Category Archives: Minimum Wage

Missouri Prop B: the Unintended Consequences of Wishful Thinking

04 Sunday Nov 2018

Posted by in Labor Markets, Living Wage, Minimum Wage, Uncategorized

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Proposition B sounds really good to many Missouri voters: all we have to do to help low-wage workers is declare that they must be paid a higher wage. That’s the pitch, of course. But voters should hear the cruel truth about the unintended consequences of this well-intentioned and ill-considered proposition on the ballot this week:

  1. Businesses are likely to increase prices to compensate for a higher mandated wage, which hurts all consumers, but especially the poor.
  2. Some low-skilled job losses or lost hours are assured, and they will hit the very least-skilled the hardest. No matter the legal minimum, the real minimum wage is always zero.
  3. Such job losses have long-term consequences: lost job experience that the least-skilled desperately need to get ahead.
  4. The harms will have a disparate impact on minorities.
  5. Large employers can substitute capital for low-skilled labor: automated kiosks to take orders and increasingly sophisticated robots to perform tasks. Again, the real minimum wage is always zero. As I’ve said before on this blog, automate no job before its time. But that’s what Prop B will encourage.
  6. Employers can make other compensatory changes. That includes reduced fringe benefits and break times, increased production quotas, and less desirable shifts for minimum wage workers.
  7. A large share of the presumed beneficiaries of a higher minimum wage are not impoverished. Many are teenagers or young adults living with their parents.
  8. All of the preceding points argue that an increase in the minimum wage is not an effective method of targeting poverty reduction. In fact, the harm it inflicts is targeted at the most needy. 
  9. Small employers have less flexibility than large employers, and Prop B would place them at a competitive disadvantage. To that extent, a higher wage floor is most damaging to “mom & pop”, locally-owned businesses, and their employees. Again, the real minimum wage is always zero.

At least 24 earlier posts appear on this blog covering the topic of minimum wages. You can see most of them here. The points above are explored in more detail in those posts.

William Evan and David MacPherson of the Show-Me Institute have estimated the magnitude of the harms that are likely to result if Prop B is approved by voters on November 6, and they are significant. The voters of Missouri should not be seeking ways to make the state’s business environment less competitive.

Voters should keep in mind that wages in an unfettered market reflect the realities of labor demand and labor supply. Wages and other forms of compensation reflect the actual quantity, quality and productivity of available labor supplies. And for unskilled labor, which is often supplied by those who lack experience, a wage that matches their marginal productivity is one that provides that valuable experience. The last thing they need is for tasks requiring little skill to be performed by more experienced employees, or by machines. We cannot wish away these realities, and we cannot declare them suspended by law. Such efforts will have winners and losers, of course, though the former might not ever recognize the ephemeral nature of their gains. And as long as there is freedom of private decision-making, the consequences of such legal efforts will cause harm to those least able to withstand it.

Bernie’s Backdoor Minimum Wage Hike

30 Monday Apr 2018

Posted by in Labor Markets, Minimum Wage, Welfare State

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Bernie Sanders’ latest jobs plan is a political fantasy, but also a fantasy insofar as he imagines such a program could improve job market outcomes and the U.S. economy. Sanders wants the government to guarantee a job to anyone who is unemployed and pay them a wage of $15 an hour. But what job roles will be identified and by whom? Will the unemployed be required to accept these jobs or else lose other benefits? Which unemployed workers will come forward voluntarily for “workfare”? What will qualify them for particular roles? How many public-sector workers will be diverted from their existing responsibilities to administer the program and manage these new workers? How much will the program cost? How will the above-market wages and administration of the program be funded? These questions deal only with the first-order mechanics of the Sanders proposal. What will be the second-order effects on the private economy?

Scott Shackford delves into these and other gory consequences that are likely under the Sanders plan, most of which should be obvious to anyone with a modicum of economic literacy. Apparently, that does not include the so-called economists at the Levy Economics Institute at Bard College, who produced a “study” on guarantees of public sector jobs that manages to prove their ignorance of basic economic principles.

The headline for this proposal is about jobs, but the real motive is to impose wage controls through the backdoor. The plan is announced at a time of full employment (now 4.1%), traditionally defined as an unemployment rate of roughly 4%. That level accounts for “frictional unemployment”, which recognizes that job transitions and the normal market process of matching worker skills with jobs are not instantaneous. It’s true that certain segments of the labor force typically experience higher than average unemployment. So Perhaps i should give Bernie the benefit of the doubt by stipulating that the program is geared toward addressing cyclical and structural unemployment, or that it’s intended to benefit minorities. But if the goal is to keep everyone working all the time, it is impossible in view of the informational frictions, skill mismatches, and mobility issues that characterize the labor market. Workers would have difficulty conducting a job search were they employed in Sanders workfare program, and that sacrifice would be particularly costly for skilled workers seeking employment at wages greater than $15/hour.

