Is California crazy for cranking up its minimum wage?

logoA Q&A with Michael Strain from AEI

032916-Minimum wageEarlier this week Californian legislators reached a “landmark deal” to become the first state to proceed with a $15 minimum wage, the fifteenth to initiate minimum wage increases this year. While some California municipalities had already moved in this direction, this measure would mean a raise for one in three California workers. And in some low-wage areas still struggling post-recession, it would mean a raise for one in two workers. But in the country’s most populous state – where the economic recovery has been almost completely a product of Silicon Valley – many fear this massive experiment will devastate already weak sectors and the general business climate, and mean major job losses for those who need jobs most.

To figure out just what the prognosis is for California, I talked with my AEI colleague Michael R. Strain. Take a listen to the podcast over at Ricochet, and read some edited bits of our conversation below.

PETHOKOUKIS: Governor Jerry Brown of California has said they’ve reached a deal. They’re going to state the state’s minimum wage, that I think is at 10 and take that to 15 over the next few years. Certainly I think there’s no other state that has a $15 minimum wage. Is that – what can we say or what know about such a big jump in the minimum wage and how that will affect workers?

STRAIN: Well, I think that depends on your epistemology, obviously. We know very little for sure. I think we can be quite confident, having said that, that a $15 an hour minimum wage, even in a state like California, will result in a lot of harm to lower skilled workers. There will be benefits also. Surely, there will be a lot of workers in California who will see their incomes rise and, you know, that’s certainly a good thing. But make no mistake that the most reasonable forecast, I think, will find that, you know, there will be quite a bit of cost to this policy as well.

What would you guess those costs will be and sort of how severe will those costs be? I doubt there are few subjects, policy subjects in economics, which have been so thoroughly and continually studied as the minimum wage. What do you think the effects will be? Who will it help? Who is this supposed to help and who will it probably help?

So I actually think that that’s the right question and I think that you’re right that there are competing narratives out there. So perhaps the appropriate place to start is with the research.

“I think a lot of the debate in policy circles is ill-defined because people are talking about different things.”

And the research findings about the employment effects of minimum wages certainly are mixed. Some studies show that if you increase the minimum wage, you have reductions in employment that are worth worrying about, and other studies reach opposite conclusions. That academic debate is mostly about the statistical methodology that’s used to estimate the employment effects of minimum wages and that’s something that the academic literature is working through. It also matters what data you use to estimate them. That’s less of a source of academic debate.

But that’s where that comes from. And then, the policy debate takes the findings from the research and attempts to, you know, use those findings to help inform policy, which is how it should be. I think a lot of the debate in policy circles is ill-defined because people are talking about different things.

And so if your goal is to put more money in the pockets of the bottom half, let’s say, of households by income, then the minimum wage is a reasonable policy and you see people saying, look, you raise the minimum wage and it will put billions and billions and billions of dollars into the pockets of workers and it will help millions of households, and that’s a good thing. And, yes, there will be job loss but, say, for example, we take the minimum wage to $10 an hour [for] the federal minimum, several hundred thousand people will likely lose their jobs, but a whole lot of people will see an increase in their incomes and that’s a trade-off worth making. But, implicit in that argument is that the goal of raising the minimum wage is to help the bottom half of households by incomes.

If instead your goal is to help the working poor, then the minimum wage is a much less defensible policy, both because the costs to workers of raising the minimum wages will be borne disproportionately by lower skilled, lower income workers. And because there are such better tools to help the working poor than the minimum wage.

And so I think a lot of the debate actually is about first principles and less about what it seems superficially.

So why isn’t it a well-targeted policy fix for the working poor as opposed to a household which is just below like the median household by income?

Well, it’s not well targeted because of the structure of the program. So the minimum wage applies to hourly wage workers regardless of the overall income of the household in which those workers live. So a single mom with two kids at home qualifies for the minimum wage. At the same time, the teenage daughter of parents who earn a six-figure income qualifies for the minimum wage. And so what you’re doing is you’re increasing the minimum price that firms can pay for an hour of labor. And it’s simply a matter of fact that those benefits are distributed throughout the income distribution.

Again, if you look at raising the federal minimum wage to about $10, the overwhelming majority of the benefits — say something like 80% of the extra income that people would receive from the minimum wage increase — goes to households above the poverty line, with incomes above the poverty line because the minimum wage goes to everybody and not just to people who live in poor households.

Now, we’ve had some cities which have raised the minimum wage. I think Seattle is in the process of a rather large increase. We’ve already seen a minimum wage increase in Los Angeles. Do we have any good data on how those minimum wage increases have affected workers?

