Why Minimum Wage Fails and What Will Succeed

The debate over minimum wage is one of the most confused arguments in American public policy. Although on its face minimum wage appears to be a promising and simple idea, it is, in fact, a very bad policy that has surely hurt the very people it aimed to help. Proponents of minimum wage (many of them well intentioned) often advocate for increases as a means to improve the personal welfare of workers earning the minimum. This is often accompanied by the argument that no one working full time should live in poverty.

The debate they’re having is: can we provide a minimum income/standard of living in America for workers? The debate relative to minimum wage law is, as Charles Blahous of 21st Century Economics points out: Whether government should establish a price barrier to employment, and if so how high it should be.

The answer to the first question is: yes, but it should be handled differently. The answer to the latter is simple: no.

The welfare of the poor and the prevailing minimum wage are not inextricably linked. Despite minimum wage’s self-evident virtue among certain ideological factions, there’s actually little reason to think this sledgehammer-style policy would help many people, let alone society as a whole. Before we talk about what would work better, I want to highlight some of the more egregious failings of the minimum wage.

  1. Minimum wage forces people out of work

Because most of us grew up with the idea, it takes effort to even begin considering the minimum wage for what it really is: a price floor. Like other price floors, it has consequences beyond those desired.

One negative effect of a minimum wage is a loss of employment. This isn’t limited to people losing their jobs or having their hours cut, but also includes the destruction of future jobs that are casualties of foregone economic growth.

Artificially changing the price of something doesn’t change how much it’s worth to people; economics is tasked with grimly reminding us that prices emerge as a function of supply and demand. As long as employment remains a voluntary transaction between employer and employee, it’s hard to believe a price floor won’t compromise the ability of some workers to sell their labor.

Tragically, this usually affects workers with the lowest skills—traditionally the young, poor, undereducated etc. By eliminating their ability to charge less for their services, minimum wage laws eliminate their competitive advantage. This forces them onto the public dole and renders them a net drain on society.

2. Loss of societal surplus, deadweight loss

This concept is a bit nebulous, but bear with me.

One of the reasons people like me (handsome, rugged) are fans of free markets (a commonly maligned and misunderstood term) is their ability to maximize surplus—the excess benefits enjoyed by producers and consumers in a transaction. (That is, when we’re talking about privately consumed goods.)

Surplus is the idea that even though someone would be willing to pay more or be paid less to consume or supply a good (in this case, labor), the free-market equilibrium price ensures that both parties enjoy a better price. In the graph below, it’s represented by the triangle formed by the crossing of the supply and demand curves.

price_floor
Left: In equilibrium, surplus is maximized for consumers and producers. Right: A price floor has increased producer surplus at the expense of the rest of society. (Graph from econ101help.com)

Forcing a price above or below the equilibrium diminishes the amount of surplus enjoyed by society as a whole; economists refer this to as “deadweight loss” (the green triangle in the graph on the right). It’s true that implementing a price floor above the equilibrium point can (but won’t necessarily) increase the surplus of suppliers (laborers), but this is a bad idea for two reasons:

  1.     It reduces economic growth and efficiency. The added supplier surplus comes at a direct expense to the rest of the economy. This puts undue pressure on consumers of labor, and thus demand for labor.
  2.     Consumers of labor aren’t exclusively employers; they’re also everyday customers—many of whom are the very laborers we meant to aid with the minimum wage.

In other words, though there is tendency to focus on people as either consumers or suppliers of labor, most are both. While they may benefit from minimum wage increases as an employee, they may lose in many other instances when they find themselves on the other side of the proverbial counter. Which dovetails nicely with my next point…

3. Poor people consume lots of low-wage labor

We all buy food. We all buy clothes. But we don’t all shop at the same places. Poor people are more likely to shop at places with lower prices and–you guessed it–lower costs of labor.