Again, all “guaranteed” jobs under the Sanders plan are to pay a wage of at least $15/hour. Low-skilled workers whose productivity is not consistent with such a wage can thumb their noses at private employers. Either pay your low-skilled workers $15 or lose them. This is Sanders’ way of implementing a de facto federal minimum wage without actually requiring employers to pay that rate by diktat. Of course, under the plan, the taxpayer is on the hook for the excess of wage payments over and above the value of these workers’ productive contributions. The bulk of those workers lack the skills and job experience to contribute value commensurate with that wage rate, and sometimes they lack even the temperament and comportment necessary to make a sufficient contribution to output, or to keep steady work absent the gift of a wage from government.

But that’s not the worst of it: Sanders’ program is cloaked in terms suggesting that it would have countercyclical effects: government hiring would increase in association with increases in the unemployment rate, and vice versa, or so we are told. But “vice versa” is a stretch: government programs have a tendency to be self-perpetuating. And this program creates instability by allowing government to compete for workers on a distorted basis. The private sector will lose workers as the government gains workers. The tax bill and its burden on the private sector will lead to business failures, still fewer private workers, and still more public-sector workfare. And as the government displaces private activity, good luck to consumers finding the plentiful goods and services to which they are accustomed. The Sanders program is a prescription for economic and social decline.

Public sector competition for workers under Sander’s plan would be distorted because work would be assigned by special interests, not by market demand. Bob Bryan of The Business Insider has the following details:

“Sanders’ plan would create 12 districts within the US that would approve jobs plans from municipalities, states, and American Indian tribal governments and then pass those plans along to the Labor Department for final approval.”

Thus, a new administrative layer of government, 12 districts, would be created wielding the authority to winnow the pool of projects for a new category of spending. In the parlance of public budgeting, this spending would be called an “entitlement” because the spending would be programmatic rather than discretionary. State and local governments would create wish lists, and their wishes would then be constrained by the decisions of district authorities and the Labor Department. Those decisions, however, would very likely be responsive to special interests. Like most administrative decisions, the spending allocations would be guided by politics, not economics.

Shackford quotes the Levy Institute:

“A local artist collective employs painters, actors, musicians, and stage hands to run year-round productions for the community. They organize school outreach programs, run summer camps, and offer free art, music, and literacy classes for disadvantaged/special needs youths. They collaborate with local schools in offering art enrichment programs.”

Those aren’t Sanders words, but he might well entertain such notions. Should we all just agree that the government ought to tax us more heavily and spend the proceeds on supporting local, “unemployed” artists (I use quotes because many artists are not fully employed at their art for lack of demand, and they often work at other jobs from which they would quickly separate given a flow of government funds for their art). Usually those who insist on such things belong to the very interests who would benefit from the programs. One can argue that the “external benefits” of the arts justify public expenditure, but there is no objective measure of those benefits, and those who benefit directly will always want more. Therefore, the Sanders program, like so many other public initiatives, would violate standards of governmental fiduciary duty to taxpayers.

What about construction and repair of public infrastructure? Those projects should be chosen and initiated on their merits and on taxpayers’ willingness to fund them, not because there are people unemployed at the moment. What’s more, construction and maintenance of infrastructure requires various levels of skills that might not be readily available in a pool of unemployed workers.

Regardless of the specifics, the jobs program promoted by Sanders substitutes a wholly unrelated goal, jobs, for the underlying rationale of particular projects. As such, Sanders’ proposal would provide opportunities for special interests to collect rents without a programatic justification for the expense to taxpayers. Shackford says:

“… the examples in the Levy study seem like descriptions of programs that certain types of local government-connected people with very particular ideas would like to see the government doing. Their plan leans heavily on the assumption that all these unemployed or underemployed people would happily do the grunt work that aligns with left-leaning environmental and public policy project goals. The report openly uses the Works Progress Administration of the New Deal as a model to support it. …

But how does one determine what a community needs while ignoring market responses? Why should taxpayers fund community plays if they have no interest in actually sitting through them? This report makes it very clear that the task falls to local public institutions and job centers, not market demands. That necessarily means it will be driven, much like this report is, by the interests of the people who are in charge of the programs or have the most influence over the programs. That these programs could end up as a corrupt breeding ground for government cronyism and nepotism in who gets assigned for which jobs is utterly absent from the study.“

Here is more from Bryan:

“The plan would also utilize job training centers to train and connect workers with jobs on the new projects.”

This is either another new agency or a demand on private job training organizations. Presumably the training would be free to the trainee, in addition to the $15/hour paid during the training period. I would have fewer objections to an explicit job training program than to the sprawling job-making and wage-paying authority called for in Sanders’ plan. Unfortunately, the absence of apprentice wage levels in the U.S. often eliminates the best training of all: on-the-job training.

