Minimum Wage Bill: Obama's $9 Proposal Won't Increase Unemployment

My article on minimum wage, originally published on PolicyMic.

In the months following the State of the Union address, in which Obama called to raise the federal minimum wage from $7.25 to $9 an hour, a series of conservative arguments about the negative effects of minimum wage hikes has appeared.

Most of these arguments are false or highly confused. They fail to accurately weigh the positive and negative effects of the minimum wage or they suffer from unawareness of the relevant facts.

One often heard claim is that minimum wage hikes increase unemployment. The standard argument for this, as the editors at the Wall Street Journal put it, is that workers whose skills do not merit a wage increase “will be priced out of the job market and their pay won’t rise to $9. It will be zero.”

This argument is remarkably simple and this gives it some intuitive appeal. But in a field as complex as economics, such simplicity should warrant more suspicion than confidence.

The fact of the matter is that raising the minimum wage does not increase unemployment. According to a study by John Schmitt from the Center for Economic Policy Research published this February, there is “little or no employment response to modest increases in the minimum wage.”

Another influential study from 2010 by Dube, Lester, and Reich found “no adverse employment effects” to minimum wage increases. And many other studies make similar claims. What’s more, even studies with conservative biases admit that the negative employment effects of minimum wage increases are small.

Why is this so? It turns out that when minimum wage goes up, employers react in more subtle and effective ways rather than by simply firing their workers. In response to minimum wage hikes, employers tend to improve efficiency, give smaller bonuses to more highly paid employees, or else absorb the costs of minimum wage increases by accepting smaller margins.

Another common response of employers is to pass on the cost of higher wages to consumers by raising prices. Many people point to this fact in arguing against minimum wage increases. Christina Romer a professor at Berkeley, for example, writes that the burden of higher prices “may harm the very people whom a minimum wage increase is supposed to help.”

But a wider investigation tells a different story. One study by Sara Lemos that reviewed over 30 academic papers on the price effects of the minimum wage showed that most studies find that “a 10% US minimum wage increase raises food prices by no more than 4% and overall prices by no more than 0.4%.” So the negative effects of higher prices are strongly offset.

Another well documented benefit of minimum wage increases is reduced labor turnover. Dube, Lester, and Reich’s study found that turnover rates “fall substantially following a minimum wage increase.” And what’s more, the cost savings associated with reduced turnover “may compensate for some or all of the increased wage costs,” comments Dr. Schmitt.

Indeed it is because the positive effects of minimum wage increases so strongly outweigh the negative that another study by Doug Hall and David Copper estimates that raising the minimum wage to $9.80 an hour by July 2014 would actually add over $20 billion to the economy and create approximately 100,000 new jobs.

The rational for this result is that poor people spend more of their incomes than their affluent counterparts. So when their income is increased through minimum wage hikes, they spend more money and this added spending could boost demand and stimulate employment as a result.

This does not mean that raising the minimum wage is always a good idea. In response to some of the arguments I’ve given, many conservatives often ask the loaded question, “Why not raise the minimum wage to $100 an hour?” An increase that substantial would cause the negative effects of the minimum wage to outweigh the positive and nearly all economists agree that this would do catastrophic damage to the economy. That is not what we should do and nor is it what anyone is suggesting. What I intend to say is, given our current economic conditions, an appropriately sized increase to the minimum wage would be beneficial.

Moreover, by any reasonable standard, the current minimum wage is too low. If the minimum wage had kept up with inflation since 1968, it would be $10.67 today.

Still, some conservative extremists go so far as to say that there should be no minimum wage at all. Milton Friedman said in an interview that when you impose a minimum wage, you “assure that people whose skills are not sufficient to justify that kind of a wage will be unemployed” — a claim echoed by enumerable conservative columnists over the generations.

But I believe this claim is confused. People who work for the minimum wage are paid just enough to avoid starvation and to have somewhat consistent shelter. Many of these people are one accident away from total financial ruin. If we really believe that there are people whose skills are so low that they do not warrant a wage that provides consistent food and shelter, then we ought to offer some sort of remedial education or other program for these people, since the notion that there are Americans whose potential skills are so low that they do not deserve enough pay to fulfill basic physiological needs is absurd.

