October 19, 2010

"Not Responsible for Advice Not Taken"

Hatched by Dafydd

Credit where it's due: That phrase is one of Larry Niven's favorite sayings. (I don't know whether he made it up or heard it somewhere.)

The advice in this case comes from many economists, including Thomas Sowell and Walter Williams, and I'm sure Milton Friedman and Henry Hazlitt had something to say about it: The real-world effect of minimum-wage laws is not to raise incomes -- but to depress employment, thus killing the incomes of the very people the Left purports to protect.

The classical theory is pretty clear: What you subsize, you get more of; what you tax, you get less of. Suppose you're an employer, and you need to hire some guys... for example, teenagers to work in your pizza joint. Taking into account your profit margin, your customer base, and your competition, you determine each employee is worth, say, $5 per hour. But then the Feds -- or more often, your state -- decides that in order to preserve the "dignity of labor," it must impose a minimum wage of, say, $8 per hour (California's rate).

The difference of $3 per hour constitutes the economic equivalent of a 60% tax on labor: By making each worker 60% more expensive than he otherwise would be, the minimum-wage law reduces employment: Where you planned to hire four employees for an extra $20 per hour total, now that same $20 will only buy you two and a half employees... which translates either to two employees instead of four, each stretched pretty thin; or else three employees, and your profit margin (never very high) goes out the window. In either case, you get a significant increase in unemployment, especially among teenaged workers, low-income workers, and low-skilled workers... the very people the law ostensibly is designed to protect and support.

(The labor costs even for higher-paid workers also increases, as many union contracts mandate salaries of all unionized employees at some fixed multiple of the minimum wage.)

That's the classical theory; but a handful of studies by more "progressive" economists in the Clinton 1990s purported to show that decades of classical theory were wrong... and in fact, minimum wage laws and increasing the minimum wage were either neutral on employment -- or actually increased employment! Wow, we could have our tax and eat it, too.

Authors studied several minimum-wage increases in this or that state, compared them to nearby states, and concluded that no evidence showed increased unemployment in the states whose minimum wage had risen, relative to those states whose minimum wage had remained the same.

But during this last decade of the oughts, grave doubt has been cast on these recent studies by even newer research. The basic criticism, I believe, is sound: The question about minimum-wage laws is not whether they exist, but whether a particular minimum is "effective" at raising wages significantly: If not, then employers can absorb the minor cost increase and make it up in other ways; but when it is, when the increase is too big to skirt, then classical theory kicks in and employment drops.

And of course, if a minimum wage increase is too small to significantly impact wages -- then what's the point, exactly?

Suppose you decide to hire those four employees at $5 per hour; but then the government imposes a minimum wage -- of $5.15 per hour, a 3% increase over what you expected to pay. That means instead of a direct labor increase of $20 per hour for your four new employees, you must pay $20.60.

But with a difference of only sixty cents per hour total, you can probably still hire all four employees; you'll just raise prices by 3% or so to make up for it, or you'll slightly decrease the hours your employees work, or some other substitution for not hiring.

But if the minimum wage is raised significantly more, then you can no longer pass the cost along to customers or just make everybody work less; there's not enough slack to stretch that far. Your only option is to cut back employment, which means cutting back services, which means a gigantic slowdown in the economy.

So why did research back in the 90s find what they found? Because, as it happens, states don't normally make drastic, overnight increases in the minimum wage; so the studies were looking at reasonably small increases over the prevailing wage -- which, not surprisingly, did not always cause statistically significant increases in unemployment. Still, it would be nice to have a case study proving what seems obvious in the classical theory: Make labor expensive enough, and business will significantly reduce employment.

What we really need in order to test the classical theory is to have a much more drastic wage increase mandated by government, then see whether that does or does not send the unemployment rate skyrocketing; but such an experiment could be so grotesquely destructive of the economy that nobody but a complete idiot or a madman would champion such a scheme.

Cue the Democratic Congress elected in 2006.

One of the first orders of business of the 110th United States Congress, which took office on January 3rd, 2007, was to raise the federal minimum wage from $5.15 to $7.25 per hour, a 40.8% increase, in three stages of 70 cents each: up to $5.85 in 2007, to $6.55 the next year, and the full $7.25 in 2009.

