Morgan Lewis (Virginia Review of Politics): Throughout the 20th and 21st centuries, there has been debate in the US about whether to have a federal minimum wage, and if so, what the wage should be. In 2009, the federal minimum wage was set at $7.25/hour, and just a few weeks ago, eighteen states raised their minimum wage rates. From an economic perspective, what is a minimum wage and what are the effects of implementing one?

William Johnson: That’s a big question: certainly the second part of it is a big question. The minimum wage is just a legal requirement that you pay a certain amount per hour. In the U.S., this started in 1935. It was part of New Deal, Franklin D, Roosevelt legislation called the “Fair Labor Standards Act.” Part of the “Fair Labor Standards Act” was the first national minimum wage. There were some workers who were exempt from it: workers who were considered not to be paid hourly. In the past, there have been groups of occupations that have been exempt, and those have slowly eroded so that the coverage is more complete than it once was. That’s the easy part.

To the second part is about what the economic effects are. I would guess that the minimum wage is one of the most studied policies by economists, and there continues to be work done on the minimum wage, and economists are not agreed about the effects of the minimum wage. The debate has to do with how much a higher minimum wage discourages employers from hiring workers. That’s the most important question. There are lots of other avenues that minimum wages would have effects on, but that’s the crucial question. You could divide economists into two groups: those who think that a higher minimum wage causes less employment of affected workers, and another group who probably would argue that the data don’t show much of an effect at all or, if there is an effect, it’s very, very small. So, that group might argue either, “I don’t think there are any negative effects on employment,” or “I think they’re small and I think the gains in terms of higher incomes for minimum wage workers outweigh the losses in terms of small disemployment effects. It’s a well-studied question and not a question that economists totally agree on. I think part of the division of opinion about the value of minimum wages is not only a debate about the science of the actual effects, but differences in people’s opinions about the value of raising low-income workers’ incomes. 

VRoP: There are some proponents of the minimum wage who argue that there is a strong multiplier effect to raising the minimum wage and that this increased consumption would stimulate the economy. Do you agree with this argument? Why or why not?

WJ: Well, I think that’s related to this “broken windows” idea. This gets us into the realm of macroeconomics, specifically Keynesian macroeconomics. I have to admit that most of the defenses of the minimum wage don’t rely on their macroeconomic effects. I think the story you have in mind is something like: “Low-wage workers are liable to spend everything they get or almost everything they get in terms of wages. So, if you do something that basically transfers income from people who are less likely to spend all of it to people who are more likely to spend all of it, there will be more consumption spending, and that’s stimulative to the economy.” It’s an old-fashioned, Keynesian argument. You still hear it made for certain policies, but I think even the strongest Keynesian would say that it isn’t really applicable when we’re essentially at full employment, and right now we’re essentially at full employment. It might be a stronger argument at an unemployment rate of 11 or 12%, but frankly, the strongest arguments in support of the minimum wage is an income redistribution argument rather than a macroeconomic argument.

VRoP: You touched on this a bit already, but nineteenth century French economist Frederic Bastiat famously described a common type of economic fallacy with the illustration of a broken window scenario. In this scenario, a boy breaks a shopkeeper's window, and the on-looking crowd rejoices that the broken window will allow work for the glazier. Would you please explain the broken window fallacy, which says that acts of destruction create opportunity for economic benefit. 