Shackford wonders whether workers hired under the program could ever be fired for cause:

“I mean, given how hard it is to fire bad teachers or dangerous cops, it’s worth wondering whether people who get these jobs will continue to get paid if they fail to show up for their job trimming the hedges of their community skate park or surveying people about their food insecurities. (According to the Post, Sanders’ plan calls for something sinisterly called the Division of Progress Investigation to handle discipline.)“

The program could employ as many as 15 million people if the Levy Institute study can be taken as a guide. That would represent a huge increase in government employment. Presumably, the burden would be spread across federal, state and local governments, all of which are facing degrees of fiscal crisis.

Bernie Sanders’ jobs program is ill-defined, but we know enough about it to safely conclude that it is economically preposterous. It will compete with job search activity that is necessary to the function of the labor market; lure low-skill workers away from their current employers, or indeed from their highest valued uses; require massive public borrowing and ultimately higher taxes; compromise other functions of government by diluting fundamental program goals and diverting human and other resources; place further strain on government budgets at all levels; lead to business failures; and lead to a permanently larger role for government in the economy. Governments, of course, do not operate under market discipline, so the program would degrade the overall productive potential of the U.S. economy. 

As David Byrge, aka Iowahawk, says about Sanders:

“Who better to get America back to work than a guy who was actually fired from a Vermont hippie commune for being too lazy.”

For a fairly thorough compendium of Sanders’ policy proposals over the years, here is Matt Welch on “Bernie’s Bad Ideas“.

The Real Minimum Wage Is Always Zero

30 Friday Jun 2017

Posted by in Living Wage, Minimum Wage

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Min Wage Denmark

A minimum wage study from Denmark reinforces the findings of the Seattle study released this week by economists at the University of Washington. Both studies conclude that increases in the minimum wage have negative effects on low-earners, at least for large increases in wage floors of the type advocated by “living wage” proponents. Alex Tabarrok provided commentary of both studies this week on the Marginal Revolution blog.

The Seattle study found that both employment and hours worked declined substantially among low-wage workers following the city’s minimum wage hikes. This became particularly clear after the most recent increase from $11 to $13 per hour. The average low-wage worker in Seattle lost $125 per month, according to the findings. The study has generally been praised for its detailed data and careful methodology.

The Danish study took advantage of the fact that the minimum wage rises by 40% on a worker’s 18th birthday. The chart above pretty much boils down the results. Employment drops by a third at age 18. Even worse, Tabarrok notes that after one year, 40% of workers who lose their jobs at age 18 are still unemployed, while 75% of those who keep their jobs at 18 are still employed. The fate of these two groups is likely driven by a gap in talent and skills, and that gap can only expand as the least-skilled are idled.

The minimum wage is a misguided policy that hurts those who can least afford it: low-wage, low-skilled workers. Firms forced to adjust to the higher mandated wage are worse off as well, not to mention their customers, who are likely to face higher prices and degraded service levels. Even those who remain employed at the minimum wage might suffer under less generous job perks and working conditions. Today, large increases in the wage floor can be expected to bring premature automation of jobs.

In the real world, workers of low skill vary tremendously in their actual ability, prior training and discipline to perform in a structured environment. Many of these individuals simply cannot add value over and above the legal wage. Some are simply incapable of understanding the demands of arriving on time and delivering effort over the course of a work day. Hiring firms cannot easily discern these differences up-front from social cues. They might try, however, which could lead to decisions that are unfair to some individuals. An even higher minimum wage makes these decisions all the more difficult and risky, and forecloses opportunities to a broader swath of low-skilled workers, consigning them to dependency on family or the state.

The minimum wage has always had appeal as an exclusionary tactic by higher-paid union workers. Cowed by its ostensible first-order effects on worker incomes, the left latched onto it as a fundamentally just policy. The negative second-order effects are predictable however. The economic evidence has been piling up, while methodological flaws in an earlier, prominent study finding the opposite in the 1990s have been exposed. As a policy, the minimum wage is unjust in its effects on the incomes of low-skilled workers and on their ability to gain valuable work experience, and on businesses attempting to deliver value to their customers.

Note: I believe Don Boudreaux should be credited with the phrase used in the title of this post, which I’m sure I’ve quoted before. For more background on minimum wage effects, see these earlier posts on Sacred Cow Chips. There are 20 posts with that tag, and some are more focused on the minimum wage than others, so keep scrolling!

The Looting Wage and Its Ultimate Victims

15 Wednesday Feb 2017

Posted by in Living Wage, Markets, Minimum Wage

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Like children asking their peers to exchange quarters for nickels, advocates of a “living wage” hope that the government and voters will agree that workers should be paid by private employers at a rate the activists deem appropriate, regardless of skills. (The “living wage” is left-speak for a very high minimum wage.) Even worse, those advocates actually believe that such a trade can be justified. Or do they? The simple economics of the claim is undermined by assertions that a living wage is simply a matter of social justice. But social justice cannot be served in this way unless one’s definition is so bound up in virtue signaling that you don’t know the difference. It’s even too charitable to say that the left’s definition of social justice is simply bound up in the present and the short-term interests of specific groups. The unfortunate truth is that the “living wage” sacrifices the very well-being of a large number of individuals in those groups, now and in the future. Here’s why:

Suppose the government mandates a “living wage” as well as a series of measures intended to neutralize all of its unintended consequences. These measures would include a complete prohibition of involuntary terminations, investments in automation, price hikes, movement of capital abroad, and immigration. The measures must also include subsidies for failing employers. Just imagine the burden of compliance costs related to these measures, and the complex task of carving out exceptions, such as the allowable price hike in the wake of an increase in the cost of raw materials. What about the additional workers who would enter the labor force to seek employment at the higher wage? Should they be prohibited from doing so, or should employers be required to hire them, or should they be subsidized to hire them? And how will taxpayers afford all of these government subsidies?

