Better Ways to Help Workers Than Minimum Wage Hikes

This year’s Nobel Prize in Economics was awarded to David Card, Joshua Angrist and Guido Imbens for their natural experiments on a range of labor market issues. The surprising findings of Card and Krueger on the impact of an increase in the minimum wage, comparing fast food restaurants in New Jersey, where the state minimum wage rose from $ 4.25 to $ 5.05 in 1992, with a control group in neighboring eastern Pennsylvania, where it was not hiked, has received much attention since then.

The standard free market economy based on the perfectly competitive firm predicts that employment will fall. In their pioneering 1994 article, Card and his late colleague Krueger claimed they found the opposite: employment actually increased in New Jersey compared to eastern Pennsylvania. In its award statement, the Nobel Committee discussed this article at length and drew a graph outlining their findings.

The minimum wage policy doesn’t just quibble over an obscure academic question. The economic impact of raising the minimum wage has been a major issue in the Trump-Biden-Harris presidential debates in the United States. In recent years, urban America, and California in particular, have been ravaged by homelessness, and many working poor are undoubtedly struggling. Strong political and social constraints have raised the wage floor in California to $ 14 an hour, starting in 2021, with $ 13 for establishments with 25 workers or less.

The federal minimum wage, the binding floor for all-state minimum wages in the United States, is currently $ 7.25 an hour. It has not been changed since 2009. As of 2021, the mandatory minimum wage for 17 US states is the federal wage. Pressure to raise the minimum wage in many states is clearly escalating, although Republican-controlled states with binding federal minimum wages may resist. This year, 21 states raised their minimum wages from 2020 levels to an average of $ 11.33 an hour.

The awarding of a Nobel Prize to David Card lends even more intellectual respectability to the widely spread campaign for a living wage of $ 15 an hour in America now. Former US President Barack Obama appointed Alan Krueger as senior political adviser and wanted to raise the federal minimum.

Take for granted Card-Krueger’s conclusion that increases in the minimum wage do not reduce employment. However, note that this conclusion is questionable, as a response by David Neumark and William Wascher to the original Card-Krueger article from 1994 and their reviews of subsequent similar articles pointed out. The Nobel Declaration does not mention the criticisms of Neumark-Wascher. Surprisingly, ditto for the pricing review I’ve read so far – which admittedly is pretty limited.

It is certain that small increases in the minimum wage over time can be absorbed by an economy without negative effects. This is due to the increase in productivity, which leads to higher and sustainable average real wages. Indeed, increases in the minimum wage can act as a spur to the design of labor-efficient machines.

Nonetheless, it does not follow that minimum wages should be the main focus of policy to help the working poor in the United States. A salary of $ 14 an hour at the market exchange rate is a princely amount in most parts of the world. If people are struggling to make ends meet at that salary in San Francisco and Los Angeles, given the skyrocketing numbers of homeless people, the first question to ask is why is the cost of living, and housing in particular is so high in America. According to recent data, the average monthly apartment rental in California was $ 1,731 (Statista.com). Consider $ 1,600 for a very low-end apartment rental in very expensive San Francisco. At close to the minimum wage of $ 14 for a 40-hour week (which all workers who want to work 40 hours a week may not get), a full-time worker left alone earns, say, $ 2,200. The rent is then more than 70% of the monthly income. It is difficult to manage and impossible to do unless the worker works 40 hours per week.

There are many reasons in general for America’s high cost of living, ranging from exorbitant medical expenses to its excessive litigation, especially for medical malpractice, and the like. However, the main reason, in my opinion, is America’s strict zoning laws which prevent the establishment of commercial dormitories for the poor, students, singles and many others in similar categories.

Allowing ‘granny apartment’ annexes on the same land, flexible sublet agreements, short-term rentals, faster evictions for default of rent and the conversion of unused garages into rented rooms will increase the rental supply and lower rents. Airbnb alone cannot do the job. The number of people per housing unit in the United States has declined since the 1950s, when the norm was a male breadwinner as a tenant with wife and dependent children. US zoning laws are tailored to its suburbs.

In short, the current proposals to increase the minimum wage in America are flawed because these increases will hardly help cover rental costs for housing. The country’s perennial minimum wage debates distract from much more crucial policies needed to lower the cost of renting housing for the working poor.

As for the limitations of natural experiments and randomized controlled trials, and the drawbacks of basing social and economic policy on them, I will discuss them in a follow-up article.

Vivek Moorthy is Professor, Indian Institute of Management Bangalore

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