Minimum Wage: Part 2

Suppose a worker earns the federal minimum wage of $7.25/hr. Moreover, suppose the worker supplies their labor 40 hours each week for 50 weeks. A simple calculation means that worker will earn $14,420 each year. However, some of those earnings are taken through FICA (7.65 percent between Social Security and Medicare). That means that the actual annual take-home earnings are $13,320. Then, additional funds will be subtracted if there is a state income tax. For the sake of the examples presented we will consider that people reside in Florida (there is no state income tax).

Of course this might not be a good assumption for more than one reason. In Tallahassee a dollar stretches like salt water taffy compared to  San Francisco. However, some cities and states with high cost of living have attempted to offset this problem through local wage policies that exceed the federal standards.* Another interesting and related point, the poverty thresholds we will be talking about are not Cost of Living adjusted. Put another way, the thresholds do not account for the fact that a dollar amount means something different in Tallahassee than San Francisco.

Consider four situations. In situation #1 the worker has zero "dependents". In situation #2 the worker is married to another person working for minimum wage and the people do not have children. In situation #3 the same couple is married has two children. In situation #4 the worker is unmarried and has two children.

A quick note about the poverty threshold, you will see that going from zero to two children increases the poverty threshold. That is because the poverty threshold represents the maximum amount a person can earn and still be considered "in poverty". Moreover, I will be using the expenses (not the income(s)) from the recent McDonalds employee budget that has caused quite a stir. In total, the expenses are $1,310/month. I think that these expenditures could be lower on some dimensions like auto payment/insurance/gas compared to public transportation. And, it is possible to live at a location that is less expensive (I've done it). But, it is also the case that the McDonalds budget does not specify a monthly grocery bill which I will do in each situation.

Situation #1: Unmarried with No Children

Take-home earnings are $13,320. The person earns an income that exceeds the poverty threshold of $11,945. For a single individual let's assume that grocery expenditures are $200/month. That is a pretty comfortable amount to spend for a single individual. Given the McDonalds monthly budget that means that expenses are $1,510/month, or, $18,120/year. There is a deficit here.

But, while this person does not earn an income below the poverty threshold this person does meet requirements for programs such as food stamps and Section 8 housing (in Tallahassee the person earns less than 50% of the median and therefore qualifies) Depending on their magnitude these subsidies would serve to erase the deficit.  Which brings up questions about what determines the magnitude of these benefits. To be honest, I do not know all the factors.

Without these programs the person would need an approx. wage of $10/hr to earn the money needed to cover the aforementioned costs.

Situation #2: Married with No Children

Combined annual earnings are $26,640. The combined income exceeds the $15,374 poverty threshold. If we increase the housing expense to $750/month to accommodate more space for two people and increase the groceries to $300/month that means that expenditures are $1,760/month or $21,120. You can see that there is no deficit between earnings and expenditures.

Situation #3: Married with two Children

The combined income is still $26,640 but with two children the poverty threshold is $23,283. Your housing expenditures will be higher to accommodate the children and there are increased expenditures on groceries. Also, there will be additional health expenses. Let us suppose all of those increases lead us into $2,000/month territory. But, the biggest expense when it comes to having children (correct me if I am wrong) is childcare.

In the past I've had classes where I asked students to attempt to figure out what their budgets would be when single compared to when they have children. One of the biggest expenditures reported is childcare that can easily cost $400/month between two children. But childcare is also interested because costs can be defrayed by one parent working part time while the other works full time. Also, if you have a nearby family member that has days off from work and is willing to work that is an enormous benefit.

This family would qualify under the Earned Income Tax Credit for approximately $4,000 which would mean that this additional cost of childcare would be mostly defrayed; however, it would be a significant benefit to have a family member near since it would free resources to help on other margins of life.

Situation #4: Unmarried with two Children

The annual take-home earnings are $13,320 however the poverty threshold is $18,498. Being below the poverty threshold means that this person would qualify for a number of programs: Temporary Aid to Needy Families, Food Stamps, Section 8 housing, WIC, and more. In addition, this person would qualify for the Earned Income Tax Credit.