Well, so in those cases, we’re talking about minimum wages that apply to cities, which isa new policy design and it’s a policy design that has some interesting economics and we don’t really know what will happen in that case.

“I’m very comfortable saying that raising a minimum wage, whether it’s a city’s minimum wage or a state’s minimum wage, or the federal minimum wage, to $15 an hour is a bad idea.”
– Michael R. Strain

There’s an argument for localized minimum wages because wages and prices differ by cities and states, but at the same time if you raise the minimum wage in a city like Seattle, that really puts the working poor who live in Seattle at a disadvantage relative to the suburbs. And so, there are reasons to do it, and there are reasons not to do it. There’s not terribly good data at this point about how any of those experiments are playing out. A lot of those policies phase in the minimum wage so they’re not even at $15 an hour yet. And, you know, it just takes a while. To really understand what’s happening, we’ll need at least a few years of data to how that policy affected employment in those areas.

So you would caution against looking at any kind of early information or early data and then trying to draw sweeping conclusions?

I’m very comfortable saying that raising a minimum wage, whether it’s a city’s minimum wage or a state’s minimum wage, or the federal minimum wage to $15 an hour, is a bad idea.

Even over an extended period of time?

Yeah. Even –

The state wage in California, it doesn’t hit $15 for about five years, 2022, so it’s not tomorrow.

Even over that time period, I’m still very comfortable saying that that’s a very bad idea. And the reason I think that is not heavily informed by any of the kind of early data we’ve seen from Seattle or anything like that, but instead, it’s informed by economic theory. It’s informed by the existing research on other minimum wages. And I think we know enough from those two sources to be able to conclude that this is not a policy event that we should enacting.

Are there any policy lessons that we can draw from overseas, from other countries which might have much higher minimum wages than the US has? And on how that affects their workers? Or  can you even draw those conclusions given labor markets are probably very different even among advanced economies?

I think it’s certainly always a good idea to take a look at all the available evidence and in this case, we certainly should be looking at the experience of other countries, especially Western European nations and Canada, Australia – economies that are similar to ours.

But I do think that there’s a limited amount of information we can learn from those, as you say, because labor markets are very different. $15 an hour is so far outside of our experience that I think looking at what’s happening in other countries really is of limited value.

I think it’s important to keep in mind the underpinnings of all the policy debate, which is at least in some part the academic research. And, the research can give you an idea of what to expect from a marginal increase in the minimum wage, and then you can use those estimates to try and figure out what would happen with proposed minimum wage increases. We’re not talking about a marginal increase in the minimum wage here. We’re talking about really, really large minimum wage increases.

And we’re not talking about minimum wage increases that will lift the pay of very low-skilled workers. If we’re going up to $15, that’s going to hit a lot of workers throughout the income distribution. It’s going to hit a lot of workers with middle skills in addition to lower skilled workers. And so this really is pretty far outside the experience that we’ve had previously, which means that it’s pretty far outside of what we’ve been able to study, which makes it not the most responsible policy move.

So to use your example from earlier, kind of a classic example, single mom working what you call a low-wage job and you want to help that family: Would you raise the minimum wage at all? What is your sort of alternate policy proposal that you think would best raise their living standards, give them more money, raise their incomes?

Well, I would raise their incomes by expanding the Earned Income Tax Credit for them or by enacting a similar earning subsidy. That doesn’t increase their labor market earnings, but it does increase the amount of money that flows into their bank account every month. You know, if you think about the minimum wage, we know that the minimum wage goes up and we know that most of that money goes to households that aren’t in poverty. So, we know it’s not a very efficient policy.

“…when the minimum wage goes up, prices go up – retail prices go up. And prices go up among corporations and in industries that lower-wage workers shop at disproportionately.”

We have good reason to be concerned that if you raise the minimum wage, lesser skilled workers are going to see their employment opportunities diminished. Maybe, some people would disagree with that, but I certainly think it’s a reasonable concern whether you think it would have that or not. There’s evidence that’s very strong that when the minimum wage goes up, prices go up – retail prices go up. And prices go up among corporations and in industries that lower-wage workers shop at disproportionately. So, you know, Wal-Mart will raise its prices. McDonalds will raise its prices and that’s going to hit lower-income people harder.

So, you’re taking more money out of their pocket through higher prices. You’re probably diminishing their employment opportunities — or at least that’s something to be concerned about. And the policy is putting money in people’s pockets most of whom are not poor.

