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Saturday, November 1, 1997

The Minimum Wage

The Minimum Wage Hurts Those Whom It Is Intended to Most Help

Mr. Sohr is a student, and Dr. Block a former professor, at the College of the Holy Cross in Worcester, Massachusetts. Dr. Block is now chair of the department of economics and finance at the University of Central Arkansas.

The second stage of the minimum-wage increase approved by Congress last year recently took effect. What will the impact be on the economy and particularly on unskilled workers? Economists have long argued that minimum wage increases cut employment, particularly of minorities and teenagers. But supporters of the minimum wage, now backed by some economists, claim that government-legislated wage hikes do not necessarily lead to less employment, and may even create more jobs for the unskilled. So does the minimum wage benefit or injure workers?

Traditionally economists have maintained that the free market establishes the wages for all workers so that they receive the value of their output. If Sam is earning $2 an hour while generating $2.50 worth of goods and services for Firm X, then Firm Y would have an incentive to offer Sam $2.01 per hour. Firm X would then counter with $2.02 and the cycle would continue until Sam was paid $2.50 an hour. No firm would bid higher because he was simply not worth it. What happens when the minimum wage is set by law at $3.00? According to classical economists, Sam will lose his job.

But David Card (now at the University of California, Berkeley) and Alan Krueger of Princeton University have challenged the traditional model. In 1992 New Jersey increased its minimum wage while neighboring Pennsylvania held its rate constant. In a study published in 1994 Card and Krueger concluded that employment in New Jersey’s fast-food industry actually rose after the wage hike. In contrast, industry employment fell in Pennsylvania. How can this be? The Card- Krueger study leads us to believe that employers demand more labor as its price rises. Such counterintuitive findings require a deeper look.

The Card-Krueger model’s method of data gathering has been widely questioned. Via phone surveys, the team interviewed managers from 321 fast-food franchises in New Jersey and 78 in Pennsylvania. This is a very small number of firms to use as evidence for such significant findings. Also, the information given by stores may not be accurate. Burger King managers are not statisticians or even bookkeepers; the study should have employed repeat interviews by a second set of researchers.

Moreover, while the law went into effect on April 1, 1992, the interviews regarding the impact of the legislation were conducted between November 5 and December 31 of that year. By using such a limited window, just seven to nine months after the implementation of the law, Card and Krueger did not give the market sufficient time to develop alternatives, such as automation, to low-skilled labor. (Had they conducted interviews on April 1, their results would have shown zero impact.) Milton Friedman rightly argues that “It takes time for firms . . . to shift to ways of doing things which place less reliance on unskilled labor.”

Yet another possible fault with their findings is the actual significance of the minimum- wage increase. At the time of the hike, two-thirds of the restaurants were already paying more than the minimum. In these cases the market had already provided lower-skilled workers with high wages.

Moreover, even if employment did increase in the fast-food industry when the minimum wage rose, this result is still not necessarily good for society. Economists David Neumark and William Wascher have found that an increased minimum wage will decrease the number of teens enrolled in high school and raise the proportion who are unemployed. Why this paradoxical result? The higher minimum encourages more skilled teens to drop out, while making it more likely that those who were already working will lose their jobs.

The dramatic conclusions of the Card-Krueger project contrast sharply with its poor quality. Observes economist Robert Barro: “An annoying feature of the Card-Krueger research is their eagerness to use their findings to discredit the law of demand. . . . It shows extraordinary arrogance to use tenuous empirical evidence . . . to proclaim the first documented case in which demand curves fail to slope down. A more reasonable view is that the demand curve is just fine, and the Card-Krueger empirical analysis needs repairs.”

Moreover, the minimum wage is not an equal opportunity destroyer. Teens in general suffer more from this law than do adults. Each succeeding increase in the minimum wage has negatively impacted teenage unemployment rates. Just as the minimum wage attacks the young more than the old, it also harms blacks more than whites. Observed Milton Friedman more than three decades ago: “Of all the laws on the statute books of this country, I believe the minimum wage law probably does the Negroes the most harm.” Each increase in the minimum wage has been followed by an immediate widening of the unemployment rate gap between black and white teens. Prior to the 1949 increase the two rates were virtually identical; immediately a gap was created. Every subsequent increase led to a dramatic increase in non-white unemployment while the white level stayed relatively stable.

The problem is not racism, but lack of employment skills. Friedman explained that black “youngsters are less productive than white youngsters. They tend to have a lower level of education, a lower level of skill.” This being the case, any given level of mandated wage is likely to trap more black than white youth.

The one advantage low-skilled workers might have over their skilled counterparts is price competition, offering to work for less. But the minimum wage makes such an offer illegal. Thus, the minimum wage hurts those whom it is intended to most help: unskilled laborers.

Given its disastrous consequences, why does the minimum receive so much support? It preys on people’s good intentions. Voters think: Poor people are not making much money. How can we help them? Mandate that their bosses pay more. When a politician opposes an increase, people hear “I want poor people to earn less money.”

The minimum wage keeps rising. The impact will continue to be to hurt poor, young, black, and unskilled workers. Despite the highly publicized study by Card and Krueger, the economic evidence overwhelmingly indicates that the minimum wage destroys jobs.

  • Walter Edward Block is an American economist and anarcho-capitalist theorist who holds the Harold E. Wirth Eminent Scholar Endowed Chair in Economics at the J. A. Butt School of Business at Loyola University New Orleans. He is a member of the FEE Faculty Network.