These situations attempt to outline a couple items.

First, life earning the minimum wage is difficult. People earning minimum wage do not have many of the comforts that most of us reading this blog post have. Also, there are slender differences between income and expenses even when welfare expenses kick-in. That means minimum wage earners are vulnerable to shocking events in life like breakdowns of automobiles, severe illness or injury, or theft.

Second, earning minimum wage without a spouse or with children is more difficult. When a couple is married costs can be shared and financial health is easier. While I think children are a blessing from God there can be little doubt that children increase expenses and make margins thinner.

Some closing thoughts.

It should be noted that, as discussed in this Forbes article 24% of minimum wage workers are teens, an additional 26% are non-teens under 25 and non-trivial number of minimum wage workers are working for minimum wage on their second job. I bring this up because not all beneficiaries of the minimum wage are the "poor" most people are attempting to help. Instead, a large portion of people earning the minimum wage are earning it in a "snapshot" but will later be working for higher wages. This is true even of low skilled individuals.

That does not even account for the possible unemployment effects discussed in the earlier article. One recent example of minimum wage harming the poor is the attempt for Washington DC to impose minimum wages on big box stores like WalMart. New jobs were not created, and, the poor are still purchasing goods from WalMart but now must continue to pay high transportation costs to venture out to locales where WalMart exists.   

Therefore, the minimum wage can be thought of as a blunt policy instrument. 

What would be better? We could increase the size of the social safety net; but, we do not want the net to become a hammock. That is, we do not want for greater welfare expenditures to present people with a perverse incentive to not work for fear that benefits will be lost. This idea called the "backward hustle" was presented here in a previous post. Or, would it be better instead to preserve the incentive to work and gain skills?

The earned income tax credit is a less blunt policy instrument that applies to people of a particular income range that are labeled independent (not dependent like your kids). The earned income tax credit also provides an incentive to gain skills and earn higher wages since there are not knife edge losses. These knife edge losses come from the fact that as a person earns more money they no longer qualify for food stamps, section 8 housing, etc.  

Obviously an expansion of the earned income tax credit would require the federal government to collect revenues to finance it. These taxes would cause their own distortions; however, I think if given the choice between an increase in the minimum wage, increases in the social safety net, and other policy initiatives I would be more in favor of a well placed tax to finance an expansion of the earned income tax credit.

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*For example, San Francisco has a wage ordinance of $10.55/hr. That means that the annual income of a minimum wage worker (after FICA) is $19,485 and a small additional amount would be subtracted for California State tax, around 1%. Let's just say the annual income is $19,300. If I move from Tallahassee to San Francisco, even with the higher minimum wage, my purchasing power is still lower.  What is the lesson here? As a tangent, I find it quite interesting that smart people can observe the *same facts* and still come to quite different conclusions. I'm sure some people would say San Francisco needs a higher minimum wage. Another thought might be, people in these positions should gain skills that employers find valuable enough to compensate at a higher wage.

Church and State: Substitutes

Earlier this year I had a great chance to reconnect with roots. In the Panel Data course we presented a research paper that utilized some of the quantitative methods we learned throughout the semester. I presented a paper titled,

"Are the Church and the State Substitutes?: Evidence from the 1996 Welfare Reform". 

The author Daniel Hungerman is one of my economic heroes and his other work was an inspiration to me when starting graduate coursework in economics. At that time (and still) one of my chief interests was taking care of the poor and how voluntary associations attempted to tackle problems of poverty. This paper starts from the basic premise that the Church and State are both interested in charitable spending. For example, churches provide food pantries and soup kitchens to the poor and the government provides food stamps. But, how is their spending towards these goods related? 

There is a literature in public economics on crowding out. Crowding out is said to occur when an increase in public expenditures towards some good/service (for example food stamps) reduces the amount private organizations like churches or nonprofits spend on that same good/service (food pantries). 

The 1996 Welfare Reform Act represented a landmark piece of legislation that curtailed spending on Aid to Families with Dependent Children, Supplemental Security Income, Food Stamps, and Medicaid. Because we think the church and state might be substitutes we want to know how this legislation impacted church spending. The chief problem in comprehending this question was that there was no variation. Since the welfare law impacted all communities at the same time we would need reason to believe it impacted some communities at different magnitudes.

