Please refrain from commenting after drinking heavily. Nothing in my post was “supply side”. Sheesh.

    Tano,

    I disagree with the claim that raising the minimum wage would actually hurt those who are the recipients.

    It is a direct wage increase. It is not taken away by higher taxes, since those at that level are not paying much in taxes at all.

    Please sharpen your reading comprehension. I didn’t say that the increase in the minimum wage would be taxed away. What I did note is that the increase in the minimum wage is very much like a tax on employers and consumers and that the minimum wage worker is also a consumer. Hence, it hurts them indirectly in terms of higher prices just as a higher sales tax would hurt them. Really, this isn’t hard.

    And if it causes incremental increases in prices for the products that they consume, such an effect is not going to come close to erasing the benefit that the wage increase gives, at least not in the short to medium term.

    Sure, some who find jobs at the higher minimum wage will benefit. However, those who don’t wont have the higher wage benefit and will face higher prices. We are talking in aggregate here, not that Billy Bob has a slightly higher wage.

    Further, all of this is irrelevant with an EITC. It would accomplish the same thing, but more efficiently.

    Yet another chapter in the long thesis regarding how pure market forces, the optimally clean theoretical basis of capitalism, needs to have its edges rounded in order to work in the real world where human beings are not idealized factors.

    No Tano, it is actually a case of where you are making stuff up, not reading carefully nor understanding how markets work.

  17. Tano says:

    Steve,

    Simply because I state the arguments for why the wage increase is beneficial does not imply that I am claiming that you said the opposite.

    I fully understood your argument that the increase could have an indirect negative effect in that it works similar to a tax on businesses, and hence consumer products. Thats why I went on to claim that the effect, to the extent that it is present, is minimal.

    In the political realm, the positive benefit to “Billy Bob” is most certainly relevant – which is why it is a smart political move. I am sure the dems would be quite happy to have Billy Bob’s vote back. And you should recognize, if your reading skills were a little better, that that was my basic point. You would also recognize that I (provisionally) agreed with you that the EIC might be wiser path to achieve this in an ideal world.

    I wan’t making anything up, I know how to read, and I understand how markets work, and how they don’t sometimes. I also know how to keep invective out of my discourse when none is directed at me. Its a good thing.

  18. Dave Schuler says:

    For those of you bashing the EITC, here’s a little support for it from that arch-conservative Max Sawicky.

  19. Steve Verdon says:

    I fully understood your argument that the increase could have an indirect negative effect in that it works similar to a tax on businesses, and hence consumer products. Thats why I went on to claim that the effect, to the extent that it is present, is minimal.

    Actually the size of the effect is something that can only be determined empirically, which you have not done. However, there is no reason to suffer such an effect when we can use the EITC which also has the added benefit of providing and incentive to work and not distorting wages which can lead to excess supply (in labor markets we call this unemployment).

    In the political realm, the positive benefit to ̢??Billy Bob̢?? is most certainly relevant Рwhich is why it is a smart political move. I am sure the dems would be quite happy to have Billy Bob̢??s vote back. And you should recognize, if your reading skills were a little better, that that was my basic point. You would also recognize that I (provisionally) agreed with you that the EIC might be wiser path to achieve this in an ideal world.

    The problem is that Billy Bob might not be one of the lucky one’s that lands the job with the higher minimum wage. In fact, it also possible Billy Bob loses his job due to the increase (or has his hours cut back). The EITC doesn’t have that problem, and Billy Bob still comes out ahead.

    You have 50 years of research that points to minimum wages generally being a bad thing. We have evidence pointing to the EITC being a pretty good alternative and it isn’t that hard to understand. And based solely on political expediency do we decide that the minimum wage is the better policy. Could there be a better argument as to why government does such a rotten job at allocating resources? I don’t think so.

    It also highlights how Arnold Kling views the government:

    The Welfare State supposedly redistributes income and reduces poverty. In fact, I believe that the Welfare State redistributes poverty and reduces income.–emphasis in the original

  20. Roger says:

    That raising the minimum wage substantially impacts employment rates or hurts the poor it is intended to help is not supported by the studies cited so far in this thread. The effects noted primarily indicate only a minor reduction in teen employment. Meanwhile, millions achieve an immediately higher standard of living. This higher sol is not offset by a corresponding cost of living. Raising the minimum wage from $5-$6 an hour provides minimum wage workers a 20% pay increase but would not even approach impacting the economy to the point of raising the cost of living by 20%.

