Tuesday, December 27, 2011

Higher Minimum Wages Won't Stimulate the Economy

Ptolomey:  Thought Sun Revolved Around the Earth

CNN Money: Thinks Higher Minimum Wages Increase GDP

A recent story on CNN Money reports that several states are about to raise their minimum wages.  The story repeats as "news" (and not opinion) the oft-made claim that raising the minimum wage will stimulate the economy and thus increase Gross Domestic Product.

According to the story:

"What's more, the increases could be a mini-boost for the economy.  The expected rise in consumer spending as a result of the wage increases would add $366 million to the nation's gross domestic product and lead to the creation of more than 3,000 full-time jobs."


"Increasing minimum wage is a key form of local stimulus," said Paul Sonn, legal co-director at NELP. "It helps front-line workers whose wages have been stagnant and falling by putting more money into the pockets of low income families who then spend the money at local businesses."

Both economic theory and empirical evidence have long falsified such claims.  Take theory first.  Yes, raising wages by coercive fiat will increase the income of some workers.  At the same time, such increases will reduce the income of other workers to zero, by inducing firms to eliminate their jobs and also to hire fewer workers in the future.  Wages, after all, are the price of a particular input --- labor --- and increasing the price of one input, whether that input is steel, labor or electricity, will cause firms to substitute to other inputs and thus reduce their purchases of the now more expensive input.  Moreover, to the extent that firms continue to employ some of the more expensive input, their costs will rise, thereby reducing their output, further reducing their use of the input in question.  Thus, raising the minimum wage above market levels will cause firms to employ less labor, by reducing their output and using less labor per unit of remaining output than before the increase.

Now consider the empirics.  As a nation, we have already experimented with using artificially-inflated wages  as a tool for increasing GDP and thus stabilizing the macroeconomy.   As previously explained on this blog (go here and here), legislation passed during the New Deal artificially raised wages, purportedly as a method of enhancing the "purchasing power" of employees and thus stimulating the macroeconomy.  The legislation did not, however, have its intended effect.  Instead, artificially high wages choked off economic recovery by increasing firms' costs, reducing their output and fostering unemployment, as workers expended resources searching for those scarce jobs that remained.  Indeed, according to one study, reported here, New Deal policies that artificially raised wages deepened the Depression and prolonged it by seven years.

The story also helps illustrate the downside of over-reaching Federal regulation.   As the story notes, there is also a federal minimum wage, currently equal to $7.25 per hour.  (There is an exception for the first 90 days of employment for juveniles --- $4.25 per hour --- so long as employment of the juvenile does not displace an adult worker.)    That wage edict applies to any employee working in interstate commerce or working for a firm, no matter how local, with $500,000 in gross sales.   Thus, federal law creates a wage floor, even in those states (and there are five) with no minimum wage whatsoever or those with minimum wages lower than that set by the national government.   As a result, states that wish to compete with other states for labor and capital by eliminating their minimum wages or, for instance, adopting differential wages for youth greater than 90 days, will find such a policy thwarted by the "one-size fits all" federal floor on wages, a floor that applies equally in Manhattan, New York and Moscow, Idaho.  Competitive federalism suffers when the national government asserts a regulatory monopoly over matters properly left to the states.