A Minimum Wage Puzzle
Two new studies show that giving pay raises to low-wage workers is good for consumers, too.
That finding could add momentum to efforts to help grocery store clerks, nursing home workers and delivery drivers who are being paid a minimum wage despite their efforts being so essential during the current pandemic.
The new research shows that raising the minimum wage improves workers’ productivity, which translates into businesses offering higher-quality service.
These are the opening three paragraphs of Seema Jayachandran, “How a Raise for Workers Could be a Win for Everybody,” New York Times, June 18.
The rest of the article goes on to highlight the results of the two studies on minimum wages. One was about the effect of minimum wage increases on nursing homes and the other about the effects of minimum wage increases on department stores.
Ms. Ruffini’s most startling finding was that higher minimum wages reduced mortality significantly among nursing home residents. Her research suggests that if every county increased its minimum wage by 10 percent, there could be 15,000 fewer deaths in nursing homes each year, or about a 3 percent reduction.
How did pay increases translate into better patient health and longer lives? It appears that with better pay, jobs in nursing homes became more attractive, so employee turnover decreased. Patients benefited from more continuity in their care.
In addition, the better paid employees may have simply worked harder, perhaps because they cared more about holding onto their jobs. Economists say they have been paid an “efficiency wage”: Employees become more productive when their wages are higher.
The higher wage may also have attracted more skilled or industrious people to the job, but this seems to account for at most a small portion of the improvements in patient health.
A crucial finding is that the benefits for workers and patients did not come with any apparent downside to nursing homeowners. Their profits remained steady because they were able to defray their increased costs by charging higher fees. That’s one reason these results might not apply in all industries. There are few alternatives to using a nursing home, so if the industry raises prices, it will not lose too many customers.
Why is this a puzzle? Because if nursing homes were able to respond this way after a minimum wage increase, why wait for a minimum wage increase? Why not increase wages on their own and get all these good results?
She has somewhat of an answer. She writes:
What unlocked these gains was government action: All nursing homes in a community had to pay employees more. That eliminated competitive disparities that might have made individual operators reluctant to raise wages unilaterally.
In other words, a nursing home could not have made these gains on its own because then it would have had to raise prices and be less competitive with other nursing homes in the area. So fees, that is, prices, increased; otherwise profits wouldn’t have remained steady while costs increased. If a lot of the nursing home patients were funded by Medicaid, and many are, then presumably Medicaid started paying more. Also, presumably private insurers of nursing home care, and maybe patients themselves, started paying more.
In her concluding paragraph, Professor Jayachandran writes:
Supporters of raising the minimum wage usually make their case based on fairness and equity. That rationale is important, but the central finding of these studies — that a higher minimum wage can boost work force productivity and save lives — is a powerful one, too.
She should have pointed out, especially since she’s a bona fide economics professor at Northwestern University, that one main reason an increase in the minimum wage boosts work force productivity is that it causes employers to lay off, or not replace, the least productive workers, those whose productivity is worth less than the new higher minimum wage. To take an extreme example, if the minimum wage were raised to $15 an hour, as many people now propose, work force productivity would increase and well over one million people would likely lose their jobs.
HT2 Cyril Morong.
For the minimum wage entry in The Concise Encyclopedia of Economics, see Linda Gorman, “Minimum Wages.”
For a relatively recent review of the literature on minimum wages, see Robert P. Murphy, “Large Increases in Minimum Wages Are Likely to Destroy Jobs,” Econlib Feature Article, October 2015.
Jun 23 2020 at 1:35pm
It seems common in many fields to focus on efficiency at the expense of production. People see a quotient and think that actions that reduce the numerator less than the denominator are good. It’s easy to forget the Econ 101 lesson that you should grow until marginal revenue equals marginal cost, even if doing so reduces your average profitability.
Jun 23 2020 at 7:50pm
Profit is maximized where MC=MR. If profit is decreasing, then MC>MR.
Jun 23 2020 at 11:00pm
He said average profit.
Jun 24 2020 at 7:03am
By definition, when marginal revenue is greater than marginal cost, then the addition of one more unit generates additional profit (marginal profit is higher). At mc=mr, that point is maximized. Average profit would fall only when mc>mr
Jun 24 2020 at 7:07am
I suppose it’s possible to have a situation where average profit stagnates/slightly declines where mc=mr if we have discrete rather than continuous units, but that doesn’t really affect my point a lot. The change would be small
Jun 24 2020 at 11:09pm
Say I have a business where my cost of capital is 10% and my return on capital is 20%. If I have an opportunity to double my business at a return on incremental capital of 12% I should do so, even if the resulting business has a return on capital of 16%.
Jun 25 2020 at 7:59am
Yes, Garrett is right.