Hungerman came up with a brilliant strategy to measure the magnitude: Because the welfare laws impacted immigrants in a different manner than the welfare population at large and because different communities had different immigrant populations we should see the church respond with more vigorous charitable work in areas with larger immigrant populations (if in fact the church and state are substitutes).

In fact, the churches do respond more in communities with larger immigrant populations. Moreover, this response is not trivial. For each dollar reduction in government spending the church increased spending of 40 cents. This becomes an even bigger question if we start to wonder who is the more efficient provider of public services.

I will close with one final interesting but dampened note on this research. While the Welfare Reform Act had an impact on church spending it *did not* have an impact on donations. This seems to suggest that during this time churches were dipping into extra funds. In the short run this might be fine; however, if this were a sustainable form of charitable action donations would need to pick up in the long run.  

Minimum Wage: Part 1

This is one of a two part post on the minimum wage. The second half will put a more human face on the discussion of the minimum wage. This half of the post will focus on how economists view minimum wage from a theoretical perspective and how those theories comport with data from the field. This has enormous consequences for human welfare; but, since I understand it is not simple to make the connection, I break it down in two posts. In this post I will attempt to be somewhat non-technical, not venturing beyond intuitive explanations of the different theoretical and empirical exercises (Nevertheless, there will be *some* jargon)

Theory
The standard framework to discuss the minimum wage in Econ 101 begins as follows:

1. At high wages firms demand less labor and at low wages firms demand more labor, 
2. Workers are willing to supply lots of labor when the wage is high but not willing to supply much labor when the wage is low. 
3. The intersection of labor-demand (firms) and labor-supply (workers) determines the "equilibrium wage".

When the equilibrium wage is considered unfair people sometimes advocate for a minimum wage.* Usually, the minimum wage is above the equilibrium wage. This makes sense because if wages for certain labor pools had a high equilibrium wage an increase in the minimum would have zero effect on the equilibrium wage. The graph from Econ 101 looks something like this,

You can see there are more workers willing to supply their labor at the new minimum wage than firms demanding labor at that wage. This means there are a surplus of workers and increased unemployment. These results hold for more sophisticated models too. For example, in labor economics "matching models" where firms post vacancies and workers search for jobs this result of increased unemployment still holds. The logic behind these models is similar to the standard framework: If firms receives equal production from workers but must compensate more then less vacancies will be posted.

These standard models suggest that in the long run firms will substitute low skilled workers for machines, outsource work to other areas, cut back on benefits, etc. The competitive pressure from other firms in the market (who are also attempting to cut costs) necessitate these decisions. All else equal, if firms did not make adjustments their business would suffer losses.

There are theories however where the minimum wage does not increase unemployment. In fact, one theory suggests it will have zero impact on unemployment or that it will increase employment! The model that suggests this begins with firms having what economists call "monopsony power".

To get a handle on this idea I want you to imagine you are a bidder on ebay.

Would you rather be the sole bidder for your beloved item or would you prefer there are several bidders? Life is good if you're the sole bidder because you can place a low bid without competition from others. A monopsonistic labor market is similar. Firms can offer low wages because there are not other firms offering higher wages. In cases like this the minimum wage could prove helpful. (To see how this might be true visit this blog post from Dave Henderson)

This discussion about monopsonistic power brings us to a junction from theoretical exercises to data exercises. This is fitting since the monopsonistic model that justifies the minimum wage was employed following the a controversial and landmark empirical study.

Data
Most minimum wage empirical papers either confirmed the standard theoretical result or failed to find a negative influence employment. However, in 1993 David Card and Alan Krueger (CK henceforth) posted a working paper that was later published in the most prestigious economics journal: American Economic Review. The paper focused on fast food businesses along the Penn. and NJ border as a "natural experiment". In 1992 NJ increased its hourly minimum wage from $4.25 to $5.05 (the treatment group) while neighboring fast food restaurants in Penn. had received no change in their minimum wage (the control group). CK's statistical methods were not iron-clad but were careful and convinced a number of scholars in the profession. Across time, the number of economic scholars who *did not think* an increase in the minimum wage had negative employment effects: 1978: 10% /// 1992: 21% /// 2000: 26.5%. The impact has been more intense among labor economists.