Consider that the average Whole Foods employee earns about $18 per hour while the average WalMart employee makes about $13. The shoppers of the corresponding stores have similar disparities in disposable income that are reflected in the prices they pay.

If the minimum wage were raised to $15 per hour, it might have a negligible effect on prices at Whole Foods. The same is not certain for Walmart. Even if prices were to increase by the same amount in both stores, the impact would be greater on the lower-income shoppers, since it would make up a larger percentage of their income.

The problem is that the money that pays for the higher price of labor doesn’t come from nowhere; too often, it comes from exactly those we’re trying to help.

4. Minimum Wage Has Sloppy Aim

A central challenge to minimum wage’s credibility as a form of poverty relief is that it only affects people with wages. It’s easy to make the assumption that poor people are the ones working low-wage jobs, but the two groups aren’t as synonymous as one might think.

First of all, in order to be considered poor, you must be from a poor household, 57% of which have no income earners (Federal Reserve of San Francisco, pg 2). The idea that we would help them by making things cost more is ludicrous.

In reality, about 22% of minimum wage earners live below the poverty line. Their median age is 25; 3/5 of them are enrolled in school; 47% of them are in the south (where costs of labor and living are lower); and 64% of them work part-time.

Fully ¾ of minimum wage-earning adults live above the poverty line.

It’s clear that we’re largely talking about two different groups of people when we discuss minimum wage earners and the poor. Given that the majority of minimum wage workers aren’t poor and that the majority of the poor are unemployed, we should consider another strategy for fighting poverty: one that doesn’t reduce employment opportunities for the unskilled.

Okay, okay…so if minimum wage isn’t a good solution, what is?

Phenomenal question! The many problems with minimum wage policies share a common root: minimum wage effects transactions before they occur. This passes the cost on to employers or customers and impacts demand. The evident solution then, is a policy that goes into effect post-market. My answer to this is a wage subsidy.

We lose more than we gain by interfering with labor markets. Instead, we should eliminate the minimum wage and—very carefully—create targeted wage subsidies for people that aren’t making enough money from their jobs to survive.

This has to be done precisely to avoid creating disincentives to work. Welfare programs can perversely discourage people from earning more money by stripping away benefits faster than wages rise (and this really is more like a welfare program than minimum wage). To give a simple example: if everyone earning under $10,000 were given an extra $5,000, it would discourage people from earning between $10,000 and $14,999, thus encouraging economic stagnation.

We want to encourage people to be as productive as possible. When we design a welfare system, we have to make sure the total benefit enjoyed by the recipient is greater for every dollar earned than the one before it. In order to accomplish this, we need to design our wage subsidy as a function of market wages (the price that employers pay) that increases at a decreasing rate until it hits a wage that we as a society find acceptable.

Wage Subsidy
The subsidy is equal to the height difference between the two curves at any given value of x.

I chose to have the subsidized curve cross with the market wage (y=x) at $13/hour, beyond which point it will cease to be applied. Of course, we could write any equation and phase it out at any point. This subsidy curve is a concept, not a strict recommendation.

There are some profound advantages to this “after-market” approach:

  1.    The cost is borne by society instead of individual employers

I’ve spoken before about how the cost of consumption should be borne by the consumer, so you can be forgiven for feeling confused about why I feel a subsidy funded by taxes is appropriate here. However, the true price of a dishwasher (for example) is not $15 per hour. We know this because there are currently an abundance of dishwashers willing to work for far less than that. If we as a society want them to take home more money for their work, we should pay the difference.

Because of the way this subsidy curve is designed, employees will still have incentive to search for the highest paying jobs available to them. By tying subsidy receivership to work, we encourage workers to maximize their productivity. As long as these conditions are met, our subsidy won’t unnecessarily burden society with the cost of inefficient labor allocation.