Clearly, the situation described thus far is not sustainable. Both the initial wage hike and many of the other steps, ostensibly intended to cushion the blow on various parties, represent flagrant abridgments of private property rights, or rather, property takings! Of course, the real intent is for private parties to pay for the “living wage”. Presumably, employers are to pay the costs, especially large employers and their wealthy investors, like you when the value of those shares in your IRA, pension or 401k plan begins to tank. The reality is, however, that the unintended consequences will spread the cost in a variety of unpleasant ways.

Those in the coalition for living-wage legislation have not given much thought to the reverberations of such a change. At the most basic level, some people cannot command a high wage because they lack higher-order skills. Some have not learned the importance of reliability, of making sure they arrive at work by a specific time every day. Some have not learned the importance of concentrated work effort, of demonstrating that effort and avoiding excessive slack time. Some communicate poorly, or fail to comport themselves in a manner that commands trust. Some have a sketchy work record, presenting a risk to prospective employers. Living wage advocates assert that all of this is irrelevant, but it means everything to an employer.

How would employers attempt to to survive under a living wage? One doesn’t have to think too deeply to realize that wage floors lead to a loss of jobs for several reasons. Those lacking the skills to justify the higher wage will be out the door. Some employers will fail, finding it impossible to pay the hike in their labor costs or to pass it along to their cost-conscious clientele. The living wage is likely to lead to premature automation of many tasks otherwise requiring unskilled to more moderately-skilled workers. The capital investment needed to automate any manual process may well become worthwhile given such a shock to wage rates. Moreover, while some in the living wage movement complain that U.S. employers seek-out lower wage rates abroad, the living wage itself would lead to more of this substitution. The living wage also creates opportunities for those willing to work illegally at sub-minimum wages, including many undocumented immigrants. By driving a larger wedge between the wages of other home countries and the U.S., the living wage creates an incentive migrate In pursuit of the enlarged set of black-market opportunities for labor.

So just imagine having the government mandate a wage that is nearly double the market-clearing level. The quanity of labor demanded declines and the quantity supplied increases, leaving a surplus of workers at the mandated wage. The demand for labor declines still more as the weakest firms close shop. And it declines still more over horizons long enough to enable investment in automation and relocation of production to foreign shores. Add to the mix an expanded flow of workers from abroad. Not all of these surplus workers, native and immigrant, would be willing to take “underground” work at a rate below the living wage, but some will.

So, which of the measures listed in the second paragraph would mitigate the costs imposed by the living wage? In reality, none of them would succeed without spreading the cost more widely. Prohibiting involuntary terminations? Businesses will fail and/or prices will rise. Prohibiting investment in automation? The same. Prohibiting price hikes? Business failures, terminations, and premature automation. Prohibiting movement of capital abroad? An outright revocation of property rights and a distortion of incentives for productive investment, which would also discourage the movement of capital into the country, not just out.

Are there measures that could make the “living wage” a sustainable outcome? Yes, but they cannot be accomplished immediately by decree. Indeed, doing so would thwart the achievement of the objective. In short, productivity must increase. While productivity is multi-dimensional, education, training and work experience all foster improvement in a worker’s ability to add value. Unfortunately, our system of public primary and secondary education has been unsuccessful in producing graduates who can compete in the labor market, even at today’s minimum wage. Wholesale reforms are needed, but even the best educational reforms will take time to come to fruition. In the workplace itself, apprenticeship programs could provide under-skilled workers an avenue toward greater competitiveness at higher wages. Again, apprenticeships may only make economic sense to employers at a legalized sub-minimum wage, as Australia allows.

Second, productivity is dependent on the quality and quality of the capital invested in a business. The key to improving this capital is profitability. It’s ironic that living-wage advocates fail to see that their proposal runs directly counter to steps that would contribute to  productivity and wages. Instead, they seem intent on killing the geese that lay golden eggs! Far better to allow those eggs to be transformed into new capital assets that can enhance worker productivity and justify higher wages. Some jobs will be replaced by automation, but capital and new technology tend to create new kinds of jobs and inevitably boost worker productivity. (See “Will Automation Make Us Poor?” by Aaron Bailey.) Employers will still have an interest in seeking out, if not developing, new talent. The automation should take place as part of a more natural evolution, not one prematurely hastened by unrealistically high wage mandates.