Another example, the first unit you sell has a marginal profit (MR – MC) of $100,000. However, every unit after that has a marginal profit of $10. For each unit sold, the average would drop, pretty dramatically for a while, but it is still good business to expand (until MC does eventually catch up).
Jun 27 2020 at 6:23pm
Are you saying “profit” as a business where profit is the return on capital paid to shareholders who gave their savings from not consuming equal to their earnings from production to pay workers to buildi capital jin expectations they will get a bonus?
Or are you using profits as a economist does to indicate the excess revenue not paid to production due to government granted monopoly power, or in rare cases, a business being too good at competing they keep ahead of the competition by delivering better produces ahead of competition constantly?
Superior competition at large scale is rare, and on a sustained basis, not that profitable, economically. Sears, for example led the way until business economists argued it was failing to exploit its monopoly power by paying shareholders high returns, leading to it cutting labor costs, eliminating the low profit business that defined it, mail order. After all, no one will shop for products to be delivered by the Post Office any more. Or so was the opinion of Wall Street MBAs in the 80s as the made it the most profitable retailer ever, forever. Obviously, Sears is in its 125th plus year the most powerful business in the world.
Jun 23 2020 at 3:04pm
Is the minimum wage increase only for nursing home workers? If not, why does the increase in the minimum wage make nursing home jobs much more attractive than other minimum wage positions, when it must not have relatively attractive before the increase?
Also, what percentage of the nurses and nurses aids in nursing homes make the minimum wage?
Jun 23 2020 at 5:21pm
Hey Danno, I assume the law is only for nursing home workers (although other businesses are obviously free to raise their employees’ wages) and remember attractiveness for a waged employee is not the same as that of a salaried employee. The analysis here is not just about total wages, but is threefold:
1- a threshold analysis based on can they now (somewhat) comfortably afford living expenses without relying on credit (impossible to do at minimum wage);
2- job stability (decent for nursing home workers because training is necessary but not great); and
3- tenure (the longer you are with a patient-> the better and more comfortable you get in the job, something that is not entirely unique to nursing homes, but certainly a major factor).
They get paid roughly the same as fast food workers in many areas, median wage for a home health aide is $11.63, mean is $12.18, 90th percentile is $15.47 https://www.bls.gov/oes/2018/may/oes311011.htm
Also this has a bunch of statistics based on 2017 that showed that the quality of nursing healthcare was diminishing due to those workers’ wages diminishing in real dollars from 2003-2013 which likely caused a lot of the issues that we currently have in our nursing homes due to Covid: https://www.theceal.org/images/reports/RTI-CEAL-Minimum-Wage-Report-2017-FINAL.pdf
This is why I think the cost in less marginal productivity of raising their minimum wage is small compared to the insurance benefit of having a stronger nursing home healthcare system (among the other reasons David offered). Hope this helps.
Jun 23 2020 at 4:06pm
‘ Interestingly, she doesn’t mention what happened to prices.’
You quote her as saying ‘Their profits remained steady because they were able to defray their increased costs by charging higher fees’ so it appears she does mention what happened to prices.
Jun 23 2020 at 5:06pm
Oops. Right you are. I’ll make the change.
Jun 23 2020 at 4:19pm
Increasing efficiency normally increases production so I don’t get your point of efficiency at the expense of production. Unless you are referring to the higher profit margins with efficiency gains that make it possible to clear more profit on less product.
On the article, I don’t get how so many people think that higher wages forced don’t necessarily result in more productivity per hour, and certainly less per dollar on the average.
I pay double time on the infrequent Sundays that we work, not because I am generous or due to employee demands, but because that is the most cost effective way for us to work Sundays when necessary. They are usually willing to show up and be productive when asked, and I have strong reasons not to unless I have to. There is no government involvement in my method, there is profit motive.
Jun 23 2020 at 10:01pm
So, since they’re raising fees, consumers are being forced to purchase a higher quality service at a higher price. Maybe this is a case of efficient paternalism and it is worth it to customers, they just didn’t realize it, but she makes it seem like consumers are getting a free lunch, when they’re actually paying more for the better quality service.
I’d also query what effect the increase in prices had on the number of ‘customers.’ Do these price increases price out any poorer people?
Jun 23 2020 at 11:48pm
This was exactly my thought as well. It’s a clear tradeoff between quality and cost. The answer Jayachandra supplies as to why nursing homes haven’t adopted this policy is very unsatisfying. Since there is also a competitive advantage to having higher quality if people demanded that higher quality at a higher cost we would expect nursing homes to have already adopted this policy. This makes me suspect that the minimum wage policy in this case a a net negative effect.
Jun 24 2020 at 12:05am
That was my thought exactly – net utility for consumers has actually decreased, because they had the option to pay more for a better home before the minimum wage hike, and did not take it. The consumers judge that a cheaper and “less good” service to be higher utility. We should not second guess them.