From a logical standpoint this is curious. There should be a negative impact on unemployment. Consider the following:

If there is no negative impact on unemployment for increasing the minimum wage from $4.25 to $5.05 why not increase minimum wage to $10/hr? $50/hr? $1,000/hr? and so on. 

I do not mean to be flippant but merely to demonstrate using reductio ad absurdum that there must be something else that these economists have in mind. Demand curves slope downward, right?

On the other hand, the monopsonistic model would suggest that the minimum wage should be increased up to the point where wages *would be* if the market were more competitive (ie, there were more bidders competing against you on ebay). But, do you think McDonalds, Burger King, Chick-Fil-A, etc. have significant market power when it comes to hiring labor? Perhaps there are industries where firms have such a large market share that workers furnish wages below their contribution to the firm. However, and I will leave this question to the reader, does the fast food restaurant seem to be monopsonistic? That is, does each fast food restaurants exert enough control over the market that it can dictate wages?

In fact, there are two crucial questions to ask when taking this monopsonistic view of the labor market. First, is the labor market in question monopsonistic? False indentification of this fact could lead to people losing their jobs and others never being hired. Second, supposing the labor market is monopsonistic who has the *correct* knowledge of what the competitive wage should be? If this correct wage is not implemented then we might develop problems that are worse than the problems we have at present.

To better understand other reasons economists might support a minimum wage see surveys Dan Klein and his co-author conducted here. There has been a massive tug-of-war between the two sides of this debate. From a logical standpoint I am unconvinced that minimum wage has no impact on unemployment. I think Bryan Caplan articulates a stance I would feel comfortable with in this blog article.

I do not believe that monopsonistic markets are ever-present (however I do plan to read this book which suggests they are numerous).

Another possible reason that CK did not find a negative employment effect is not monopsonistic labor markets but time lags. One famous labor economist, Mark Isaac knew, made the simple point that when the minimum wage increases employers do not say, "Whelp! That does it! Let's get rid of these employees." Instead, employers grin and bear the increased costs until some future point where economic forces like competition or economic downturn prompt them to make cuts. This kind of time lag is difficult to capture.

What is also difficult to capture are the people never hired because minimum wages are higher. One way to attempt to measure those "never hired" is to look at employment growth rather than employment levels. This brand new study on NBER demonstrates that the minimum wage has a negative influence on job growth.  

One more episode in an ongoing saga. If it were not so important (the human side - which is the topic of my next post) it would not be worth wading through all the different arguments.


*An interesting post for another time would be to explore how this perceived unfairness emerges and how price-ceilings (maximum prices) and price-floors (minimum prices) relate to just-price theory. There has already been a blog post done on this but I'm not a good enough Aquinas scholar to know whether this is a good depiction.

Thursday Thoughts 2

I've been re-reading through Dan Ariely's book Predictably Irrational (review forthcoming). The chapters that have been most thought provoking were the chapters on self control and emotions. Research on emotions demonstrates the decision-making in the heat-of-the-moment is much different than decision-making in calm states. 

"The results showed that when Roy and the other participants were in a cold, rational, superego-driven state ... they always took the moral high ground ... They thought that they understood themselves, their preferences, and what actions they were capable of. But as it turned out, they completely underestimated their reactions." (p. 127)

"Of course!"you might exclaim. This is common sense to most people who have ever experienced regret. Anger leads to speaking sharp words. Lust leads to thinking in a selfish manner. Envy leads to hatred or making false idols. But, emotions can also lead to honorable action too. When coupled with the spiritual fruit of self-control we can sense that we are becoming impatient and act in an opposite spirit. We can sense the stink of our pride and act in humility. We can sense the needs of those around us and act in kindness.