The living wage is a prescription for failure and a death-knell for the private economy. It will fail the least-skilled workers and even some semi-skilled workers who cannot compete for jobs at the living wage. It will automate jobs before the natural time dictated by the market-driven process of technical evolution. It will lead to higher prices, which drive down the real value of any wage gains that workers manage to capture. It will lead to business failures, especially among small businesses. It will offer false hope to unskilled immigrants. It will reduce capital investment among smaller firms struggling to meet the higher wage bill. It may well lead to a slew of even more destructive public policies, such as business subsidies and other price controls. And it will create dependency on the state. The living wage is a destructive policy and ultimately a prescription for the death of self-sufficiency. It  cannot foster real social justice.

Are The Native-Born Idle By Choice?

21 Wednesday Sep 2016

Posted by in Immigration, Labor Markets, Minimum Wage

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Native-born Americans don’t seem to want low-skilled work, even when they have no skills. Immigrants, on the other hand, seem more than happy to take those jobs. The fact is that hours worked by native high-school dropouts have declined relative to the hours of immigrant dropouts, as noted by Robert Verbruggen in “When Young Men Don’t Work“.

Of course, American men in general are working less, with fewer jobs in occupations and sectors traditionally dominated by men, such as manufacturing. The total demand for manual labor may be decreasing due to automation. Among the youngest cohort, hours spent in educational activities have increased. However, another contributing factor may be that the supply of labor is held down by negative work incentives created by government policy. In any case, the changing composition of the low-skilled work force is a curiosity. Many of the native-born appear to be opting out of work, but not the foreign-born:

“Native high-school dropouts of ‘prime age’ (25–54) work only about 35 weeks per year, on average; comparable immigrant dropouts work 49 weeks. Native dropouts are the outliers. Immigrant dropouts work roughly as much as both native and immigrant men with higher levels of education—and they do 60 percent of the work performed by dropouts in America, despite being less than half of the dropout population.“

Clearly low-skilled work exists , and immigrants are doing a disproportionate share of it. Are some of these low-wage jobs simply inaccessible to the native-born? I doubt it. The argument that immigrants are taking low-wage jobs from Americans implies that immigrants have lower reservation wages. But if that’s so, it confirms the hypothesis that natives are less willing to take low-skilled jobs.

In fact, the native-born might have better leisure alternatives than many of the foreign-born. Verbruggen reviews the work of Erik Hurst of the University of Chicago, who argues that technology such as video games and the internet have increased the value of leisure relative to work. Perhaps natives are better situated than immigrants to draw on other resources to finance an idle, gaming existence. Whatever they do to occupy their time, those resources might include relationships with family having the means to support them, and even a familial tolerance for idleness.

It’s also possible that natives have better access to the bounty of the welfare state. Undocumented foreign workers are at a disadvantage in this regard, but that handicap is eroding. Whatever the reason, it appears that native-born Americans are spared the need to bid aggressively on work they consider undesirable. That decision will often be costly in the longer-run, given the lost opportunity to develop skills on the job.

Another possible explanation for the disparity in average working hours is that more immigrants are willing to work (illegally) in sub-minimum wage jobs. That might well be true for undocumented foreign workers, even in occupations that would otherwise be legal. One could argue that this is unlikely to reduce opportunities for work at or above the minimum wage because wage offers tend to align with skill level. However, sub-minimum wage offers to illegals are probably driven by the risk faced by the employer in making such hires. Just the same, illegal opportunities to work below minimum wage are not the exclusive domain of immigrants. Cash compensation can allow an employer to pay sub-minimum wages to anyone willing to work. Moreover, many natives work in the underground economy in areas such as illicit drug distribution, which might or might not involve sub-minimum wages.

Of course, an individual working at a lower wage must work more hours to earn the same income as one earning a higher wage. Subsistence for the immigrants might require the extra hours. That would explain the disparity in average hours if natives and immigrants truly can be sorted by wage rate, but if that is the case, then the natives must have less interest in low-wage jobs, as postulated, and the natives are content to live at the same subsistence level as the low-wage immigrants by working fewer hours.

Thus, it is difficult to escape the conclusion that native-born Americans are less willing to work in low-wage jobs than the foreign-born. Further increases in the minimum wage would have a tendency to create more idle time among the low-skilled, both native and immigrant. The total legal demand for low-skilled labor would decline. More natives might be willing to supply labor at the higher minimum, but incumbents have an advantage in holding onto jobs that remain after the increase. A higher minimum would certainly convert some formerly legal opportunities into illegal opportunities (at wages below the new minimum), attenuating the total increase in idleness.

Growth in the labor force is a fundamental driver of economic growth, and immigration has always been an important source of labor for the U.S. economy. Low-skilled, native-born Americans seem less willing to offer their services at wages matching their skill levels, but immigrants help to fill that gap and are usually happy for the opportunity. A higher minimum wage will not make their lives easier in the U.S. It should also be noted that greater tolerance for immigration at the low-end of the socioeconomic spectrum need not imply a sacrifice in border security or careful vetting, but it would provide a supply of able and willing workers eager to improve their standard of living.