  1.     No one is locked out of the labor market

Young people’s employment opportunities are eroded by high minimum wages. Keeping them out of the labor market has negative repercussions for their futures. From the Center for American Progress:

Not only is unemployment bad for young people now, but the negative effects of being unemployed have also been shown to follow a person throughout his or her career. A young person who has been unemployed for six months can expect to earn about $22,000 less over the next 10 years than they could have expected to earn had they not experienced a lengthy period of unemployment. In April 2010 the number of people ages 20–24 who were unemployed for more than six months had reached an all-time high of 967,000 people. We estimate that these young Americans will lose a total of $21.4 billion in earnings over the next 10 years.

Everyone, even the White House, recognizes that the larger implications of a “first job” for our young labor force extend far beyond the pay they receive. Absurdly, they have crafted a program that calls for $5.5 billion in grant funds to help young people get the jobs they have been priced out of by their own government.

  1.     Markets will function better

Advocates of raising the minimum wage are effectively claiming that making a market inefficient will improve outcomes. Here this fallacy is presented as: if the cost of labor is higher, workers will have more money to spend and demand will increase.

This is tempting logic, but it doesn’t hold up to scrutiny. To see how, we can substitute workers for something more specific, like carpenters. Yes, if we passed a law saying that carpenters had to be paid more it would be great for some carpenters. But any additional money spent on carpenters can’t be spent on something else. Society loses any additional benefits it might have gained from having more surplus.

If the reverse were true, it would make sense to ban power tools and all sorts of technology, thereby increasing demand for and price of human labor.

An efficient market creates more surplus, and is less burdened by the cost of those who must rely on public welfare. Additionally, the cost of supporting those people will be defrayed by their renewed ability to provide (in some part, at least) for themselves.

  1. It’s way more targeted than a minimum wage, and could absorb other welfare programs

We could write different equations for different people who might require larger or smaller subsidies to meet their basic needs. For example, a single mom of four kids in Long Beach could receive a steeper subsidy than a childless teen living in rural Alabama, who might not need one at all.

This could theoretically absorb other welfare programs. Instead of receiving a SNAP card, a section 8 voucher, and WIC benefits, the cash needed to cover one’s expenses can be calculated in the subsidy. This has the benefit of cutting down on expensive bureaucratic systems and increases the utility of the money given through welfare while incentivizing work.

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The United States is a rich country. If we spend our money wisely, there’s no reason we can’t afford some minimum standard of living for workers. Helping our poor citizens is one of the best uses for taxes and far better than a lot of the things we spend public money on.

But rather than mess with markets, we should simply give more money to the people we want to help by redistributing income after markets are allowed to produce as much wealth as they’re able. Additionally, if we’re going to combat poverty with public money, we should do it in a way that stands a chance of eventually readying people to support themselves and without sacrificing economic efficiency. Minimum wage fails both of these tasks.

How Should We Protect Our Environment?

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About a month ago, I was talking with some friends on the beach and the topic of environmental regulation came up. When I mentioned that I disagreed with strict environmental regulations and subsidies, it became less of a conversation and more of a melee. I found myself frustratingly inarticulate (3 hours of sleep and a bottle of wine) and was unable to give my argument the explanation I thought it deserved. This essay fulfills my promise to clarify some of my ramblings and, more importantly, it details what I believe to be the best strategy to address environmental concerns. For arguments sake, let’s set aside any disagreement over the disputed realities of climate change and its respective causes.

As I see it, there are two types of motives for conservation: one is economic, the other political (though we might also consider it emotional). The former is aimed at establishing that natural resources have utility beyond that which can be obtained by harvesting them. For example, a specific fish population is valuable to us not only as food, but also in the ocean, since it plays a part in the larger ecosystem upon which we depend. The latter might be described as conservation for conservation’s sake. It is not only common, but expected for world leaders to address climate issues by wielding political power (the UN recently met for its 21st conference on climate change since 1995). This has nothing to do with promoting efficiency and everything to do with satisfying an agenda. I feel comfortable saying this because there is a very clear, simple solution to environmental degradation—at least on the national level.