WJ: This gets back to Keynesian economics. Remember, Keynes was writing during the Depression, when we had unemployment rates of 25%, so there were a lot of unused resources: workers out of work, factories closed down, etc. Keynes made the argument in his most famous work, The General Theory, that it might be worth it for the government to take currency, to take $10 bills, put them in jars, hire people to dig deep holes, put the jars at the bottom of the holes, and then cover them up and let other people dig up the jars to get at the money. You could give someone $10 a lot more easily than burying it in the ground and having someone dig it up. That’s the waste in the broken windows fallacy. But, Keynes’ argument was that, in a depression economy, where we have a lot of idle resources, we need to stimulate demand. This would be one way of stimulating demand: people would want to hire workers to dig those $10 bills out of the ground even though it’s a totally wasteful exercise from society’s point of view. It doesn’t add to our goods and services. The same goes for the broken window fallacy. A broken window is bad, not good. World War II was bad. It was wasting resources on things that don’t increase consumption, but it did have a stimulative effect in a Keynesian, high-unemployment economy. So, I think the debate about this fallacy is really a debate about whether we’re in the Keynesian world where markets really don’t seem to be bringing us to full employment and therefore, even crazy sounding activities may be beneficial or whether we are in a full-employment economy where it is obviously wasteful to break windows or to bury $10 bills in the ground.

VRoP: You talked about inefficiency and waste from digging up the jars with the $10 bills. Is there any inefficiency and waste like this generated by the minimum wage?

WJ: There is a waste in any kind of restriction on prices or wages. It’s not a waste that involves a depression scenario. It’s a waste that involves the misallocation of resources. Part of that waste is something that is involved with the disemployment effect of minimum wages. If the market wage for a certain category of workers is $7, and we impose a $10 minimum wage, then employers are going to hire fewer of those workers. Maybe there will be a little more supply of workers willing to work, so we’ll have a gap between quantity supplied and quantity demanded. That waste is the kind of inefficiency some economists would emphasize in the minimum wage

VRoP: When we look at the group of minimum wage earners, what percentage of this group is trying to support a family on these wages?

WJ: Well, that’s a good question, and I tried to look that up. It’s harder to answer that question than you might think. One general proposition about minimum wage workers is that there are at least some who are not in particularly low-income households, such as teenagers in a household with parents who make more than the minimum wage. The flipside of that is that there are a lot of low-income households that have no minimum wage earners. In 2016, there were twenty-two million adults between the age of eighteen and sixty-four living in poverty. What fraction of those were full-time, year-round workers? The answer is 10%. So, 90% of adults in poverty were not full-time workers. You might say, “Well, there are some people who worked part-time or part of the year.” But, when you add the people who worked full-time and year round, you still get fourteen million out of the twenty-three million adults in poverty who didn’t work at all during the year. They are obviously not affected by the minimum wage. That shows the limit of the minimum wage as a device to raise people out of poverty. It isn’t as if it would have no effect, but it would have less effect than you might think. There are a lot of low-wage workers who don’t live in a low-income household and there are a lot of low-income households that don’t have any low-wage workers. So, that slippage limits the ability of a minimum wage to reduce poverty.

VRoP: You just touched on this a bit, but, as Americans, we want our citizens to be able to earn enough to support themselves and their families through hard work. Does increasing the minimum wage advance this goal?

WJ: It does for some and it may not for others. One feature of a minimum wage is that there may be gainers and losers among the population that is affected by the minimum wage. Let me give an example. Seattle has recently raised its minimum wage to be on the path to $15, and the city of Seattle has invited economists at the University of Washington to evaluate the effects of the minimum wage. The second wave of their reports came out last summer, and they are finding that this higher minimum wage has raised the wages of some low-wage workers, but it has reduced the employment of other low-wage workers. So, the net effect of that in the study of the Seattle experiment is actually negative. While some workers are getting higher wages, employment is going down more and so the net effect is negative. There are going to be losers and gainers.

VRoP: Will teens and low skill workers in minimum-wage jobs be priced out of the market with a minimum wage hike?