On a related note, I add the following: James Pethokoukis points to an interesting irony with respect to Donald Trump’s policy positions: “Trump wants 4% (or higher) US growth. Easy. Just massively increase immigration“.

Pay and Productivity

05 Sunday Jun 2016

Posted by in Living Wage, Markets, Minimum Wage

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allaboutproductivity

Remember, the real minimum wage is zero, and state-imposed unemployment is not justice. In the private economy, wages rise with productivity, and that’s true across workers at any point in time, for workers over time, and for workers in different industries over time. Don’t think so? Contrary to the blithe pronouncements of Barack Obama and reports by the union-backed Economic Policy Institute (EPI), there has been no divergence in productivity and pay since the early 1970s. This is shown convincingly by James Sherk in “Workers’ Compensation: Growing Along With Productivity“. Sherk’s work shows that hourly productivity increased by 81% since 1973, while average employee compensation increased 78%. In contrast, the EPI has claimed that productivity grew 91% since 1973, but  employee compensation grew just 10%.

How did the EPI (and Obama) reach such a faulty conclusion? Sherk breaks the error into three major parts: 1) comparing the pay of a subset of workers to the productivity of all workers; 2) excluding the pay growth of the self-employed; and 3) inconsistent adjustments of pay and productivity for inflation.

The link between wages and productivity is immutable in a market economy. The state can attempt to short-circuit the relationship, but such intervention comes at the cost of dislocations in resource utilization and damage to well-being. Veronique de Rugy discusses Sherk’s findings and emphasizes the folly in thinking that the government can somehow divorce the pay of workers from their underlying contribution to the value of output:

“One of the assets of the American economic model is a relatively flexible labor market, especially when compared with labor markets in many European countries. It explains some of the consistently lower U.S. unemployment rates and higher economic growth. Unfortunately, this flexibility is increasingly threatened by government policies that would increase the cost of employing workers.“

Populists and statists share some destructive tendencies, such as a fixation on increasing the cost of labor to employers. The current debate over a “living wage” of $15 per hour involves more than doubling the minimum wage in many parts of the country. This is so far out of line with the productivity of low-skilled workers as to make absurd claims that it won’t have a serious impact on their employment. There are employers who won’t be able to survive under those circumstances. There are others who will have to scale back operations. Employers having access to capital in industries such as car washes and fast food know that automation is more than viable as a substitute for low-skilled labor. And new labor-saving innovations are inevitable when creative entrepreneurs are confronted with an obstacle like high-cost labor: necessity is the mother of invention. But premature automation is not an obvious consequence to living-wage advocates. And that’s to say nothing of the futures destroyed when low-skilled workers are denied opportunities for work experience.

The connection between wages and productivity is part of a well-functioning economy and it is just as alive and well in today’s economy as ever. The “right” wage cannot be determined by central planners, bureaucrats or legislators apart from productive reality, and the adverse consequences of their attempts to do so cannot be wished away. Only markets that price the real value of productive contributions can put resources such as low-skilled labor to their best use, avoiding the waste inherent in regulation that is always ignorant of dynamic preferences and resource availability.

 

Costco Labor Productivity Drives Its Wages

26 Thursday May 2016

Posted by in Minimum Wage, Uncategorized

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Buyer beware: various memes promoting a higher minimum wage, or a mandated “living wage” of $15, cite Costco as “proof” that a higher wage floor does not imply that product prices must rise. In fact, Costco pays relatively high wages to its hourly workers and it is a discount retailer, but it is highly misleading to treat these facts in isolation or to suggest that they imply anything about cost-price causality and the consequences of changes in costs. A higher wage floor would add cost pressure to any business employing low-skilled labor and even some employing more skilled workers like Costco. Many of these firms would have to raise prices to remain viable.

Costco says that it pays an average wage of $17 plus benefits. A quick glance at Glassdoor.com shows starting pay rates well below that average, which is no surprise. Costco recently increased its lowest pay rates for the first time in eight years, to $13 and $13.50 an hour from $11.50 and $12. However, there may be some slight-of-hand used to support other quotes of Costco’s average wage. It’s been claimed elsewhere that the company pays an average wage of $20, and President Obama asserted that Costco’s average wage is $21. Typically, quotes of hourly wages do not include the value of benefits. One blogger suggests that these higher figures may have been calculated by averaging across job classifications, rather than dividing the company’s total hourly wage bill by the number of worker-hours. One other qualification is that roughly 10% of the workers in a typical Costco warehouse store dispense free samples but are not employed by Costco. The average hourly wage of “workers at Costco” would likely be lower than $17 if they were included.

Nevertheless, it’s true that Costco pays a relatively high wage rate to its hourly workers. How can they afford to do so? As it happens, Costco has relatively few workers relative to other retail operations, and its average revenue per transaction is high. According to Megan McArdle at Bloomberg, in 2013, Costco’s average square-feet of floor space per employee was almost twice WalMart’s; according to MarketWatch, Costco’s average revenue per employee is now nearly three times the comparable figure for WalMart (enter COST and WMT). Obviously, Costco employees are highly productive in terms of revenue, and that is closely associated with higher wages.