Coincidentally, the U.S. unemployment rate rose from 4.6% in January, 2007 to 4.9% one year later (an increase of 6.5%); then up to 7.6% by January, 2009 (an increase of 55%); then to 9.7% this last January (another 28% increase), where it has more or less stayed all year. The total increase in unemployment under the Democratic Congress has been 108.7%.

Obviously, you can't attribute the entire surge in unemployment on the drastic increase in the minimum wage; but circumstantial evidence certainly makes it seem likely that the policy must shoulder at least some of the blame. ("Not responsible for advice not taken.")

But the effect of minimum-wage laws can be seen even more transparently when minimum wages designed for the First-World United States are applied, willy-nilly, to its effectively Third-World territories. One of the other provisions of the Democrats' minimum-wage debacle in 2007 was to force the same rule to apply to American Samoa and the Northern Mariana Islands.

As Walter Williams notes, prior to the 110th Congress, the minimum wage in American Samoa was $3.26 per hour; thus the Democratic scheme to increase wages to a minimum of $7.25 per hour amounted to a 122.4% "raise" for all workers in that territory. Surprise, surprise, even though the law is being phased in at fifty cents per hour per year (slightly slower than in the United States) and hasn't gotten anywhere near the looming peak, the net result has been to devastate the Samoan economy, particularly the tuna canneries:

Chicken of the Sea International moved its operation from Samoa to a highly automated cannery plant in Lyon, Georgia. That resulted in roughly 2,000 jobs lost in Samoa and a gain of 200 jobs in Georgia.

Given Samoa's low cost of living, $3.26 provided Samoan workers a higher standard of living than some of their neighbors on other islands. Now these workers are unemployed. What's worse is that Starkist, Chicken of the Sea's competitor, might leave the island as well. If that happens, increases in the minimum wage will have cost more than 8,000 jobs in Samoa's canneries and related industries; that's nearly half of its labor force.

And now, the Democrat-induced extreme labor surplus in Samoa has become so glaringly obvious, even the Democratic Congress has (reluctantly) noticed and been forced (even more reluctantly) to undo its own "progressive" scheme:

Just three years after a Democrat-led Congress imposed the federal minimum wage on two U.S. territories in the Pacific, lawmakers last month halted the program in its tracks, acknowledging the move had sapped thousands of jobs from American Samoa and the commonwealth of the Northern Mariana Islands.

The two-year delay in the case of American Samoa and one-year reprieve for the Northern Mariana Islands was imposed even as both parties have sparred over the effects of the minimum wage in the U.S. during the troubled economy.

"We said this increase would be harmful in 2007, and the Democrats did it anyway," said Rep. Patrick T. McHenry, North Carolina Republican. "It proves our point that the federal government setting wage rates is destructive to job creation, whether it's in American Samoa or western North Carolina."

So it appears that classical economics theory is still valid; not even so eminent a liberal as the One We Had Supposedly Been Awaiting All This Time can repeal the basic relationship between marginal cost and supply and demand, of labor or any other commodity: By making labor more expensive, you reduce its demand and therefore increase unemployment. And the more expensive you make labor, the higher you drive unemployment (take a long look at Europe).

I believe the experience of the last few years of Democratic control of Congress and (after the 2008 election catastrophe) the White House should cause even ultra-liberal economists, such as Paul Krugman, to rethink their tendentious rejection of any linkage between (a) increasing the cost of doing business, and (b) decreasing the amount of business being done... and in particular their risible contention that increasing the cost of labor actually reduces unemployment.

But I would put the odds that even the hardest reality can penetrate the liberal-progressive-socialist body armor of faith-based ideology at somewhere south of zero. Perhaps instead of teaching college students the joys of Keynesian economics -- or worse, Alinskyism -- universities should make every student read and pass a comprehension test on the classic sociology book When Prophecy Fails, chronicling how true believers in a UFO cult react when their date for the end of the world comes and goes, but Earth abides.

(Study hint: A few cultists peeled off, but most not only remained they picked a newer, later date for world destruction -- and redoubled their efforts to proselytize for new members! Sound familiar?)

Hatched by Dafydd on this day, October 19, 2010, at the time of 3:08 PM

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The following hissed in response by: Geoman

You forgot the other devil - inflation. If wages increase across the board, won't the costs simply be passed on to the consumers? Who in turn have to raise their wages to cover new expenses?

I think it is no coincidence that the U.S. experienced low inflation when minimum wages were stagnant.

The above hissed in response by: Geoman [TypeKey Profile Page] at October 25, 2010 9:54 AM

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