WJ: Some of them will. Employers must make a decision about whether it’s worth hiring this person. They think, “If I hire this person, this person is going to bring me revenue that will add to my profits. For example, they’re going to produce stuff that I can sell. On the other hand, I have to pay them money. So, I have to compare what they’re going to bring me (marginal revenue product) versus what they’re going to cost me. If they’re going to bring me more than they’re going to cost me, it’s a good deal and I want to do it. If not, it’s a bad deal and I’m not going to do it.” If you raise the wage, you’re not raising anyone’s marginal revenue product, so there will be some workers for whom the employers will say it’s not worth it to hire. I sometimes give the analogy of the automobile market. Imagine there are only two automobile manufacturers: Chevrolet and BMW. If Chevrolet produces a car that costs $25,000 and BMW produces a car that costs $45,000, some consumers will choose the Chevrolet and otherwises will choose the BMW based on their incomes, tastes, etc. If the government came in and said, “We’re going to help Chevrolet. They’re only getting $25,000 for their car. So, we’re going to pass a law saying that you can’t sell a car that’s priced less than $40,000.” Well, is that going to help Chevrolet? Now consumers are not confronted with $25,000 Chevys versus $45,000 BMWs, they’re confronted with $40,000 Chevys versus $45,000 BMWs. More of them are going to say that if they have to pay $40,000 for a Chevrolet they might as well chip in $5,000 more to get the added quality of the BMW. In fact, it might increase the demand for BMWs and reduce the demand for Chevrolets. Since workers have different values to employers (you can think of the Chevrolet workers as having a lower value than the BMW workers) then raising the cost of the Chevrolet workers doesn’t necessarily do them a favor. Perversely, BMW might benefit because they’re now going to get a lot more customers than they had before since their competition is now much closer in price.

Before the 1930’s the center of the shoe and textile industry in the United States was New England. It started moving to the South: to North Carolina, Virginia, and South Carolina, because wages were lower in the South. Well, the New Englanders thought about how they could reduce this competition from the lower wage workers in the South. They decided to require those southerners to pay a higher wage than they otherwise would by instituting a national minimum wage. I’m not saying that was the only reason for the minimum wage, but it was certainly the case that New Englanders supported the minimum wage even though the wages in New England were above what the minimum wage was supposed to be. So, there is some interesting political economy to these minimum wage debates that it could be that the people most in favor are not the people directly affected. 

VRoP: So, is it possible that, counterintuitively, the people affected directly – minimum-wage workers – might be hurt by a minimum wage hike? 

WJ: Some will be hurt and some will gain. It’s a mixed bag. To some extent, proponents are like the optimists who see the glass as half full and the opponents are more like the pessimists who see the glass as half empty.

VRoP: Finally, do you see a good alternative to a minimum wage increase that would assist chronically low-income Americans?

WJ: There is a good alternative. We already have it, though we could expand it and make it more generous. It’s something called the “Earned Income Tax Credit,” which came during the Clinton administration. It’s one of the few policies that almost every economist thinks is good. There’s a famous economist named Christina Romer, who was chair of the Council of Economic Advisors under Obama, who wrote a piece about the minimum wage. Now, the Obama administration was very pro-minimum wage, and here’s Obama’s chief economist writing, and basically she says, “Really, if I had my preference…the minimum wage is not a very good way to redistribute income. I would rather have a policy like an Earned Income Tax Credit.”

The Earned Income Tax Credit, a feature of our federal income tax program, says that if you go out and earn $10,000, not only will we not tax that, we’ll also add something to your income. We’ll add say 30%. That means your earning capacity has been expanded by this program. It’s basically the taxpayers coming up with money for low-income workers, redistributing income to low-income workers. It’s not the employers who are paying a higher wage. It’s the rest of us who are concerned about low-income workers and think that people who work hard for a living should be recognized for that. We decide to spend some of our tax dollars to give them a little extra. That doesn’t have the negative disemployment effects. There are more subtle effects of it, but most economists think that it is a superior way to redistribute income. With that tool, you could say that we’re not that worried about teenagers at the minimum wage income, but we are concerned about adults who have to support children. So, we can say that we’re only going to give this to people who have children as dependents. Then you’re better targeting the ones who may be more deserving. 

VRoP: Thank you for your time and for your answers!