A sound environment is valuable to all of us. There is no doubt that rapacious consumption of natural resources would lead to adverse and possibly catastrophic consequences. The difficulty lies in the fact that the costs of environmental degradation are not always apparent, nor are they isolated to specific locations or populations. When people consume natural resources or conduct activity that pollutes, and don’t compensate society for the entirety thereof, they are externalizing part of their costs. This externalization is tantamount to a subsidy, and a particularly difficult one to measure at that. For this reason, we cannot rely strictly on a free-market system to sort out environmental issues. In this, government can be a useful tool because it has the unique ability to tax.

I am of the mind that environmental protection is the most worthwhile capacity in which the government can be involved in the economy. There is, however, a right and a wrong way to go about achieving such goals. The wrong ways are through subsidies and quota-based regulations that encourage market inefficiencies and prioritize certain industries unfairly. The right way is through corrective taxation: a process by which environmental costs can be accounted for and passed on to the consumer. This can be achieved by traditional pricing methods and non-market valuation.

It would be disingenuous of me to present this as a novel idea. Most of us have heard of corrective taxation, though perhaps not by that name. The most notable examples are probably carbon tax proposals, whereby producers would be held accountable for the cost of carbon output during their production, ultimately passing that cost on to the consumers (it is also used for non-environmental purposes, such as in the case of so-called “sin taxes” applied to curb consumption of alcohol, tobacco, etc.).

A bleeding heart may object that no price can be put on clean drinking water, the rainforests, atmospheric carbon content, etc. They are, of course, incorrect. An easy way to do this would be to calculate the cost of correcting the damage caused. For example, let us stipulate that the consumption of 1 gallon of gasoline produced negative environmental effects that would cost $0.50 to fix.  Adding a $0.50/gallon corrective tax to the final cost of gasoline would compensate for these impacts. This would accomplish 4 goals:

  1.     Internalizing costs that were previously externalized
  2.     Procuring funds to alleviate the impacts of environment-harming consumption
  3.     Curbing demand for environmentally harmful products
  4.     Promoting the most efficient products—thus increasing quality of life

The market is the most valuable tool we have in the effort for conservation. It incorporates the best rationing mechanism humanity has yet to devise: price. The answer is not to try to circumvent this process, but rather to help it more accurately reflect reality and then use it as a tool to determine how resources should be consumed. Unfortunately, much of the current rhetoric surrounding environmental protection pays little heed to the dismal science. Rather than address these issues through the price system, some prefer arbitrary quotas and subsidies. The inferiorities of such policies are legion, but I’ll have to content myself with addressing their main deficiencies.

The purpose of economics is to promote the most efficient use of resources, natural or otherwise. Creating a quota or cap that cannot be surpassed distorts this process. The reason for this is that circumstance may dictate that an object’s value changes from one time to another. Quotas do not–and cannot–take this into account because they aren’t receptive to demand. No matter how well calculated a quota is, it can’t respond to shifts in the economy or ecosystem.

For a thought experiment, pretend that with the intention of preserving forestry, there is a forest of 500 trees that cannot be cut down. No one would deny that those trees have utility in the forest: they provide shelter to animals, filter water and carbon, and much more.

However, when something changes, those same trees could be better utilized in another capacity. If, for example, a nearby railroad track which was the only means by which to reach a city were to be destroyed it may very well be that some of the trees are more valuable as railroad ties, and thus should be extracted from the forest and put to that purpose.

How can we know if this is the case? If there is a strict prohibition on harvesting the trees, it’s a non-starter. No amount of demand can warrant the removal of the trees from the forest. However, if we have a complete account for the value of the trees in the forest and can incorporate that into the price of the wood (passing that cost on to the consumers as an internalization of the environmental loss), we can form a clearer picture. All we would need to do is weigh the value of the trees in the forest against their value as railroad ties—ultimately a means by which to get goods–upon which some of them may be dependent–to people.

