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Thursday, January 21, 2021

Minimum Wage Effect At The National Level

The possibility of an increase in the minimum wage at the Federal level of the United States is an extremely interesting reform. By itself, I am unconvinced about its macro significance (for reasons to be discussed herein). However, if part of a slate of policies aimed to run the economy hotter, it could be one potential component of a hypothetical structural shift.

Sub-National Experience Different

There is a long ongoing debate about minimum wage policies within the economics literature. When I looked at the discussion (years ago), the literature was focused on trying to estimate effects at the sub-national level. (Given that the U.S. Federal minimum wage has not been raised in decades, national data are scarce.)

At the sub-national level, keeping the minimum wage below the national average is a form of "smokestack chasing": trying to develop by drawing investment from other sub-national regions. As such, I can accept that there might be effects worth taking into account when discussing sub-national (state, provincial) minimum wage changes.

At the National Level, Macro Policy Exists

When we jump to the national level, we have to accept that any effects of the minimum wage hike would show up in the national aggregates -- and can be dealt with via macro policy.

Although academics might try to do some "all else equal" analysis (estimating the marginal effect of changing the national minimum wage), this is ignoring macroeconomics. Why did neoclassical economists insist that fiscal policy was ineffective before 2008? Because monetary policy would cancel out the effect of fiscal policy.

There is absolutely no reason to believe that fiscal and monetary policy are inadequate to compensate for any side effects of a hike in the minimum wage. The only interesting question is if there are a large number of policy changes that are all pointing in the same direction. It is easy to imagine that critics of the Biden administration making that claim.

Inflationary Effects?

The closest to a "smokestack chasing" effect at the national level is the possibility of production moving overseas in response to higher wages. I accept that this might be an issue in the face of an extremely large rise in the minimum wage, but I am unconvinced about the magnitude of the effect at $15/hour. As such, Keynesian-style economic theory suggests that the effect of the minimum wage hike would show up via higher aggregate wages and output prices (inflation): the added wage income increases nominal demand, so there is no reason for firms in aggregate to cut production.

(Firms that rely on minimum-wage employees that compete against those that do not would lose out, and presumably lose market share. That is offset by the increased market share of competitors. National income is only hit via an increase in imports. That effect is small relative to overall economic volatility.)

Instead, the rise in the minimum wage should show up by a wage hike in the lowest income cohorts. However, wage growth for different cohorts are different (as evidenced by changes in income distributions). The magnitude of the aggregate rise in wages is an empirical issue.

Estimating the Impact?

The starting point of the analysis is to see how many workers are affected. Unfortunately, I am not familiar with the wage distribution data sets.

However, the easiest starting point is to look at where $15/hour is versus state level minimum wages. I just glanced at this list by Paycor, and noted that this level is much less radical than it is just comparing to the current Federal level of $7.25/hour. If we look at the 2020 level in large coastal Democratic states -- e.g., New York ($11.80), California ($13.00), Massachusetts ($12.75), the percentage increase is much smaller.

Meanwhile, those states are the most populous, and probably represent the bulk of national GDP. As such, I would not lose a lot of sleep worrying about the national level impact. I could easily be complacent, but this starting point already biases me towards the view that the macro effect of such a hike would be hard to disentangle from other economic disruptions.

For an American, one can see a political economy angle. This minimum wage hike generally has the greatest effect in more rural states with lower average incomes. The benefits and/or costs will show up there, and I am not the person to ask about such effects. This reality also means that the political fighting over this change will be disproportionate to the macroeconomic impact.

Macro Policy Still Exists

Even if aggregate wages do jump, it is still a one-time shock. Developed economies have been hit by many large shocks since the early 1990s, yet core inflation has not budged. Other institutional factors would have to shift to allow higher average inflation to take root, and I see no evidence that policymakers would stomach such a shift.

Concluding Remarks

It is a safe bet that analysis of a $15/hour Federal minimum wage is going to be split down party lines. The only way to get a more impartial feel is to dig further into income distribution statistics, to give a better handle on the magnitude of affected wages.

(c) Brian Romanchuk 2021

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