The Minimum Wage As Economic Alchemy

 

 

Believed in (Chemical) Alchemy

 

 

Touts Economic Alchemy Instead

 

A few days ago President Obama issued an executive order requiring firms that provide goods or services to the federal government to pay employees working pursuant to such contracts a "minimum wage" of $10.10 per hour, substantially higher than the current federal minimum wage of $7.25 per hour. (See here for the story.)   The requirement will take effect slowly, over time, as new contracts are awarded and current contracts renewed in the ordinary course of business. 

The President also used the event announcing the order to advocate national legislation raising the minimum wage to the same level, $10.10 per hour, which he said, was "just like" what he had done with his executive order.  The President claimed that such legislation would "is not going to depress the economy.  It boost the economy [because] it will give more businesses more customers with more money to spend.  It will grow the economy for everybody."  (See here for a video of the President's remarks.)

Any parallel between the President's Executive Order, on the one hand, and the proposed increase in the national minimum wage is illusory.  Indeed, the juxtaposition of the two policies will help illustrate why raising the minimum wage applicable to private markets will, if anything, reduce overall employment and stunt economic growth.  Assertions to the contrary, as explained below, are reminiscent of arguments by alchemists that, with enough practice, humans could learn how to transform lead into gold. 
 

Take the Executive Order first.  Presumably such contractors will simply pass the costs of higher wages on to the federal government.  (The Secretary of Labor claims this will not be necessary, because paying workers more will increase their productivity.  But of course if this were true firms would increase wages voluntarily so as to reap such gains.).  The federal government, in turn, will spend more to receive the same services.  If one subscribes to the Keynesian macroeconomic paradigm, the net impact of such additional spending will depend upon the method of financing it.  For instance, the government could simply raise taxes or cut spending elsewhere, thereby offsetting the stimulatory impact of increased spending for the services provided by such contractors.  However, the government could finance such additional spending by borrowing, in which case the net impact of the Executive Order on aggregate demand could be positive, partly offset, of course, by the impact of higher interest rates resulting from more government borrowing.
 

What, though, about the proposed legislation raising the minimum wage to $10.10 per hour in private markets? Unlike federal contractors, other private employers cannot simply pass along the entire cost of higher wages to their customers who, after all, lack the power to raise taxes or issue ever-increasing debt.  Thus, as Nobel Laureate George Stigler explained long ago, basic price theory predicts that increasing wages by legislative fiat will reduce current employment. See George J. Stigler, The Economics of Minimum Wage Legislation, 36 American Econ. Rev. 358 (1946).   After all, firms will hire any employee whose marginal product equals or exceeds the prevailing market wage. At some firms, the marginal product of the firm's least productive employee will just equal or barely exceed the prevailing wage. Legislation that coercively raises the prevailing wage by a non-trivial amount will thus force some firms to pay one or more employees more than their marginal product, an irrational decision for firms free to lay off one or more workers. As a result, the minimum wage will cause some firms to discharge one or more employees, just as a state-imposed increase in the price of steel or electricity will cause firms to reduce their consumption of such inputs.  Thus, two economists recently estimated that a ten percent increase in the minimum wage would reduce employment among minimum wage workers by between two and four percent. See Eric French and Daniel Aronson, Product Market Evidence on the Employment Effects of the Minimum Wage, 25 J. Labor Economics 167 (2007).   Some individuals will lose their jobs altogether, while some will work fewer hours in the same jobs.  The President's proposal, of course, would raise the minimum wage by far more than that, namely, by thirty-nine percent.

Of course, some on the political left continue to resist the predictions of basic microeconomic science, claiming that raising the minimum wage will have little if any impact on employment for low wage workers.  A recent post by William Poole at the Cato Institute provides some additional confirmation of the predictions that some on the left reject, as if such confirmation was necessary.  In particular a recent paper for the National Bureau of Economic Research concluded, after surveying numerous studies of the impact of minimum wage increases, that such coercive increases reduce employment, particular for low-skilled workers.  Poole's post quotes from the abstract of the paper, which summarizes its findings:

"[T]he oft-stated assertion that recent research fails to support the traditional view that the minimum wage reduces the employment of low-wage workers is clearly incorrect. A sizable majority of the studies surveyed in this monograph give a relatively consistent (although not always statistically significant) indication of negative employment effects of minimum wages. In addition, among the papers we view as providing the most credible evidence, almost all point to negative employment effects, both for the United States as well as for many other countries. Two other important conclusions emerge from our review. First, we see very few - if any - studies that provide convincing evidence of positive employment effects of minimum wages, especially from those studies that focus on the broader groups (rather than a narrow industry) for which the competitive model predicts disemployment effects. Second, the studies that focus on the least-skilled groups provide relatively overwhelming evidence of stronger disemployment effects for these groups."  (emphases added).

Thus, minimum wage legislation will, to paraphrase the President, mean fewer, not more, "customers with money to spend."

One might still argue that raising the minimum wage will, despite these disemployment effects, still stimulate the economy.  After all,  raising the federal minimum wage will increase the income of some of those employees fortunate enough to keep their jobs.  Such increased wages may even reflect a more just remuneration for these individuals' hard work than a purely competitive market would products.  Perhaps increased spending by these workers will offset the reduced spending by those who lose their jobs.

Unfortunately, legislation that raises the minimum wage does not magically create the money necessary to pay those employees who retain their jobs higher wages.  If it did, Congress should increase the minimum wage to $25 per hour or more!   Instead, to pay higher wages, business must reduce their profits (assuming they have profits), increase their prices (and suffer reduced sales), or both.  In other words, even if one assumes away negative employment effects,  increasing the minimum wage is  a zero sum game.  Yes, some workers will have more money to spend.  However, businesses and their customers will have less money to spend.  To be sure, low wage workers may spend a higher percentage of their income than business firms or their consumers, but even this is not certain. After all, many minimum wage workers are members of middle class or even upper middle class households. Indeed, according to one study, a significant majority of minimum wage workers are in the middle and upper classes, with the result that low income individuals receive only a small fraction (fifteen percent) of the benefits of higher wages, even assuming no negative employment effects.

In short, basic economic science informed by empirical evidence predicts that increasing the minimum wage will reduce employment, thereby reducing the number of customers "with money in their pockets."  Moreover, additional spending by those employees who retain their jobs will not offset the combination of reduced spending by those who lose their jobs, businesses who see profits fall and consumers who pay higher prices.  Arguments to the contrary rest on some form of economic Alchemy, whereby legislation that does not increase output or income but instead reduces employment magically rearranges purchasing patterns of consumers and business so as to increase aggregate demand.   The theory of chemical alchemy did not work for Rudolf II (pictured above) who, as Holy Roman Emperor, subsidized research on the topic.  Nor will it work for President Obama and those members of Congress who vote for such legislation, once again rejecting economic science.  (See also here.)

One need not rely solely upon scientific theory to rebut the claim that increasing the minimum wage will stimulate the economy. After all, the Nation has in the past experimented with the manipulation of wages as a means of inducing economic recovery, and the results were not encouraging. In particular, during the Great Depression, Congress, via the National Industrial Recovery Act ("NIRA"), imposed so-called "Codes of Fair Competition," including minimum wages, on over 500 American industries.  By coercively raising wages, it was said, enforcement of the Codes would increase "purchasing power" and thus increase workers' demand for goods and services, stimulating the economy and counter-acting the Depression.

While the Supreme Court unanimously invalidated the NIRA in 1935, see Schechter Poultry v. United States, 295 U.S. 495 (1935), Congress doubled-down on this approach to macroeconomic stabilization,  passing the National Labor Relations Act that same year.    The Act, whose preamble asserted that free market wage setting had the effect of  "depressing wage rates and the purchasing power of wage earners" required private firms to allow employees to form unions --- labor cartels --- if they wished, as a means of increasing purchasing power and thus aggregate demand.   Three years later, Congress passed Federal minimum wage legislation as part of the Fair Labor Standards Act.

