Of Course Minimum Wage Reduces Employment

In his opus, Economics in One Lesson, Henry Hazlitt devotes an entire chapter to minimum wage laws. He’s quick to identify a semantic problem that lies at the heart of the debate on minimum wage.

“…for a wage is, in fact, a price. It is unfortunate for the clarity of economic thinking that the price of labor’s services should have received an entirely different name from other prices. This has prevented most people from realizing that the same principles govern both.

Thinking has become so emotional and so politically biased on the subject of wages that in most discussions of them the plainest principles are ignored”

Today Hazlitt’s gripe still rings true.

Presidential candidates Clinton and Sanders are calling for huge increases in the federal minimum wage (Clinton recently echoed Sanders’ call for a $15 federal wage floor). California and New York scheduled incremental increases in the state minimum wages to $15/hour by 2022 and 2021 (with New York’s timing of increase stratified by county). All this is sold to the public as a means to help poor workers, with rarely a mention of the costs of such policy, or who would bear those costs.

Despite a wealth of study on the subject and large consensus about the effects of price floors, economists aren’t speaking out against such an aggressive price-fixing scheme as loudly as one might think.

Twenty-four percent of economists surveyed by the University of Chicago disagreed that advancing the federal minimum wage to $15/hour by 2020 would reduce employment. That is, a quarter of economists disagreed that forcing employers to pay twice as much for labor would reduce their ability or desire to employ people. Fully 38% of economists surveyed responded that they were “uncertain.”

It’s hard to imagine economists making such a statement about anything else. For example: that doubling the price of  laptops would have no effect on the amount of laptops purchased. Since labor is purchased just like anything else, we can expect that making it more expensive will cause people to consume less of it.

Consider that when governments want to cut down on behaviors they deem harmful, one of their go-to tools is taxation aimed at increasing the price paid by consumers. Sanders understands that making people pay more for producing carbon means we will produce less carbon. Other politicians have proposed or implemented taxes on soda, tobacco, alcohol, and more activities in order to suppress demand for them. Yet apparently even economists fail to see the parallels between this and minimum wage.

As Hazlitt states, labor is best thought of as another good. Raising its price by mandate will yield the same effects as any other minimum price: some will be purchased for a rate higher than the free-market equilibrium, but a portion of the previously available supply will not. In other words, while some workers will get a raise, others will work less, be fired, or not hired to begin with and employers will enjoy less productivity from their workers.

No one—least of all economists—should be surprised to hear that setting the price of labor higher than people are willing to pay and accept will lead to less efficiency and productivity, nor that this would lead to slower job growth and less employment. We can even observe this happening during past increases of the minimum wage.

Minimum wage is rationalized as an intervention to alleviate poverty and give a leg up to the most vulnerable workers. However raising the minimum price of labor not only prevents consumers (employers) from buying labor beneath such a floor, but also prevents producers (employees) from selling labor below that cost. Since some people don’t have skills that are worth at least $15/hour to employers, they are going to have a much harder time finding employment under such a policy.

When we consider the people that most likely fit this description, the cynicism of minimum wage laws becomes clear. Those most unable to command premiums for labor–the young, poor, under-educated, and inexperienced—are the very people we purport to be helping! It’s no coincidence that minimum wage laws all over the world have roots in racism and ethnic nationalism. In many cases, their goal was to create unemployment among marginalized groups by eliminating their comparative advantage to native workers.

As for employers, it actually gives an advantage to bigger businesses and puts undue pressure on marginal producers (think mom and pop stores, rural and inner-city employers, etc.) who have smaller profit margins and must operate more efficiently. Quite bizarre for an election cycle marked by consternation of income inequality and skepticism of big business.

The ability to sell your labor competitively is important when you don’t have a lot to offer. We seem to understand the value of this for the affluent. No one thinks twice when a college kid takes an unpaid internship or starts volunteering to gain experience. If it’s fine to work for $0/hour, why not $1, $5, or $7?