This reminds me of a favorite observation from Dallas Willard, "Feelings make excellent servants, but terrible masters." Self-control is crucial for emotions leading to improved decision-making. But, in his research Professor Ariely stated that his experiments suggested we have limited prospects for changing behavior in emotional states across time. I think this conclusion overreaches. Instead, Professor Ariely should note that there were no experimental interventions made to help people improve their decision-making. Different interventions might yield different results in the future.  

But, Professor Ariely does offer a piece of advice that is quite useful and that is something your parents or grandparents also shared: Avoid situations where temptations exist (and I would extend that to avoiding lines of thought where temptations exist). 

Next Thursday I will discuss another topic related to self-control: commitment devices that help stay on the preferred course of belief/action.

Capitalism and Poverty

In 2000 the United Nations set forth "The Millennium Development Goals" in an attempt to spur international efforts to eradicate poverty, improve health outcomes, and promote gender equality. All the various goals are supposed to be met in 2015. The goals will not be met; however, there has been substantial progress on some dimensions ---progress that was not prompted by the Millennium Development Goals. Brett Schaefer and Terry Miller have a great article on National Review about the source of that progress. Also, in a recent speech at Georgetown U2 frontman Bono he remarked,

"Aid is just a stopgap. Commerce [and] entrepreneurial capitalism take more people out of poverty and aid. We need Africa to become an economic powerhouse."

The National Review article and the endorsement of capitalism from a rock star-humanitarian (not normal) prompts me to make this simple point: The leadership in these countries needs to unleash capitalism. What do I mean by capitalism? An environment where citizens are free to produce, consume, make investments, etc. without burdensome regulations that increase the cost of doing business. People in these communities already have problems. What capitalism does is coordinate these problems with problem solvers - and it does it better than any other economic system that exists.

No other economic system has generated more wealth than capitalism. In addition, there are a number of other benefits that flow from capitalism that are on the MDG list. For example, capitalism has been related to improving the treatment of women. For example, in the book Half the Sky Kristof and WuDunn write, 

"Microfinance has done more to bolster the status of women, and to protect them from abuse, than any laws could accomplish. Capitalism, it turns out, can achieve what charity and good intentions sometimes cannot." (p. 187) 

A friend at FSU is currently working on how broader economic policies are related to different female empowerment indicators. When she has a working paper I will post her findings on the blog. Another MDG goal that is addressed through wealth generating capitalism are the environmental goals. Yes, in the short run as countries became wealthier there would be more pollution. But, as those countries became wealthier they would begin consuming more environmentally conscience goods (This relationship is called a Kuznets curve). The logic is simple. When you are impoverished the environment is not a good that you pay a premium for. However, when you're wealthy you have extra money to spend on the environment. Finally, it should come as no surprise that as citizens become wealthier they spend larger portions of their income on health goods and services. 

Thursday Thoughts 1

"For whoever wants to save their life will lose it, but whoever loses their life for me will save it. What good is it for someone to gain the whole world, and yet lose or forfeit their very self?" (Luke 9:24-25, NIV)

Jesus presents his disciples with a curveball. A person who lives for themselves has chosen a path that results in death; but, a person who sacrifices their own path for God's path will gain life. Then, he follows with a beautiful common sense question that cuts to the heart of the matter.  

When two roads diverge man must choose. That means man must give up one opportunity for another. Economists call the foregone road the "opportunity cost". As a Christian I want to choose God's path; but, the alternate path seems so attractive sometimes. 

How do we come to the point in our faith where Paul was at in his letter to the Philippians? In particular, I mean when he wrote,

More than that, I count all things to be loss in view of the surpassing value of knowing Christ Jesus my Lord, for whom I have suffered the loss of all things, and count them but rubbish so that I may gain Christ (Philippians 3:8, NIV)

From personal experience my best guess is that when Paul magnified God other things paled in comparison. We magnify God in our lives when we worship Him and take actions that are in accordance with obedience, humility, and love. This leads me to wonder how other actions might alter our opportunity cost. How do spiritual disciplines like prayer, fasting, confession, etc. alter our opportunity cost (perception about the cost of what we're giving up compared to God's path)?