There seems to be less dispute about the impacts from the Earned Income Tax Credit. The response often is, “You’re talking about some sort of wage subsidy. Isn’t what you’re really subsidizing is a certain kind of business model from companies that count on low-wage workers? And, therefore, since you’re subsidizing them, you allow them to continue to pay a very low wage to these workers instead of raising their wages? So this is really the Wal-Mart subsidy plan.” How do you respond to that?

So I think that’s not accurate. I think it misunderstands where wages come from. I mean, look, fundamentally, we have a skills problem in the United States. And, when you’re talking about wages, you have to be thinking about skills and productivity.

It might be nice if employers would pay a worker $15 an hour when that worker is only producing $10 an hour in goods and services, when that worker is only bringing in $10 an hour in revenue. But in that world, a business is losing $5 for every hour the worker works. And, you know, that’s just not something that businesses are going to do. And, maybe we wish they would and maybe we think there are good reasons that they would, but that’s just not a realistic goal to have.

And so, when you push that wage floor up,  you’re really putting workers who are only able to bring in $10 an hour in revenue at a disadvantage. And so, that worker cannot work and that worker’s children can be very low income and the taxpayer picks up a lot of the responsibility there — or that worker can work for $9, $10 an hour but that worker can receive a wage subsidy from the government to make sure that, because that worker is working hard and putting in a day, that the worker isn’t in poverty, the worker’s children aren’t in poverty. I think that’s really a better way to think about it.

“Businesses don’t want to lose money on their work forces. Businesses want to make money on their work forces.”

I went on Twitter before the podcast and I asked people for their questions. One question: Why aren’t corporations that have many customers on minimum wage pushing to raise the minimum wage nationally? I guess the theory there is if the minimum wage is raised nationally, then you’d have all these customers, maybe they’d have to pay their workers more. But you’d have all these customers making more money who could then spend it at Wal-Mart. What about that logic?

I think it gets back to what I just said. Businesses don’t want to lose money on their work forces. Businesses want to make money on their work forces. And, we may not like that, but that is the reality of it. And, we’re looking at the possibility that technology will continue to be able to replace workers and at a world where workers with lesser skills have been hit pretty hard. There’s not a lot of reason to think that that’s going to get terribly better. And, fundamentally, I think we have to ask ourselves: do we want to raise the price of hiring those workers right now or not? And I think, it doesn’t make the most sense.

The fact that we have minimum wage as low as what it is, does that lead to an economy that depends too much on low-skilled workers and not enough on automation?

No. I don’t think so. Again, this is a simplistic – or I should say it’s a simplified understanding of how wages work, but, imagine that we had a minimum wage of $3 an hour and there was a worker who was able to bring in $5 an hour in revenue. A firm would want to hire that worker at $4 and then that firm is making $1 off every hour of work. And the firm down the street says, I want to hire that person for $4.50. I’ll make fifty cents and lures that person away. And so the market will bid up wages to the point where workers are getting paid for the amount of revenue they bring in.

And so a minimum wage can be established as the floor, but if a worker can say to their firm, “hey, I can get more money down the street, this business wants to hire me, so you’re paying me minimum wage but they’ll pay me above minimum wage,”  then the worker will either be able to do that or the firm will want to match the worker’s offer if the firm thinks that the worker is worth that.

It’s not to say that firms say, oh, this is the minimum wage, I’m going to pay the minimum wage and then workers say, oh, OK, that’s the most I could get. Certainly there are issues of bargaining power that need to be brought into the conversation and that is a simplified understanding of the way the wages work. But it’s a good simplification because it helps to highlight what most likely is the fundamental process at work.

So if we left the minimum wage at $7.25 and none of these states increased their minimum wages and workers grew more productive, we would expect to see their wages go up. And if workers stayed at the same level of productivity, we would expect to see wages stay the same, and that’s the right way to think about it as a first pass.

So you would not want to take a risk on dramatically raising the minimum wage, clearing out all lowish-income jobs, replace them all with kiosks and iPads at restaurants? So then you would have those jobs and those people could then go find new skills, and we’d end up with a much more productive economy because we’d have more high-skilled people, more high-wage jobs, fewer low-skilled jobs — more automation but then a higher caliber of job. 

I don’t think we should be putting our thumb on the scale for the robots. I think the robots are going to be able to handle that themselves.

Here’s another Twitter question: What outcome would allow California’s minimum wage experiment, the $15-an-hour minimum wage experiment, to be judged a success in X number of years? 

If we saw, you know, minimal job losses, if we saw minimal exit of workers to neighboring states, if we saw increases in productivity, if we saw firms treating workers better because they’re paying them more money and if we saw that really a lot of this money – the wage increase– was actually kept with workers anddidn’t just result in price inflation, then I think we would have quite a bit to think about and I’d be open to revaluating my view on some of this stuff.

