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Monday, August 5, 2013

Breaking the Law of Demand

Krueger and Card’s New Minimum-Wage Theory After 20 Years

For several decades after World War II, there was a big division between professional opinions and public opinions about the minimum wage. Back then, nearly all professional economists agreed that minimum-wage laws cause unemployment among low-productivity workers. But minimum-wage laws remained popular with the general public, and consequently with most politicians. Today, the consensus among professional economists isn’t as clear.

President Obama recently proposed an increase in the minimum wage, to $10.10. How does the administration justify it?

A little over 20 years ago, Alan Krueger and David Card published a study that appeared to justify minimum-wage laws. According the Krueger-Card theory, raising the minimum wage will not cause significant job losses, and may actually lead to increased employment of low-productivity workers. Krueger and Card supposedly invalidated the laws of economics, particularly the law of demand.

How did they perform this miracle? New Jersey raised its minimum wage over 20 years ago. Pennsylvania did not change its minimum wage law at that time. Krueger and Card carried out a phone survey of fast-food places and found that the number of fast-food workers in the Princeton area had gone up relative to the Philadelphia area.

Politicians, unsurprisingly, embraced the study immediately, both for political and ideological reasons. It received significant media attention when it was published, and supporters of minimum-wage laws considered the study a definitive refutation of the old professional consensus against minimum wages. They not only used it to justify President Clinton’s efforts to raise the minimum wage, but Krueger eventually became President Obama’s chairman of the Council of Economic Advisors. And yet Krueger himself urged caution regarding increases in the minimum wage.

Had the law of demand been repealed?  Could lawmakers successfully control the price of labor without perverse effects like layoffs, substituted labor, or reduced hiring?



Subsequent review of the 20-year-old study suggests caution doesn’t go nearly far enough. Indeed, careful analysis has overturned the conclusions of the Krueger-Card survey, suggesting that the entire episode was a mistake.

First, to interpret the Kruger-Card study as proof that economists had been wrong for all those years was an unreasonable interpretation. Decades of separate empirical research indicate that minimum wages increase unemployment, especially among teenagers. While it is technically possible for one study to be right, and many others to be wrong, this outcome is highly unlikely. Anomalies do turn up in empirical studies from time to time. But the Krueger-Card study at best showed short-run effects limited to the Princeton area. Those who already believed in minimum-wage laws, however, accepted it uncritically.

Second, the Krueger-Card study in particular has serious defects. Krueger and Card counted the number of employees, not the total hours worked by employees. David Neumark and William Wascher examined written records of the number of hours worked in New Jersey and Pennsylvania restaurants and found that the New Jersey minimum wage increase reduced labor demand by 4 percent.

Saul Hoffman and Diane Trace examined the employment of low-productivity workers in New Jersey and Pennsylvania during the late 1990s. They found that the federal minimum wage increase of 1996–1997, which eliminated the difference between the two states’ minimum wages, reduced the employment of low-productivity workers in Pennsylvania, especially among high school dropouts. The Hoffman-Trace study examined more evidence over broader areas than Krueger-Card, and over more time. Once again, a superior study yielded the usual conclusion: minimum wages are bad policy.

Third, employment in the Philadelphia-area fast-food industry appears to have been trending downward, relative to New Jersey, anyway (see J. Angrist and J. Piscke, Mostly Harmless Econometrics, p. 231). Thus, any evidence of relative decline in employment of fast-food workers around Philadelphia after the New Jersey minimum-wage increase is coincidental.

Fourth, the gung-ho pursuit of higher minimum wages contradicts what Krueger and Card both said about the law of demand in labor markets. In one interview, Card stated,

There are frictions in the market and some imperfect information. It doesn’t mean that if we raised the minimum wage to $20 an hour we wouldn’t have massive problems, if we enforced it … economists who objected to our work were upset by the thought that we were giving free rein to people who wanted to set wages everywhere at any possible level. And that wasn’t at all the spirit of what we actually said. In fact, nowhere in the book or in other writing did I ever propose raising the minimum wage.

Card also stated that “Realistically, of course, the U.S. is never going to enforce a draconian minimum wage.” Card made this statement long before recent calls for a draconian doubling of the federal minimum wage in the McDonald’s sector of labor markets. The reality that we face is that minimum wages will reach draconian $15–$20 levels unless people who understand the law of demand resist pressure for higher minimum wages.

Does Obama’s economic advisor approve of President Obama’s “modest” proposal of $10.10 per hour?

In a PBS interview, Alan Krueger claimed that a small increase in the minimum wage would not affect employment adversely, but a large increase would. Krueger thinks that there are tipping points in labor markets (so do I). However, unlike Krueger, I don’t see this tipping-point theory as only a theory.


Black Teens and Dropouts

Over the past decade, the teen unemployment rate has ranged from a low of 12.7 percent (April 2006) to a high of 27.6 percent (October 2009), and it has been over 20 percent since March 2009. The unemployment rate among black teens has ranged from 23.5 percent (December 2005) to 48.6 percent (September 2010). The latest figures for July 2013 show a black teen unemployment rate of 41.6 percent. These figures do not count teens who gave up and dropped out of the labor force entirely. Since unemployment rates among teens are always in the double digits, it would seem clear that minimum wages went beyond a tipping point long ago. There is similar evidence regarding high-school dropouts. Over the past decade, their annual unemployment rate has ranged from 6.8 percent (2006) to 14.8 percent (2010). The average unemployment rate for dropouts over the past decade was 11.3 percent. Total repeal of minimum-wage laws would put U.S. labor markets on the right side of the employment tipping point.

President Obama claims that higher minimum wages are “good for the economy” because higher incomes translate into higher consumer demand. Minimum wages transfer a small amount of income from business owners to employees, while at the same time encouraging owners to hire fewer workers or give them fewer hours. The laws end up reducing the incomes of those workers.


Labor Pains

Krueger and Card, along with a few other economists, attempted to carve out an intermediate position on minimum wages. They suggested that cautious experimentation with small minimum wage increases could increase wages for some without decreasing employment. All they really showed was that politicians will misinterpret and misuse research that tells them what voters want to hear. Minimum-wage laws have failed to help the people whom these laws were supposed to help. Those who truly want to help lower-income Americans should press for the repeal of these laws.

  • D. W. MacKenzie is an assistant professor of economics at Dickinson College.