What is the forest’s integrity worth? What if there is urgently needed medicine on board? What if a store is waiting on a shipment of laptops? Where is our tipping point in this decision? These are questions we can answer with non-market valuation (the process by which we will determine the value of the trees) and price, if given the opportunity.

It may sound implausible or perhaps even unethical; I assure you that it is neither. This is the way that we have been deciding how resources are consumed and procured for centuries. There is a huge network of cooperation in which materials (or anything) are directed by the price people are willing to pay for them. This system is one of the greatest advantages of a market economy, and it is so far unmatched by any centralized model.

The purpose of this thought experiment is to underline that decisions are made on an equilibrium; there is a point at which even a very large cost becomes the more attractive of two options. This same scenario can be extrapolated to Arctic drilling or mining coal. These aren’t things that people (or corporations) just do for no reason. To deride them for being “profit-hungry” is to miss the point. They can make money doing those things because those things are the means to achieve an end that people value; in this case, everything from turning on the lights to staying warm in the winter. However, we should make sure that the full cost of such activity is passed on to the consumer.

The point I’m trying to make here is that strict regulations that implement quotas or prohibitions take whole options off the table—and that’s not a good thing. The concept of utility is utterly absent from such approaches. They lead to inefficient allocation of resources, which can mean anything from waste to starvation to loss of life. Our conservation efforts should be aimed at promoting the greatest quality of life for people, while acknowledging that a sound environment plays a part in that equation.

Subsidies are equally villainous, even when used for industries that we consider to be “good”. Instead of propping up inefficient industries (if they were huge successes, as people claim, they wouldn’t be reliant on subsidies) while sometimes aggravatingly continuing to subsidize the “bad” alternative, we should let the market do its job, once we have put effective environmental taxes into place. The government should not be picking winners and losers. Doing so precludes the development of innovative technologies in the future and reduces industry competition.

Think about it. If the cost of oil plus a corrective tax to produce a certain amount of energy is still exceeded by the cost of producing that amount of energy through solar panels, why not take the first option? The point of technology like solar panels is to be more efficient and ultimately lower costs. If it isn’t, it’s not doing its job and it needs to become more competitive. Human labor and capital, represented in this exchange by money, are also valuable resources and there is no sense in wasting them. After all, we want our lives to improve, not worsen.

This is politics, though. Instead of a rational approach to curbing emissions, we are treated (read: subjected) to bureaucratic tendencies to measure input instead of output when crafting policy. Indeed, as Ira Stroll points out, Clinton’s plan to set up half a billion solar panels across the country conflates a means with an end. Having a lot of solar panels is a ridiculous goal. Lowering emissions is a smart goal, the solution to which can rely partly on solar development, as well as other industries–some of which may not even exist yet. There is no reason to divert resources to a politically favored product that isn’t yet competitive. As Stroll points out, that would be a great way to prematurely litter our country with inefficient infrastructure.

Subsidies are additionally invidious because they often involve perverse transactions of wealth from the poor to the wealthy. If the government is going to be involved in redistribution, it should be to support the poor. When users of advanced, expensive technologies enjoy tax credits and direct subsidies, they are doing so at the expense of less wealthy tax/rate payers. The kind of corrective tax I am proposing would also be of a regressive nature, as is any tax on consumption. In order to offset any damaging effects on the poorer taxpayers, tax credits could be issued to cover some of the accrued costs. Or perhaps our progressive tax system will be enough to offset any adverse effects spurred by this consumption tax.

Perhaps the greatest advantage of a such a program would be its simplicity. I think it’s a safe assumption that a program like this could eliminate a lot of the overhead cost associated with environmental overhaul. Importantly, it eliminates the top-down central model that ignores basic economic realities and puts progress in the hands of individuals. History has a lot to say on the benefits of markets. Who knows how much time, effort, and money could be saved by circumventing the regulatory web woven by ever increasing branches of federal and state governments?