    Note also that most of the studies of the impact on employment cited (and apparently provided by Republican sponsors–i.e., big business interests)involve data affected by the interaction between pre-1990s welfare program structures and a minimum wage. I.e, they include persons who presumably chose not to work rather than accept an increased wage while losing welfare benefits. With welfare reform, these particular studies are no longer relevant–not to mention that they are flawed as actual measurements of impact on available employment.

    Additionally, the presumption informing the argument that modest minimum wage increases will affect low wage employment is that employers currently operate as charities and provide employment from the goodness of their hearts. I.e., they let excess unneeded workers just hang around and draw a paycheck now, but if employers are required to up this charitable giving, they will cease to do so. Actually, few low wage employers employ more workers than they need for the sake of charity and thus are not in the position to arbitrarily cut their workforce for spite.

  21. Dave Schuler says:

    That raising the minimum wage substantially impacts employment rates or hurts the poor it is intended to help is not supported by the studies cited so far in this thread.

    That’s a misstatement of what the studies show, Roger. What the studies show is that the employement effects are negligible to modest in the lowest-wage group.

    The studies say nothing, as far as I can tell, about the unemployment effects of the increase in the minimum wage on employment in higher wage groups. To the best of my knowledge that’s never been studied and that’s my concern and the reason that I’m inclined to favor reform in the EITC rather than the minimum wage as a means towards helping the working poor.

    In addition to Max Sawicky, Brad DeLong also favors the EITC as a means to the desired end. However, DeLong believes in a modest increase in the minimum wage until it would begin to have employment effects (which acknowledges that there would, indeed, be employment effects at some level).

    I’m not as confident as he is in the ability to finetune this closely.

  22. Roger says:

    “The studies say nothing, as far as I can tell, about the unemployment effects of the increase in the minimum wage on employment in higher wage groups.”

    Barring some reason to anticipate a negative effect, I would tend to think the reasoning in my last paragraph would apply here as well. That’s not to say I don’t also approve of the EITC approach as a factor in promoting a living wage.

  23. Dave Schuler says:

    As I noted in my earlier comments in this thread, Roger, there are good reasons to expect negative effects above the level of the lowest wage earners: many union contracts call for their members to be paid at a multiple of the minimum wage. 1 1/2 times minimum wage. 2 times minimum wage. Whatever. Consequently, an increase in the minimum wage tends to ripple through the economy.

  24. ken says:

    dave, can you actually name one union contract that has a provision that sets member wages at a multiple of the minumum wage?

    How many times the minumum wage is a airline pilots wage set, or a school teacher, or fireman, policeman, steelworker, teamster, stevadore, electrition, plumber, or nurse?

    I’d like to see how doubling the minumum wage paid to a kid making your morning latte at Starbucks is going to ripple right on through the economy to double all these peoples incomes as well.

    Actually, I think you are just making it all up.

  25. Steve Verdon says:

    Iâ??d like to see how doubling the minumum wage paid to a kid making your morning latte at Starbucks is going to ripple right on through the economy to double all these peoples incomes as well.

    It wont. Just because you double one economic variable such as price of a given good does not mean that everybody purchasing the spends double. The proof is left as an exercise.

  26. Steve Verdon says:

    Roger,

    Amy Ridenour agrees with Dave Schuler.

    Janice Houston of the NBER.

    United Farm Workers

    For the first time, a union contract will require that agricultural guest workers receive a 2 percent pay increase above the Adverse Effect Wage Rate mandated under federal law, which is always higher than the state or federal minimum wage. Currently, the wage rate for agricultural guest workers in Washington state is $9.01 an hour.–emphasis added

  27. Roger says:

    Both Ridenour and Houston are members of the Center for Public Policy, a right wing think tank. I wouldn’t put a lot of credence into their “studies.” Nonetheless, I concede that an increase in the minimum wage may have some impact on employment. I am skeptical, however, the negative impact approaches outweighing the widespread benefits dervied from increasing the living standards of millions, injecting fluid cash into the economy, etc.

    As for the union correlation, unions represent a small proportion of the workforce. Those unions that may tie their wage base to the minimum wage would be an even smaller subset–likely much smaller. Thus, any impact to the larger economy would presumably be modest indeed. And again, not all bad.

  28. Steve Verdon says:

    Roger,

    Thanks for agreeing with me 100% Roger.

  29. Roger says:

    You’re welcome.