Message to Michael: There's No Tooth Fairy
By David Henderson
In an article today, Shikha Dalmia goes after Democrats’ attempts and proposals to raise the minimum wage by a lot. She quotes my thinking about monopsony. But she also made me aware of work by U.C. Berkeley economist Michael Reich that he and colleagues did for the Los Angeles City Council. So I looked at that work more carefully.
It contradicts basic economics.
One of Reich et al’s arguments is that the added wages to low-wage workers will have a multiplier effect by increasing demand for goods and services. But how can this be? Those who keep their jobs will have more income. They’ll also, presumably, have fewer benefits to the extent that employers can cut benefits. The reason: the mandated wage increase would not make them magically more productive and there was a reason their wages were what they were: they reflected low productivity.
But let’s assume that benefits don’t decline dollar for dollar with wage increases. So these lower-wage employees who keep their jobs will have more real income.
But who pays for that income? Employers. Employers will either take it out of hide, so that they will have less to spend, or will increase prices so that consumers have less to spend, or both. Reich et al discuss this but somehow conclude that the net effect is positive. They write:
To conclude, we find that the benefits of the proposed minimum wage law will largely outweigh the costs in Los Angeles City, and when the larger region is considered, the net impact of the law will be positive.
Their conclusion is driven by their model rather than by basic economics.
It’s possible that Reich et al are assuming that some of cost to employers is borne by employers that have a span beyond Los Angeles or Los Angeles County, so that a firm operating in Los Angeles that is based in, say, San Jose, will pay some of these costs. So the reduced income the San Jose firm suffers does not result in reduced demand in L.A. But it will result in lower income and demand somewhere. If they are assuming that some of the cost is borne outside the Los Angeles County area, then their policy amounts to “beggar thy neighbor.” It’s not a policy for increasing overall real incomes.
How do we know that increasing the minimum wage will cause real incomes overall to fall? Because at a higher mandated wage rate, especially one raised a lot, the number of people employed will fall. With fewer people working, there is less output. With lower output, there is less real income.
If the effect that Reich et al discussed were dominant so that the gains in real income exceeded the losses in real income, there really would be a good reason, from a straight real income viewpoint (putting aside the morality of the issue), to raise the minimum wage to $20 an hour. But there’s no tooth fairy.
By the way, for referral to evidence of some hanky-panky by Reich’s co-author Ken Jacobs, see this.