That’s not very likely. There’s a reasonable consensus that if you double the minimum wage or take it from $10 to $15, you’re going to see some pretty significant job losses.

And so I think, again, the argument will likely come down to goals. If there’s not some catastrophe, then I think the argument will come down to whether or not you want to help the working poor or you want to help the bottom half or the bottom two-thirds of the earning distribution. I think we’ll see the cost of this policy borne by the working poor and the benefits enjoyed by households that are pretty close to the middle class if not in the middle class.

And that’s the debate about what the goal of the policy should be and how we want to distribute the fruits of the economy, but my concern is with the working poor and I think this is going to be a pretty bad deal for the working poor.

Would you raise the minimum wage at all? Would your raise it, maybe indexed to inflation, and then combine it with a higher earned income tax credit? Would you get rid of the minimum wage and do it all through wage subsidies? What would be your preferred policy to help the working poor, as you put it?

Well, I think these policies are often contingent on external factors and I think it’s important not to go too wild in either direction. So, given where the labor market is right now, given the challenges that we’re already facing lesser-skilled, lower-income workers, given the challenges that are facing the poor and the working poor, I would not raise the minimum wage. And I would increase the Earned Income Tax Credit.

Now, you know, it’s possible that 10 years from now, the situation in the economy will be different. It is reasonable for economists to argue for modest increases in the minimum wage periodically but we’re not talking about a modest increase. And we’re talking about an increase that would take place in a labor market that’s not terribly friendly right now to lower-income workers. So given where we are right now, I certainly would not raise the minimum wage. And if I were to raise the minimum wage, I certainly would not raise it to $15 an hour.

$15 an hour is one thing in California. It’s one thing in Manhattan. It’s, you know, quite another thing in Keokuk, Iowa.

I’ll take your word for that.

You were talking about having a localized minimum wage and that what might be an extraordinarily high minimum wage in some places, it’s less so even in California, which is broadly is a higher-wage state. It makes for a catchy slogan, “fight for $15.” But there’s not a lot of research saying, yes, you can bump it up that high and there will be minimal negative effects.

That’s right.

We talked about helping low-wage workers, but then there’s that other group you mentioned, people who are not quite the working poor. They’re better off. How do you help them if the EITC iS really more for the working poor? What about those people who are that next income level up? How would you boost their incomes?

“…the higher up the income ladder you go, the nature of problems changes…there’s really no need for the government to take other people’s money and help you.”

Well, the higher up the income ladder you go, the nature of problems changes. And I think you reach a point where there’s really no need for the government to take other people’s money and help you. I don’t think anybody would argue if you’re making $10 million a year that you should be getting assistance from the government.

So I think as you move into the middle class, certainly wages and income are a concern, but I think the education of your children is a concern. I think health care expenses are a concern. I think higher education – if you aspire to send your children to college if your children aspire to go to college — I think that becomes a concern.

And so I think we need creative policy proposals to address those middle class concerns where wages and incomes are an issue but they’re not nearly as big of an issue as they are for the working poor.

Last question, and we’re almost out of time: Why is the minimum wage the go-to policy that people on the left talk about When talking about low-income workers, rather than the EITC?  I know there’s plenty of people who want the EITC to be expanded, too, but it doesn’t seem to have quite the same oomph on the left as raising the minimum wage. 

I think it’s really a good question. I think there are political reasons. You know, the overwhelming majority of the American people support raising the minimum wage and that makes it a politically salient issue.

I think the minimum wage appeals to people’s basic sense of fairness that if somebody is going in and putting a day and working hard working week after week that they should be earning than $14,000 or $15,000 a year, especially at a time of growing income inequality and a time when there are people in our society that who are making really extravagant amounts of money – eight-figure salaries, things of that nature. And so it appeals to people’s basic sense of fairness, which is completely understandable, and that makes it an issue that people want to mobilize around.

I think economically, it doesn’t impact the budget deficit. You know, this does not require government money. The EITC requires an increase in revenue, an increase in spending depending on how you want to count it.

It seems like a free lunch for politicians.

It seems like a free lunch for politicians because they don’t have to pay for it and that makes it appealing as well.

James Pethokoukis is a columnist at the American Enterprise Institute. Previously, he was the Washington columnist for Reuters Breakingviews, the opinion and commentary wing of Thomson Reuters. James Pethokoukis was the business editor and economics columnist for U.S. News & World Report from 1997 to 2008. He has written for many publications, including The New York Times, The Weekly Standard, Commentary, National Review, The Washington Examiner, USA Today and Investor’s Business Daily.

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