Coyote Blog

Apparently there is a new CBO report on the effect of a Federal minimum wage hike to $15.  Before I get into the economic impacts, I want to observe that the $15 Federal minimum wage is a political smart bomb that hits mostly red states in much the same way as the reduced Federal tax deductions for SALT (state and local taxes) was a smart bomb that mostly hit blue states.  From an equity standpoint it is insane to have the same minimum wage in rural Alabama as in San Francisco, but since its main negative employment effects will be in red states I think this may be a feature rather than a bug for Democrats.

Anyway, for years folks have made the argument that government-mandated minimum wages are necessary because of the power imbalance between employers and low-skill workers which allows employers to exercise monopsony power and keep wages below some theoretical market clearing price (which is a total laugh -- if you really believe this you can come to my company and try to hire for unskilled positions at the top of the economic cycle and see how much power we have).   The progressive theory is that companies therefore earn excess profits due to this power.

But that is almost impossible.  To actually profit from such power, a company would have to have a consumer monopoly and monopsony hiring power and those two are Venn diagrams that don't overlap much.  As I wrote before (excerpt from a much longer piece)

Let’s consider a company paying minimum wage to most of its employees.  At least at current minimum wage levels, minimum wage employees will likely be in low-skill positions, ones that require little beyond a high school education.  Almost by definition, firms that depend on low-skill workers to deliver their product or service have difficulty establishing barriers to competition. One can’t be doing anything particularly tricky or hard to copy relying on workers with limited skills. As soon as one firm demonstrates there is money to be made using low-skill workers in a certain way, it is far too easy to copy that model.    As a result, most businesses that hire low-skill workers will have had their margins competed down to the lowest tolerable level.  Firms that rely mainly on low-skill workers almost all have single digit profit margins probably averaging around 5% of revenues (for comparison, last year Microsoft had a pre-tax net income margin of over 23%).

If there were some margin windfall to be obtained from labor market power that allowed a company to hire people for far less than their labor was worth to it, and thus earn well above this lowest tolerable margin,  new companies would try to enter the market, probably by lowering prices to consumers using some of that labor premium.  Eventually, even if the monopsony premium exists, it is given away to consumers in the form of lower prices.  If the wholesale price of gasoline suddenly falls sharply, gasoline retailers don't get to earn a much higher margin, at least not for very long.  Competition quickly causes the retailer's lowered costs to be passed on to consumers in the form of lower retail prices.  The same goes for any lowering of labor costs due to monopsony power  -- if such a windfall exists, it is quickly passed on to consumers.

As a result, the least likely response to increasing labor costs due to regulation is that such costs will be offset out of profits, because for most of these firms, profits have already been competed down to the minimum necessary to cover capital investment and the minimum returns to keep owners interested in the business.

I have not read the CBO report.  Interestingly, apparently both Kevin Drum and CNBC have and they summarize the findings differently -- not just draw ideologically different conclusions but report the key data differently.  I have not made any attempt to reconcile this (my guess is that Drum has picked the most optimistic case).  But I will take this from Kevin Drum's version:

• Total wages for workers would rise by $44 billion (accounting for both higher wages and increased joblessness). Income for business owners would fall $14 billion.
• Consumers would pay higher prices amounting to a total of $39 billion. That’s an increase of about 0.3 percent.

You can see that the CBO obviously does not buy the progressive argument about excess corporate profits.  90% of the wage increase is paid for by consumers in the form of higher prices.  My bet is that most of the business income loss is not margin compression as much as lost sales due to higher prices.  Note also the inefficiency of the minimum wage even in these optimistic numbers -- consumers and businesses contribute $53 billion in value to increase wages by $44 billion.  The rest is a net loss to the economy and my bet is that these numbers underestimate this loss.

The other problem with minimum wage increases as an anti-poverty program is that people are in the bottom 20 percentile of earnings mostly due to insufficient work hours, not due to wage rates.  It turns out that increasing the wage rates of the poorest 20% to middle class levels yields $6,335 a year in gains for a person in the poorest 20% while increasing that same poor person's amount of work done to middle class levels yields $28,844 a year in gains (government data here).  If you want to help poor people, economic growth and reducing barriers to hiring low-skill workers (combined with efficient transfer programs) is the way to go -- in this context the minimum wage increase can actually be counter-productive.

One other reason minimum wage increases are a bad anti-poverty program is that most of the data I have seen points to about a third of minimum wage jobs held by earners in families below the poverty line. So 2/3 of the increased wages from a minimum wage increase go to non-poor households

Last summer I had the cover story in Regulation Magazine titled, "How Labor Regulation Harms Unskilled Workers." I fear we are heading to a European model of very high minimum costs of employing anyone, which tends to result in a two-tier system of well-paying jobs for skilled and educated employees and lifetime government relief for the unskilled and under-educated.