While there was some popular enthusiasm for these policies, those who knew better predicted they would make things worse.   For instance, a report commissioned by Columbia University concluded that the NIRA "would make for general impoverishment and would solve the problem of 'poverty in the midst of plenty' by removing the plenty."  See Economic Reconstruction: Report of the Columbia University Commission, 20 (1934).  Moreover, as previously explained on this blog, in an open letter to President Roosevelt, John Maynard Keynes argued that the NIRA probably impeded recovery and that FDR's sympathizers in England wondered "whether some of the advice you get is not crack-brained."  Henry Simons at the University of Chicago also argued, again in 1934, that labor unions and other monopolistic combinations exacerbated the Depression by artificially raising wages and prices.   See Henry Simons, A Positive Program for Laissez Faire (1934). 

Empirical research by economic historians confirms the prediction by the Columbia Report, Keynes and Simons.  For instance, President Obama's first Chair of the Council of Economic Advisers, Christina Romer, concluded that the NIRA raised prices and wages and thus slowed economic recovery. See Christina D. Romer, Why Did Prices Rise in the 1930s?, 59 J. Econ. Hist. 167, 187-93, 197 (1999).   More recently, two UCLA economists, Harold Cole and Lee Ohanian, concluded that various New Deal policies, including the NIRA and NLRA, both deepened and lengthened the Great Depression, particularly by artificially increasing wages. Indeed, these scholars conclude that these policies prolonged the Depression by seven years.  (See also pp. 1664-66 of this source summarizing the findings of Professors Romer, Cole and Ohanian.)

None of this is to say that States or even the national government should stand idly by while some individuals are unable to earn enough income to lift themselves and their families out of poverty.  Instead, in the opinion of this blogger, society should take steps to increase the rewards that individuals receive for work.  Fortunately, society has already put into place a mechanism to do just that, namely, the Earned Income Tax Credit.  Indeed, according to this tax calculator, an individual with two children who earned the minimum wage at a full time job would pay no federal income tax and also receive a $5,372 refundable tax credit in 2012.  The same individual would also receive $2000 in refundable child tax credits combined,  thereby increasing his or her effecive wage to over $10.00 per hour and household income by more than 40 percent.  It is thus no surprise that, in a 2013 Op-Ed, Professor Romer, mentioned above, endorsed increasing the Earned Income Tax Credit instead of increasing the minimum wage.  Such an approach would also help stimulate the economy, at least according the Keynesian paradigm, so long as the government borrowed the money necessary to pay for such increased spending.   Hopefully "cooler heads will prevail," and Congress and the President will follow Professor Romer's advice instead of clinging to economic theories that, like Alchemy, were debunked long ago.
 

The Annual Dairy Cliff

"Orderly" Price Gouging

Pushed Nation Over the Dairy Cliff in 1934

With many fixated on the so-called "fiscal cliff," some fear that the nation will soon fall off the "dairy cliff."  In particular, current legislation setting milk prices higher than the competitive level (see below) is due to expire on December 31.   If such legislation does expire, then federal law will revert to that contained in a 1949 statute.  That statute, in turn, will require the Department of Agriculture to begin purchasing milk and other dairy products in an effort to drive milk prices even higher than they already are.  According to a recent essay in the Economist magazine:

 "[I]f there is no farm bill by the start of the next agricultural year, the government’s price-support scheme will automatically revert to what it was in 1949. Most crops have until the spring or summer, but the deadline for milk and other dairy products comes at the end of December. Applying the old formulas today would require the federal government to buy up enough milk to establish a minimum wholesale price more than double its current level."

As explained elsewhere, these "old formulas" set milk prices "based on what dairy farm production costs were in 1949, when milk production was almost all done by hand." Presumably the government would hold milk, cheese and other products off the market indefinitely, allowing them to spoil while some Americans go hungry. 

So far as this blogger is aware, no public official or pundit wants the nation to revert to the 1949 legislation, and the current Administration and some in Congress have proposed various solutions. If, however, the nation does fall off the "dairy cliff," the result will simply be the most extreme manifestation of welfare-reducing federal intervention in dairy markets.  Even under current law, the national government issues annual "milk marketing orders" that set minimum prices that dairy processors must pay  milk producers, "to assure dairy farmers a reasonable minimum price for their milk through the year." (See this articulation of the policy by the United States Department of Agriculture.)  These prices vary, sometimes by almost a factor of four, county by county (compare the price set for most of Montana with that for parts of Florida, for instance).  Prices also vary according to the use the purchaser plans to make of the milk.  Processors must pay the highest prices for Class I or "beverage" milk and lower prices for milk used in yogurt and cheese, for instance.  The image posted above, from a USDA website, shows only Class I prices.   Such marketing orders, the government claims, "make the buying and selling of fluid milk an orderly process."