The high productivity at Costco is not an accident. While a good wage is certainly a motivating factor, the productivity of Costco’s work force starts with screening during the hiring process, where the company is known to prefer significant retail experience. They also emphasize the demanding physical requirements of certain jobs, and given their thin staffing, a relatively high level of responsibility for a retail worker. Newcomers are said to be under a watchful eye, and effective performers are rewarded. It takes four to five years to reach the top of the wage scale in a job category. Many of those categories involve specialized skills, such as licensed opticians, butchers, cake decorators, forklift drivers, licensed hearing aid dispensers, and registered pharmacists (these categories drive up the average wage). The company provides training opportunities in various areas, and average employee turnover is low, which reduces costs. The Costco warehouse stores are without typical retail amenities; they are bare-bones with goods sitting on pallets rather than displayed on shelves. This also lowers costs, giving the company additional leeway in shaping its generous wage policy.

Returning to the question of pricing, Costco’s example cannot be generalized. First, it might not be such a good example of price restraint in the face of higher wages to begin with. To bolster earnings, Costco is expected to raise its membership fees by about 9% in 2017; undoubtedly there is also room for retail margins to increase. Time will tell. Second, again, Costco’s wage policy works fairly well because its business model rests largely on high labor productivity. Basic economics teaches us that higher productivity drives higher wages. Workers who earn less than Costco wages are, in general, less productive. This is a consequence of more limited skill sets, less experience, and sometimes weak desire. Those earning at the minimum wage are handicapped by an inability to contribute at high levels, or an inability to demonstrate that they can at their hiring date. Thus, they work in jobs that do not require developed skills. For their employers, higher wages are not a path to profitability.

Mandating an increase in the wage floor is not possible without other market adjustments. First, like anything else, the demand curve for low-skilled labor slopes downward, so a higher wage floor reduces the desired labor input. Job losses befall the least skilled in such a scenario. This consequence has greater breadth in a world in which opportunities for automation are plentiful. Another possible adjustment is an increase in the price charged to customers, which might be a reflexive response among business operators. However, they must compromise when confronted with the competitive effects of passing along an increase in costs. There could be other cost-reducing changes in job structure, benefits, break times, and any number of other conditions and circumstances of employment. Finally, some business owners might accept a lower level of profitability, depending on their disposition and the competitive tenor of the markets in which they operate. Some Costco shareholders believe that might be the case, as the company’s earnings have softened recently.

The final outcome is likely to be a combination of the adjustments described above. Unfortunately for proponents of a higher wage floor, the economy cannot and will not transform itself into a community of Costco clones. With limited skills, the motivational power of higher wages goes only so far. All price floors create excess supply, in this context unemployment. Excess supplies tend to consist of the most marginal units, in this case, the least productive workers. Perhaps sheer ignorance causes agitators for wage mandates to overlook this inevitable marginalization. The real minimum wage is zero.

A note on the cartoon above: It reminded me of an amusing passage in Margaret Mitchell’s “Gone With The Wind” when Rhett Butler, in a sardonic moment, suggests to Scarlett O’Hara that she change the name of Kennedy’s General Store in Atlanta to “Caveat Emptorium, assuring her that it would be a title most in keeping with the type of goods sold in the store. She thought it had an imposing sound and even went so far as to have the sign painted….” Later, Rhett learns that she actually had the sign made, but an embarrassed Ashley Wilkes clued her in to the meaning. She is furious, and Rhett laughs hysterically.

The Inhumane Minimum Wage Fantasy

22 Monday Feb 2016

Posted by in Minimum Wage, Poverty

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min-wage ball n chain

An analysis by the Economic Policy Institute (EPI) is the basis for breathless claims by the Left that a substantial increase in the minimum wage would have “sweeping benefits for low-income families.” The EPI study purports to show that spending on public assistance will decline significantly with the increase in the minimum wage. Author David Cooper’s analysis is purely static, dressed up with a few linear regression equations relating participation in federal welfare programs to the wage distribution. However, his conclusion is preordained by the very design of the analysis, which relies on pooled data from public assistance programs across 2012 – 2014. This was a period over which wages were generally rising, but the federal minimum wage was constant (and only a few state minimum wages were increased).

It’s no surprise that higher wages are associated with a reduced likelihood of receiving needs-based public assistance in a cross section. That’s not quite the same as measuring the dynamic impact of an increase in the minimum wage. The adjustment to a higher wage floor involves more complex shifts in the structure of the economy, including higher prices, a higher incidence of small business failure and the substitution of automated systems for labor. And celebration would not be in order if the policy change prompted a deterioration in the employment prospects of the least-skilled workers, and it would.