The scale of federal minimum wage is what truly makes it a bad idea. It’s one thing to try to fix the price of a specific item in a given location (though it’s still a bad idea). But to impose a national price floor on all incarnations of labor should be unthinkable. To suggest that this won’t lead to any reduction in employment (especially in poorer places) is ridiculous.

Some proponents of minimum wage hikes seem to understand this, yet proceed regardless. Upon signing California’s minimum wage increase into effect, Governor Jerry Brown stated:

Economically, minimum wages may not make sense. But morally, socially, and politically they make every sense because it binds the community together to make sure parents can take care of their kids.

To be honest, I don’t understand the morality of pricing people out of work or making consumers spend more than they have to. Given that “57% of poor families with heads of households 18-64 have no workers”, I don’t think making them harder to employ is going to be beneficial to anyone.

It’s good to care about the poor and try to implement policies that help them, and to be clear, I’m not advocating that nothing be done. But economic policies should make economic sense, rather than being rooted in feel-good or politically expedient gestures. Minimum wages help some (often the wrong people) at the expense of others, who, now unemployable, are unable to gain experience that might lead them to prosperity or at least self-sufficiency. At the same time, the rest of society is robbed of the potential productivity of those victims of the wage floor.

After-market transactions (which I’ll get into next essay) are a much better method of helping the poor, precisely because they don’t distort labor markets or reduce demand for labor. Hopefully, our economists will soon get back to the dismal science and stop playing politics.

 

“Free” College Would be a Terrible Idea

The free college crusade represents a perfect collision of ignorance and entitlement. The movement is popular with self-interested students seeking debt forgiveness or a free ride and contributes heavily to the appeal of Bernie Sanders’ candidacy among them. While he is the most extreme in his rhetoric and supposed intentions, the venerable senator is only one among many high-profile Democrats to opine that higher education should be at least partially subsidized by federal money (or more accurately that federal subsidies should be expanded, since they already exist).

Their argument is predicated on the idea that there is a moral or economic obligation to protect students from the rising costs of college education. The underlying assumption is that the federal government is actually capable of containing such inflation by throwing money at it. However you dice it—morally or financially—it’s a bunk policy move that, if implemented, would certainly do more harm than good.

There is no free lunch…or sociology class

Let’s start off with the obvious; professors, administrators, and other faculty aren’t going to work for free. Nor can universities maintain, power, and supply themselves free of charge. It will still cost a lot to keep a college operating, so free college is a misnomer. It will still be paid for, but we would change the payer.

A basic tenet of economics is that costs should be borne by the consumer. There’s good reason for this. When consumers have skin in the game, they ration much more effectively because they’re confronted with the opportunity costs of their decisions (any money or time spent on education can’t be spent on something else) as well as the reality of paying that money back some day.

By contrast, having prospective students make unobligated investments with other people’s money would almost guarantee that more bad investments are made. That means too many people earning degrees in areas that aren’t in high demand and are unlikely to pay for themselves. It’s not that I don’t want anyone to major in art history or theology, but if you’re going to you should pay for it yourself.

Funneling more money into education will inflate costs further

Think about it: if a stranger gave $10,000 to a pizza place so that other people could eat for free, customers would probably order more than the efficient amount of pizza. Why not? There’s no risk involved, at least not to the guy taking the pizzas home.

Let’s say this generous stranger kept funding the restaurant so consumers could continue to enjoy “free” pizza. What might we expect to happen to the cost of pizza? You might be tempted to think that it will stay the same, but the truth is that it would probably rise as overhead and total cost increase. Of course, customers wouldn’t feel the burden of rising prices, and would keep eating away happily.

Meanwhile, behind the scenes the shop has had to hire more cooks and cleaning staff; order more ingredients; use more electricity etc. because they have to produce ever more pizza. Where does that money come from, if not the customers? It comes from the generous stranger, our allegorical taxpayer, who is analogous in all but one crucial aspect: her funding is given by choice and can be halted when the cost becomes prohibitive.

