Can We Live With a Living Wage?

Here at the University of Virginia, I am fortunate enough to be a member of the Burke Society, a conservative group dedicated to the principles of Edmund Burke that meets every Thursday evening for debate and discussion. With the generous support of the American Enterprise Institute, distinguished labor economist Michael Strain addressed the Society and the greater UVa community, and shed some light on various issues relating to the minimum wage, including UVa’s Living Wage campaign and President Obama’s recent state of the Union address. I thought it would be valuable to compose a broad summary of his major points for those who could not attend the lecture.

Strain began by offering a basic economic principle which he was argued critical to a proper understanding of wages and the labor market. A wage is ultimately constrained by supply and demand and the economic value that a worker contributes to a firm. If you can flip 20 hamburgers in one hour, Strain explained, and each of those can be sold for two dollars, you have added forty dollars of value to a firm. A firm can not and will never pay that worker forty one dollars. Typically, minimum wage, low skilled and uneducated workers don’t individually contribute very much value to a firm. That is simply a point of fact. This does not mean that those individuals don’t work extremely hard, aren’t wonderful people and aren’t indispensable to the business in the aggregate. This simply means that the revenue brought in by each individual low-income worker is relatively quite small.That wages are determined in the market by the quality of the work and the supply of workers is a generally agreed upon economic theory as old as Adam Smith (though this point, admitted Strain, was far from  unanimously accepted).

Next, he addressed and attempted to debunk the major arguments made in favor of a minimum wage.

The first, and perhaps most controversial argument is the nature of the existing empirical evidence. Strain fully acknowledged the presence of several serious and well respected studies contradicting established economic theory. In my own experience, most advocates of a high minimum wage, including the UVa Living Wage Campaign, point to the Card-Krueger Study, a groundbreaking and controversial piece of research, the results of which defy accepted theory and experience.  Fortunately, when results contradict well established conclusions, those conclusions are rightfully scrutinized for error or bias. In the case of the Card-Krueger study, two famous economists, Neumark and Wascher, found what they believed to be serious problems in Card and Krueger’s phone-interview data collection method, and upon collecting the very same data in a more reliable method (actual payroll data), they came to precisely the opposite conclusion, which Strain summarized: when price (in this case a wage) increases, demand (in this case hiring) decreases.

With regards to the living wage campaign, explained Strain, the most compelling piece of evidence against their platform came, albeit unintentionally, from their very own website, which complained that after raising the minimum wage from $10.65 to $11.30 an hour, the University had been turning to contracted employees to cut costs. Furthermore, the Living Wage campaign’s list of over 300 faculty sponsors contained not a single name from our economics department.

Strain then addressed the common objection that many CEOs and other higher level workers are paid extraordinary salaries and that higher wages for minimum wage employees could simply be raised by detracting from their pay. Strain was quick to note that arguments like these, and efforts to justify them economically, come from a basic conception of fairness typical of American culture. Strain reminds us that it’s important to remember what’s possible is not the same as what’s optimal, and businesses would still have no incentive to pay anyone more than what it thought their labor was worth, irregardless of the salaries of its CEOs. Furthermore, Strain argued, altruistic companies who tried would easily be competed out of the market by companies who didn’t at home and abroad.

Very much to their credit, Americans, said Strain, value equality and are uncomfortable with income inequality. Though proponents of a higher minimum wage have good intentions, Strain points out that the minimum wage is an ineffective way of alleviating the hardships of the poor. This is not simply due to the connection between wage floors and unemployment, but also because of the way benefits from increased wages are distributed in practice. Because hikes in the minimum wage deal only with per hour wages and are blind to the household income of the recipients, only a modest fraction of people who benefit from minimum wage hikes are from poor households, a much larger portion of beneficiaries being part-time workers from middle class households. Finally, and perhaps most importantly, because minimum wage hikes make hiring unskilled workers more expensive, they provide an obstacle towards upward mobility for America’s poorest workers, particularly young minorities, who find themselves unable to gain valuable entry level work experience and grab on to the lowest rung of the job market ladder. To support this claim, Strain cited the disturbingly high unemployment rate among young minorities.
Michael Strain received his PhD in economics from Cornell University and is currently a research fellow at the American Enterprise Institute.