There are a few gaping holes in the EPI analysis. One involves a data limitation whereby the distribution of public assistance by wage decile is related to individual workers or their families. It is one thing to say that most recipients of public assistance work for a living. It is quite another to say “Most recipients of public assistance work or have a family member who works.” Obviously, the latter does not imply the former, yet the analysis asks you to accept that the wage rates of family members who perform work during a year are the determining factor in welfare program participation, rather than the employment status and hours of all members of the household.

The analysis includes cross-sectional regressions relating the receipt of public assistance (yes or no) to wages imputed at the individual level, controlling for a complex function of age (polynomial terms), other demographic factors and part-time work status during the previous year. As stated above, the data are plagued by measurement issues. Furthermore (and this is a technical critique), linear regression is not an appropriate statistical methodology with a binary dependent variable. The author should have known better, but we’ll leave that aside.

Controlling for part-time status is intended to create a more reliable estimate of the effect of wages on program participation, as part-timers are more likely to earn low wage rates. But if hours matter in that way, then the regression is all the more suspect because hours of work are otherwise ignored (except in the imputation of wage rates).

The truth is that poverty is not a wage problem as much as a jobs and hours problem. A recent post by Angela Rachidi  of the American Enterprise Institute notes that “Only 11.7% of poor working-age adults worked full-time for the entire year in 2014.” Impoverished individuals who work full or part-time are concentrated in low-skilled occupations. Those are likely to be the same kinds of jobs for which impoverished non-workers might otherwise compete. Many of those jobs are at or near the minimum wage, but increasing the wage floor will only exacerbate the problem of unemployment or underemployment.

An increase in the minimum wage might help those workers who are able to keep their jobs. Unfortunately, if they remain employed, they are likely to suffer non-wage repercussions at their jobs. Therefore, the size of the net economic gain for those lucky enough to keep their jobs is open to question, though their measured income will rise. Still, keeping your job may be a big challenge.

The EPI analysis pays no heed to the negative employment effects of changes in the minimum wage. These stem from  employers’ efforts to control costs, hiring only when the skills and expected productivity of a worker exceed the cost. Growth and job opportunities are thus quashed by the intervention, including the gain in skills that comes with experience. If a business hikes price to defray higher labor costs, the negative impact on customers will induce them to buy less, reducing the need for labor. Another possible impact may be caused by the so-called “welfare cliff“, or the tendency of many program benefits to decline as income rises, which imposes a marginal tax rate on beneficiaries’ labor income. A higher wage floor might induce a worker to reduce hours to avoid the cliff, if their employer allows it, or it might induce another employed member of the same household to reduce hours.

Here is the extent of EPI’s treatment of the negative employment effects of a higher minimum wage, quoting the Congressional Budget Office (CBO):

“CBO predicts that federal expenses would initially go down, but could later increase if the higher minimum wage has a significant negative effect on employment. On net, they conclude that ‘it is unclear whether the effect for the coming decade as a whole would be a small increase or a small decrease in budget deficits.’ It is important to note that the CBO’s ambiguity on this point is driven by their atypically high estimates of the probability of significant employment loss stemming from such an increase. If employment loss is insignificant (as most research on a minimum-wage increase of this magnitude indicates), the budget savings would surely dominate.” [Emphasis added]

The parenthetical, bolded statement is offered by Cooper without any support whatsoever, and it is incorrect. First, the evidence that the wage floor has negative employment effects “has been piling up” of late. “Living wage” advocates should not be encouraged by the recent experience of six large cities that have increased their minimum wages. Here is further information on the District of Columbia and WalMart’s reaction to a recent wage hike. The long-run effects of minimum wages are the most destructive, according to a recent paper authored by David Neumark and Olena Nizalova:

“The evidence indicates that even as individuals reach their late 20’s, they earn less and perhaps work less the longer they were exposed to a higher minimum wage at younger ages. The adverse longer-run effects of facing high minimum wages at young ages are stronger for blacks. From a policy perspective, these longer-run effects of minimum wages are likely more significant than the contemporaneous effects of minimum wages on youths that are the focus of most research and policy debate.“

Other recent work shows that minimum wage increases during the Great Recession increased unemployment among workers age 16 – 30 with less than a high-school education. Another paper finds that minimum wage hikes are bad anti-poverty measures, poorly targeted and regressive in their effects on the poor due to higher prices. A couple of previous posts on Sacred Cow Chips include many links to other work on minimum wages: “Major Mistake: The Minimum Opportunity Wage“, and “Unintended Consequences: Living (Without a) Wage“. Today, many jobs are at risk of automation, so the responsiveness of employers might be greater than ever.

In a strong sense, EPI’s findings and conclusion are beside the point for the many low-skilled workers whose jobs would be at risk, as well as those who might never be given legitimate employment opportunities under a higher wage floor. Those erstwhile workers and job seekers are generally the least skilled and most in need of experience. But EPI, and unthinking living wage advocates, are all too eager to signal the humanity and virtue of their favored policies, foolishly ignoring the negative and inhumane employment consequences.