Recognize the costs of increasing minimum wage

The harder we make it for young people to get on the first rung of the job ladder, the harder it will be to move up.

By IKE BRANNON | April 8, 2015

A productive dialog about poverty in America must recognize the need for transparency about policies aimed at addressing the issue. Milwaukee’s Public Policy Institute seems to do the opposite by appealing to the conclusions of a “sophisticated microeconometric model” when describing how the fiscal reform plan it has concocted will reduce poverty in America by 50%.

To do that would be a gargantuan achievement, almost unprecedented in American history and worthy of support even at a price tag twice as high as the one the institute reports. Unfortunately, its promises exceed reality – or any economic consensus – and skip over details that many economists would disagree with.

For instance, a minimum wage increase would have two contradictory effects on poverty: For those who keep their jobs, it would improve their lot, but some workers at or near the minimum wage would lose their jobs. This represents a fundamental truth about minimum wage: We face a trade-off that pits gains for some against job loss for others.

Trying to figure out why the Public Policy Institute’s model allows it to avoid this trade-off is difficult, and the authors’ analysis seems to dismiss it. They state that the effect is "uncertain" and cite a report by the Urban Institute that looks solely at the minimum wage in Washington, D.C., where wages and labor demand are much higher and economic conditions much better. But that piece doesn't try to estimate the impact of a higher minimum wage on employment; it merely teases out an implied statistic from a 2014 Congressional Budget Office study that says a 10% increase in the minimum wage would result in a 1% drop in employment.

It's a reasonable estimate, but research shows that even recognizing this trade-off isn’t enough when considering minimum wage policy; labor markets are vastly different across the country and even across Wisconsin.

Andrew Hanson, a Marquette University associate professor of economics, and I examined each labor market in Wisconsin in a 2014 study for the Wisconsin Policy Research Institute (and elsewhere for all 50 states in The Journal for Labor Research) to look at where low-income workers tend to dominate and estimate the impact of a minimum wage increase across these areas. That allows us to avoid imposing a single metric on a population for which it is not well-suited.

There's another long-term cost that minimum-wage defenders ignore: The harder we make it for young people to get on the first rung of the job ladder, the harder it will be to move up. What a 17-year-old gets from his 15 hours a week at McDonald’s isn't just a paycheck but a lesson about showing up on time, dressing up for a job interview, getting along with co-workers and that going to school to improve job prospects is probably a good idea.

This takes us to a more fundamental truth about economics: Beware of studies that are long on outcomes from models and short on explaining what assumptions they make. If someone begins by assuming that the minimum wage scarcely matters to employment, then raising the wage obviously is going to boost incomes and reduce poverty with no downside. It is incumbent on authors of such a study to explain why they choose to brush aside careful empirical studies that estimate job loss from raising the minimum wage by simply stating that the effects are “uncertain” and then assuming that they're not uncertain but nonexistent.

I agree with some of the solutions proposed by the Public Policy Institute, most notably an expansion of the Earned Income Tax Credit. The political attractiveness to boosting the minimum wage instead of expanding the EITC is that the minimum wage doesn't cost governments or taxpayers anything, at least in terms of a line item in a budget. But this ignores the larger social costs from displacing some of the very workers it is aimed at helping.

Economic growth also reduces poverty. The recent increase in starting wages by Wal-Mart, the Gap and McDonald’s is not a reflection of some sudden magnanimity by those corporations but a realization that nearly six years of economic growth – albeit somewhat uneven – have helped to erode the pool of the unemployed and now these companies need to compete for workers. Doing more to encourage economic growth – whether it be tax reform, improving schools or boosting investment in infrastructure – would help the poor find and keep jobs.

A discussion that recognizes a mix of policies directly aimed at poverty reduction and those aimed at increasing economic growth should be the starting point for how to solve both Wisconsin and America’s poverty problem.

Ike Brannon, PhD, is president of Capital Policy Analytics in Washington, D.C., and a senior fellow at the George W. Bush Institute. This column represents his personal opinion.