In real life, taxpayers would be on the hook for an increasing amount as constraints on demand are removed and overhead costs increase. A cheaper and more effective method of reducing the cost of college might be easing the accreditation process. Costs might (and probably will) also be driven down by innovations such as online learning and other challenges to the traditional college process.

Free college wouldn’t help the right people

A tuition subsidy would directly benefit the education industry and students who have, are, or will go to college. None of these groups is so destitute as to warrant burdening taxpayers, 68% of which don’t hold a diploma, with the cost of their voluntary, secondary education. On the contrary, 81% of college graduates in 2012 came from families with above-average incomes while merely 7% came from families in the bottom quintile.

Free tuition would fall in with subsidies for electric cars and solar panels: well-meaning policies that essentially transfer wealth up the income ladder to those who are much more likely to take advantage of such incentives. This makes it a very bizarre choice for a candidate, and indeed an entire party, that spends so much time perseverating on the onerous effects of economic inequality.

A major point of college is to accrue human capital: to improve your skills and come out more valuable and employable than you were when you went in. Secondary education is an investment: the benefits of which are enjoyed by the recipient in the form of higher future earnings. Making the taxpayer foot the bill for wealthy kids to invest in their futures is pretty cynical, even by modern standards.

How can you decry tax cuts on the rich and then turn around and hand them a blank check for college? More importantly, how can any of us get behind this? Campuses all over America are full of kids condemning social and economic privilege. And yet they want to vote themselves, the most fortunate echelon of the richest generation ever, out of debt with other people’s money. Let the petulance of that sink in.

What it boils down to is a notable dearth of understanding of basic economics among our generation. Even very smart people that I know are simply unable to reckon with the most fundamental principles of supply and demand and basic price theory.

A better way to help

Even if fully subsidized tuition did make it more likely that low-income people attended college, that wouldn’t necessarily be a good thing and certainly wouldn’t be the best way to improve their lot. It’s pretty unlikely that someone from a poor community who has been forced to attend an underfunded school in their neighborhood is going to be adequately prepared for a college curriculum.

We see this play out again and again. We saw it with affirmative action and we see it in community colleges, where a measly 20% of students seeking a degree receive one within 3 years. It seems a large part of succeeding in college is being prepared to attend it—who could have guessed?

The most frustrating thing about this is that there is a very clear method by which we might compensate for this–it’s just wretchedly unpopular with Democrats[1]…and teachers unions.

What if instead of waiting for someone to turn 18 and encouraging them to enter a college they’re not ready for, we allowed them the ability to choose better schools as children? Instead of sequestering children from poor areas in underfunded and overcrowded schools, we should help parents send their young kids to better schools.

Make no mistake; school choice isn’t a magic bullet or a catch-all solution to educational inequality. But it would greatly improve on some of our current policies, in my opinion.

Tying kids down to public schools (44% of whose funding is procured locally) in their district is a recipe for disaster. Financing public schools through property taxes might work well in affluent communities, but it perpetuates a lack of access to education in poorer areas. Allowing people to choose where to send their kids and giving poor families vouchers for primary education would make a lot more sense than shelling out money to send unprepared students to universities. The only trouble is getting the politics to align.

If the Democratic Party really cared about improving access to education, increasing social mobility for the poor, or cultivating a competent workforce, they would give parents more choice in the schooling of their children. They might also acknowledge that there are other paths to success that don’t involve credentialism and a rigid bureaucratic structure.

Instead, they propose a plan that would pump $70 billion of public money annually into dubious investments and subsidies for the wealthy. It might not make any economic sense, but it’s great for courting votes.

 

[1] To her credit, Hillary Clinton isn’t totally against school choice. She would be fine with allowing for choice among public schools, but not private. Oddly, she cited a fear of parochial schools training terrorists to support her decision. She also thought that a voucher system would be unconstitutional. Sanders stated that he was “strongly against” any program that might redirect funding from public to private schools, including doing so in the form of tax credits.