The Lame Duck Dilemma

There has been no shortage of articles declaring that the lame duck congress is intransigent. Paul Krugman of the New York Times, for example, writes that the most striking feature of Obama’s presidency is not his management of the troubled economy, but “the scorched-earth opposition of Republicans.” Perhaps the most salient episode of Republican opposition occurred last summer, when Republicans threatened a government shut-down by posturing to deny raising the debt-ceiling and reduced the nation’s credit rating in the process.

It hardly seems questionable that the obstinate voting patterns of (largely Republican) congresspeople are harming the nation and slowing its economic recovery. But why is this so? Why is obstructionism so detrimental? I think that a surprising amount of insight can be gained from considering a famous ethical case called the prisoner’s dilemma.

Imagine that you and your accomplice are arrested while robbing the bank. You are placed in separate isolation cells. Later, a prosecutor interviews you and your accomplice separately and makes the following offer to each of you: “If you confess and your accomplice remains silent, then I will use your testimony to ensure that your accomplice will be imprisoned for six years while you’ll get off scott free. If, on the other hand, your accomplice confesses and you are silent, then you will serve the six year sentence and your partner will go free. If you both confess then you’ll both go to prison, but I can guarantee an early parole so that you’ll both serve five years each. Finally, if neither of you confesses, I’ll have no case. However, you’ll both go to prison for a mere two years for whatever charges — like firearm possession and trespassing — I can scrape together.”

The crux of the prisoner’s dilemma is that the effectiveness of your decision is entirely dependent on your partner’s decision. If you both choose to cooperate with each other by remaining silent, then overall jail-time is minimized; whereas if you both defect from each other by confessing, then overall jail-time is maximized. But if one of you defects while the other makes the cooperative move, then one person gets off scott free while the other is totally screwed over. From a purely self-interested point of view, this is the best case.

What is the connection between all this and the lame duck congress? I think that there is an analogy between the two prisoners of the dilemma and the Republican and Democratic parties, where their actions over the last four years roughly correspond to the case in which overall jail-time is maximized.

Consider, for example, last summer’s debt bill or the more recent Obamacare bill. In both cases, the bills that were finally passed by congress were marred in that they contained legislation that neither party really wanted. The debt bill did not raise any new revenue and cut $2.1 trillion over the next ten years in both domestic and military spending — an outcome favorable to neither party and whose efficacy in reducing that national debt is still dubious. The Obamacare bill was also tarnished by the removal of the public option, which would have easily made the bill fiscally sound. The resulting healthcare bill is reportedly so abstruse that there is still a question as to how it will impact the country when fully implemented.

Indeed better bills might have been passed if Republicans and Democrats had cooperated with each other. That involves each party’s taking on a small amount of jail-time in the form of compromises so that overall jail-time is minimized.

That outcome, however, is unlikely to happen because of one major respect in which the current state of congress and the prisoner’s dilemma differ. In the textbook prisoner’s dilemma, you don’t know what your partner will choose to do and that information would affect your decision. In politics, you do know what your partner will choose. It’s no secret that the Republicans continually choose to defect on certain issues. The Democrats are well aware of this and are forced to respond by defecting also, since otherwise they would serve the maximal jail-time by allowing Republicans to have their way in congress without opposition. However, the Democrats, for their part, also cause Republicans to defect by refusing to yield on other issues, like the Keystone Pipeline and Fracking, for instance.

The problem with this outcome is that when both parties choose to defect, the overall jail-time is maximized. There is constant conflict that is borne by both parties and, more importantly, by the American people. This makes the refusal to cooperate totally irrational, since the well-being of a nation consists not in the well-being of one party over another, but in the well-being of its people, which is affected by the amiability of both parties. As Bill Clinton said in his speech at the Democratic National Convention last Wednesday, “What works in the real world is cooperation.” But if Republicans and Democrats continue to be implacable, we can continue to expect maximal jail-time.