Raise the minimum wage?

Not so fast, Peretz: Research shows it would increase poverty.y

November 22, 2005 22:05
4 minute read.


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With an election campaign looming and Amir Peretz leading the Labor Party, it is a safe bet that you will be hearing a lot in the near future about the pros and cons of raising the minimum wage. Virtually everything you will hear will be wrong or, at best, misleading. Here are the facts. There are number of reasons why mandating a minimum wage may make sense. The most important is that employers sometimes function as "monopsonists" - which is like a monopolist, but refers to control over the demand for something rather than the supply. Just as monopolists artificially limit supply in order to drive up prices, monopsonists artificially limit demand in order to drive prices down. This means that when there is a single monopsonistic employer, he may limi t the number of people he hires in order to drive wages down. Now, if minimum wage laws restrict the monopsonist's ability to drive down wages, he won't bother. In this situation, a minimum wage would boost wages and lower unemployment. But it is rare that employers are monopsonists. It turns out, however, that in a world of uncertainty (i.e. the world we actually live in), every employer - even the corner store - is a "mini-monopsonist." So far, a minimum wage still seems like it may indeed make sense. There are, however, some good reasons to believe that minimum wage legislation is a terrible idea. If labor markets are competitive, minimum wages simply drive up wages to a level that engenders a lot of unemployment. This unemployment is not random. Society's least skill-endowed members are specifically targeted. For example, say someone is only able to work productively enough to justify a salary of $300 a month. A $500 minimum wage assures that this person will never hold down a job. He will never know how satisfying it is to come home after a hard day of productive work. True, society can look to his physical needs, but it will have denied him the right to define himself as a productive person. Another drawback of minimum-wage legislation is that most people who earn the minimum wage are relatively inexperienced workers. As they gain more experience and seniority, their wages go up sharply. If someone, however, never succeeds in entering the labor force due to a prohibitively high minimum wag e, he will never have the opportunity to gain the experience required to earn more than the minimum wage - hence his income loss will be huge. Meanwhile, any of his colleagues lucky enough to get jobs will soon have enough experience to earn higher wage s anyway, so the benefit to them from a higher minimum wage will be small. GIVEN THAT minimum wage legislation may or may not be a good idea, the only way to determine its efficacy is to study the effects of minimum wages in real-world settings. Indeed, Nobel Laureate Milton Friedman - in his seminal 1953 essay "The Methodology of Positive Economics" - specifically cited the minimum wage as an idea whose merits can be determined only by rigorous examination of the real-world evidence. Then he noted tha t the empirical research required had yet to be conducted. Now, over half a century later, we need not rely on guesswork; we can look at the research. Literally hundreds of studies have demonstrated the destructive effects of the minimum wage. To the bes t of my knowledge, only one - the (in)famous Krueger/Card study of the New Jersey fast food industry - suggested that the minimum wage was benign. That study, however, later proved to be based on data that was deeply flawed ,and it is no longer taken seri ously. The bottom line? While in theory a minimum wage increase may be a good idea, the painful reality is that, in practice, minimum wages are part of the problem of poverty rather than part of the solution. Given the evidence, no one serious about de aling with issues of economic efficiency or social equity should be advocating minimum wage increases. Much can be done to reduce poverty, but we should begin by not promoting policies that would increase it. The writer, a senior lecturer in economics at the Academic College of Judea and Samaria, is chief economist of Forum FIE, the Israeli distributor of Vanguard Mutual Funds.

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