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President’s proposal to raise the minimum wage sounds good, but could there be unintended consequences?

A few weeks ago, while many in south Louisiana were celebrating Mardi Gras, President Obama delivered his State of the Union address to the Congress and to the nation.  In it, he not only remarked about where he thought we were as a nation, but also, where he wanted to lead us in several areas.  One policy he mentioned was to increase the federal minimum wage from its current $7.25 to $9.00 per hour over the next three years (listen to a National Public Radio Discussion of the minimum wage proposal here).

While this sounds like a good idea, could there be a downside?

The French economist and writer, Frederick Bastiat, the namesake for this blog, noted in a famous essay of his, “What is seen and what is not seen,”

In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

What is “not seen” are the unintended consequences.

Another way of thinking about this is that we need to be thoughtful and good “positive” economists and not just “normative” economists.

Raising the minimum wage puts a higher floor on wages, raising the price for labor while not raising the value to the employers, the demanders of labor, or reducing the supply of labor.  It changes the price while not changing the values, the demand or the supply.

Employers especially retailers, when faced with a higher minimum wage, cut the hours of their operations as some time periods that used to bring in more money than the cost of those operations in those periods as labor costs rise.  Employers also shift to substitutes for low-skilled workers, such as more productive and better paid workers.  At the same time, a higher minimum wage brings more people into the labor market.   Raising the minimum wage, then, pushes down the amount of labor demanded while it increases the amount of labor supplied, causing a surplus, or a glut of low-skilled, low-educated, and mostly younger workers.  A glut of workers also goes by the name, “unemployment.”

Higher minimum wages also make going to work seem relatively more attractive than staying in a boring high school, leading to more drop outs.  With higher unemployment due to the minimum wage, it is harder to accumulate job experience.  Even though there is a limited “training” minimum  wage, that training minimum wage goes up when the minimum wage goes up.  With it more expensive to train workers, employers do less on-the-job training.  The very things that make a person more in demand as a worker, more education, more job experience and more on-the-job training, are all reduced, so some people may get higher wages, but now they will have greater trouble moving beyond minimum wage.

The minimum wage also increases racial and other discrimination in the workplace.  Suppose there is no minimum wage, or it is below the equilibrium wage.  Then, only the most temporary unemployment exists and the number looking for jobs just matches the number of jobs.  In that case, if a racist employer refuses to hire certain qualified (for the job) workers just because of their race, ethnicity or sexual orientation, he would either have to pay more for his “kind of workers,” or he would have to leave some jobs unfilled, because there just aren’t enough workers applying for his jobs.  So, with no meaningful minimum wage, a racist employer would find that there are high costs consequences to behaving in a racist manner in the job market.

But what happens when the minimum wage is raised above the equilibrium level, when unemployment begins to hit the low-skilled, low-educated, younger workers?  When there are more and more people to pick from for only a few jobs, an employer with racist tendencies can behave like a racist, hiring only his preferred type of worker, reducing the “marginal cost” of racist employment practices, increasing racist hiring.

Racial discrimination in hiring increases in another way as well, in the form of “unintentional discrimination.”  Here is what happens.  When the minimum wage is high enough to cause unemployment in the way described above, young workers with few skills and who have not completed high school find it very difficult to find jobs.  In these cases, the workers with good connections, what some call “social capital,” perhaps parents with friends of employers, find it easier to get a job than those who have few such connections.   “Who you know” becomes more and more valuable.  This also reduces the incentive to acquire as much “what you know,” making increases in pay beyond minimum wage even more difficult.

In the NPR discussion mentioned above, Kevin Hassett suggests that the minimum wage, while a poor way to help the poor, is a way that does not involve raising government spending or reducing taxes.  What we should notice is that there is a somewhat public purpose to raising the minimum wage, but the cost of doing so, higher unemployment of some, higher prices for consumers, lower profits for job creators, are really hidden taxes.

Perhaps, if we want to help the poor, we should do so in a manner that the costs of doing so are transparent and not so hidden.  Hiding the costs of collective action is just not ethical.  There are other ways of helping the poor that might just work better, as Hassett suggested in the NPR discussion above.

-MC

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