Jun 24 2020 at 9:17am
The professor could have pointed out that the same results could have been obtained by just raising the EITC/wage subsidy.
Jun 24 2020 at 10:05am
There’s a problem I have with this justification for the minimum wage: it assumes that the only margin along which firms can adjust is prices. But that’s not correct. If nursing home A raises wages, and subsequently their prices charged, it does not necessarily imply that they would lose business (outside of the perfectly competitive model). If the Home improves their quality, then they are therefore differentiable from their competitors and thus can raise prices and likely increase profits. Firms do this sort of thing all the time.
Hayek wrote that the purpose of competition is to teach us precisely who will serve us the best. If the Home charges higher prices but also offers better care, then they are competing; they are showing they can serve us better.
Jun 24 2020 at 5:42pm
Pardon me if someone already made the point that I’m about to make….
The puzzle, correctly noted by David, is indeed this: If raising the minimum wage caused worker productivity to rise by at least enough to justify the higher wage, why did not individual nursing homes raise wages on their own? Why, as David rightly asked, did not each nursing home increase wages on its own “and get all these good results?” Why indeed. But the answer that David reports the author of the paper gave does noting, in my view, to solve this puzzle. That answer, as given, is this (as quoted above by David):
This explanation of why no individual nursing home would raise wages on its own makes no sense. If – as is claimed – raising worker pay so increases worker productivity as to justify the pay increase, why would any individual nursing home have to raise the prices it charges to customers in order to remain solvent? Answer: it would not. The increase in worker productivity would at least cover the higher wage expenses. Greater production efficiency pushes prices lower, not higher.
Indeed, without the mandated uniform rise in wages that occurs when the minimum wage is increased, each individual nursing home would likely have even more incentive to raise its workers’ wages if it believed that doing so would result in a sufficiently large increase in its workers’ productivity. Nursing home A that raises its wages when nursing home B does not would find itself better able to keep and attract the best workers.
What am I missing here? Are nursing homes different in some essential way from other firms? Most other firms, after all, do not need to be lassoed by government into collectively hiking of wages when such hiking is good for the bottom line.
David is correct to point out that, because higher minimum wages render unemployed all workers who are incapable of producing hourly output valued by at least as much as the minimum wage, raising the minimum wage of course results in higher measured worker productivity. But I think that the point that I make above is also warranted.
Jun 24 2020 at 10:47pm
Actually, Don, no one did make the point you make and you make it well. An important addition to my analysis.
Jun 24 2020 at 6:40pm
I fail to see how this isn’t just the same old “efficiency wage” argument that gets brought up all the time.
An efficiency wage has no power when it becomes the new minimum wage. If I can get $15/hour whether I work in a nursing home or a retail store, I will take the easier job. It only has an effect when it stands above the crowd.
Maybe the author is making the argument that higher wages should be mandated in sectors where lives are at stake. But I fear it would be generalized across the whole economy and fail to be effective. Also, if the efficiency effect really is there, how do we know it persists? Seems like after a year or two, it becomes the new normal and the effect wears off.
Jun 25 2020 at 1:15pm
“Economists say they have been paid an “efficiency wage”: Employees become more productive when their wages are higher.”
I thought efficiency wage effect was an explanation for the observation that sometimes self-interested employers voluntarily choose to pay higher than market clearing wages. That is, inherent in the theory is that those wages are already being paid, so no government wage fixing could improve upon it.
It just seems that to suggest that expanding the low wage prohibition also expands efficiency wages, a new theory of efficiency wages without explanation is being used–a theory where either the wages don’t more than pay for themselves, or where employers aren’t driven by higher profits.
Or, “efficiency wage” is being misused.
Jun 27 2020 at 6:56pm
Back 50 years ago, economic efficiency meant zero economic profits because all factors of production were employed and thus there was no scarcity that allowed any profit.
Think about it, if monopoly allows more revenue than producers are paid, the monopolist must consume equal to 100% of profits, even if he was too fat, too full, because someone must buy all the production of highly productive low wage food workers to put all of them to work so they are not idle factors of production. Or lots more clothes, or take many more vacations, …
Jun 27 2020 at 6:42pm
Aren’t workers consumers?
Or are consumers defined as those who are given money by government to buy stuff from businesses who pay people who do not consume anything to work producing things consumers buy?
Unless government gives consumers all the money paid to businesses, isn’t the only way businesses can do sell more stuff to consumers is buy paying consumers more money for working?
The idea that cutting labor cost will increase consumer spending is a big puzzle to me. Can anyone explain how consumers have more money to spend if both businesses pay them less to work, and government pays them less to consume?
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