These regulations result in two obvious and inter-related harms. First, they protect inefficient producers, by preventing more efficient producers from gaining market share by pricing below the coercively-established price.    Second, they injure milk purchasers by pricing some out of the market and forcing others to pay higher prices for the same product than they would pay in a competitive market.  Those consumers forced out of the market will, of course, purchase other, perhaps less nutritious, products.  In short, current federal law enriches producers at the expense of consumers and ensures that the milk industry employs more scarce resources than are necessary to produce its output, depriving other industries of such resources and making them less competitive vis a vis foreign rivals.

Of course, such price-fixing by the nation's dairy farmers would be a felony under the Sherman Act and analogous state antitrust laws.  These statutes reflect the nation's faith that competition, not collusion, should determine prices, output and thus the allocation of resources.  Unfortunately, both Congress and the states repeatedly displaced competition with government planning or authorization of private cartels during the 1930s, ostensibly to combat the Great Depression.  Wages, trucking, airlines, insurance, and agriculture --- all fell prey to anticompetitive governmental intrusion that enriched producers and injured consumers. The Supreme Court stood idly by, validating such legislation, including milk price controls.   Thus, in Nebbia v. New York, 291 U.S. 502 (1934), for instance, the Court, in a 5-4 decision, sustained a New York statute that set minimum resale prices for milk during the depths of the Depression, while many  of the state's families were struggling to put food on the table.  The majority opinion, by Justice Owen Roberts (pictured above) rejected or mischaracterized relevant precedents, many of which had invalidated such coercive state price fixing.  The Court also claimed that the legislation served a valid public purpose, without identifying any such purpose.   As Justice McReynolds observed in dissent, the state may as well have enacted legislation that "required householders to pour oil on their roofs as a means of curbing the spread of fire when discovered in the neighborhood."  Instead, he observed, there was a "superabundance" of milk, "which no child can purchase from a willing storekeeper below the figure appointed by three men at headquarters."  A few years later, Congress enshrined New York's anti-consumer policy into Federal Law in the Agricultural Adjustment  Act of 1937.  As previously explained on this blog, these Depression-era measures, including the cartelization of labor, both deepened and lengthened the Great Depression, as John Maynard Keynes had predicted in an open letter to President Roosevelt in 1933.

In short, the nation has been falling off the dairy cliff each year since the New Deal.  Unless Congress abolishes federal (and state) regulation of milk prices, such intervention in the free market will continue to gouge consumers, foster inefficiency and destroy economic welfare.  Perhaps the severity of the pending 1949 cliff will jar Congress into action.  We can only hope.

If This is Fairness ......

In a CNN Op-ed, Professor Julian Zelizer urges the Democratic Party to make economic fairness to the middle class the centerpiece of its political agenda as the 2012 election approaches. Zelizer sees an analogy to his own characterization of the party's strategy during the 1930s. Quoting another historian, Zelizer claims:

"This is a familiar strategy for the Democratic Party. During the 1930s, according to the historian Lizabeth Cohen, the Democratic Party fought for a vision of moral capitalism whereby government and other institutions, such as unions, would lessen some of the suffering that could be inflicted in the free-market economy."

Zelizer's history is a little out of date. Despite the rhetoric, 1930s Democrats in fact fought for a vision of state-enforced cartelization, including the cartelization of labor, that, when implemented, both deepened and lengthend the Depression. (Many 1930s Democrats also fought to defend Segregation, hardly an example of "fairness to the middle class." Though it should also be noted that, during post-New Deal World War II, FDR issued executive orders banning racial discrimination in factories making weapons and ammunition for the military.) That vision first came to fruition in the 1933 National Industrial Recovery Act ("NIRA"), the centerpiece of FDR's New Deal. The NIRA encouraged industries to proposed so-called "Codes of Fair Competition," which, if approved by the President, would have the binding force of law. Such codes imposed express price fixing, output limitations, barriers to entry and/or various practices that facilitated anticompetitive collusion. Moreover, industries could only obtain approval of such codes if they agreed to pay minimum wages and allowed their employees to join unions --- labor cartels --- that then bargained for higher wages.

Of course, the Supreme Court unanimously invalidated the NIRA in Schechter Poultry Corp. et al. v. United States, reversing the criminal conviction of a small corporation and several of its middle class owners. (The Roosevelt Administration had indicted the defendants on 60 counts of violating an NIRA code. Violations included failure to pay minimum wages (that is, employing too many workers) and --- get this --- allowing customers to select individual chickens for purchase, contrary to the code requirement that the defendants and their rivals sell chickens in blocks.) Ironically, the Supreme Court would later declare so-called "block booking" (requiring customers to purchase an entire package of movies, for instance, unlawful per se under Section 1 of the Sherman Act.) The Court unanimously held that the Act was an unconstitutional delegation of authority to the Executive Branch and that application of the statute to the defendants exceeded the scope of Congress's power under the Commerce Clause. After the decision, Justice Brandeis sought out a lawyer from the Department of Justice and asked him to convey a message to FDR:

“This is the end of this business of centralization, and I want you to go back and tell the president that we're not going to let this government centralize everything."

Congress responded to Schechter by passing the National Labor Relations Act, which empowered individual employees to form unions --- labor cartels --- and thereby drive wages above free market levels.

Of course, proponents of centralization (both then and now) claim that expanding the power of the National Government will somehow encourage economic recovery and thus full employment. But the data show otherwise. For instance, President Obama's first Chair of the Council of Economic Advisors, Christina Romer, concluded that the NIRA raised prices and wages and thus slowed economic recovery. See Christina D. Romer, Why Did Prices Rise in the 1930s?, 59 J. Econ. Hist. 167, 187-93, 197 (1999). More recently, two UCLA economists, Harold Cole and Lee Ohanian, concluded that various New Deal policies, particularly those that artificially raised wages, both deepened and lengthened the Great Depression. Indeed, these scholars conclude that FDR's New Deal prolonged the Depression by seven years. Finally, in 1999, this blogger argued that 1930s state and federal policies that raised wages likely exacerbated the Depression, by thwarting the process of ordinary macro-economic adjustment. See Alan J. Meese, Will, Judgment and Economic Liberty: Mr. Justice Souter and the Mistranslation of Liberty, 41 William and Mary L. Rev. 3, 48-49 (1999). (I hasten to add that unlike Drs. Romer, Cole and Ohanian, this blogger's arguments were purely theoretical and did not rest upon the sort of sophisticated econometric analysis deployed by these economists.) That is to say, FDR's policies deprived millions of middle class or potentially middle class Americans access to employment, hardly a "fair" result or exemplar of "moral capitalism." Indeed, the NIRA, with its coercive limits on price, wages and output was hardly capitalism, moral or otherwise

To be sure, some New Deal policies ameliorated the plight of unemployed Americans. For instance, the Work Progress Administration ("WPA") provided jobs for millions working on parks and various forms of public infrastructure. Ironically, many who took such jobs were unemployed because other New Deal policies, such as the NIRA and NLRA, eliminated jobs these individuals might otherwise have obtained. As Richard Epstein has observed, coercive interference with free labor markets and resulting unemployment often gives rise to offsetting policies designed to ameliorate the human cost of such misguided policies. Speaking of the New Deal, Epstein has observed:

"[I]n 1935, American labor law created a system of collective bargaining whereby employees bargain with a single voice. That system allows unions to seek, and often obtain, monopoly profits for their members. That system in turn reduces the number of workers hired by the unionized firms. So what is to be done with the excess workers? They should be shepherded into job-training programs, funded by the public, which would allow them to reenter the labor force with other jobs."

The WPA, of course, was an example of such a countervailing program only made necessary by antecedent and unjustified interference with free markets that destroyed middle class private sector jobs.

Hopefully today's Democrats have a different conception of "fairness to the middle class" that that which apparently animated the NIRA, NLRA and similar New Deal policies.