The Minimum Wage Does Indeed Cause Unemployment

The minimum wage is being spoken about again thanks to Obama’s recent State of the Union Address. To be honest, I don’t know how people still manage to sit through the whole thing to find out what he’s saying, but kudos to them!

In his speech, Obama proposes raising the federal minimum wage from its current $7.25/hr to $9.00/hr. Why anyone would want to raise the minimum wage when unemployment is already very high is beyond me. Oh, but wait! The Department of Labor says it doesn’t cause unemployment  (HT2 EPJ).

The president’s plan to raise the federal minimum wage will benefit 15 million American workers, and have a positive effect on the economy. Still, there are some common myths about raising the minimum wage. We checked in with our Chief Economist Jennifer Hunt on the following three myths:

Myth: Raising the minimum wage reduces employment. False Minimum wage increases have little or no adverse effect on employment as shown in independent studies from economists across the country. Additionally, a recent letter by leading economists including Lawrence Katz, Richard Freeman, Joseph Stiglitz and Laura Tyson points out that “[i]n recent years there have been important developments in the academic literature on the effect of increases in the minimum wage on employment, with the weight of evidence now showing that increases in the minimum wage have had little or no negative effect on the employment of minimum wage workers, even during times of weakness in the labor market.

Myth: Raising the minimum wage will negatively affect teen employment. False Eighty-nine percent of those earning the minimum wage are 20 years of age or older, and studies have shown that minimum wage increases have had little or no adverse effect on teen employment.

Before I show why the above is incorrect, let me go through the logic of why the minimum wage does cause unemployment. I have already explained it here and here, but I will give a very brief explanation again. Many economists like illustrating the effect of the minimum wage on employment through supply and demand. If a price floor is put above a market equilibrium price, then it will cause a surplus. In the case of the minimum wage as a price floor, the wage is the price, and labor is the commodity. In other words, there will be a surplus of labor supplied by prospective workers over labor demanded by employers.

However, a simpler and even more intuitive explanation exists. The goal of most companies is to earn profits. Employers will not hire employees unless it helps them earn a profit. So if an employee contributes $8/hr, an employer will not hire that employee at a wage any higher than $8/hr. If in this example, the minimum wage is at $7.25/hr, the employer can profitably hire that worker for $0.75/hr ($8.00 contribution – $7.25 wage = $0.75 profit). If, however, the minimum wage is raised to $9/hr, then he would earn losses of $1/hr by hiring that worker ($8.00 contribution – $9.00 wage = $1.00 loss); in other words, he will not hire that worker and the worker will be unable to find a job. Therefore, the higher the minimum wage, the fewer workers that can find a job, and the higher the unemployment rate.

But what about those studies the DoL is claiming disproves my logic? Well, to put it simply, they don’t. Logic should be debated against on its own terms. If a premise is true, and valid logic is used, then the conclusion must also be true. Empiricism does not change this. Empiricism may give us reason to doubt logic and look for errors, but it does not disprove logic itself.

In addition, many empirical studies come to completely opposite conclusions. I and two classmates did an econometric study about the effect of the minimum wage on youth unemployment, comparing state by state. We found a positive correlation of 4.6 (i.e., for every increase of $1.00/hr in the minimum wage, there was a corresponding increase of 4.6% in the youth unemployment rate). This is in complete contradiction of the study they cite above.

Does my study prove that there will always be an increase of 4.6% in the youth unemployment rate for every $1.00/hr increase in the minimum wage? Absolutely not. The study is only historical. It is not predictive. Economics is the study of human action. Human action can always change. Humans can invent new ways to act. They don’t have to act exactly as they did in the past. There is no law of behavior mandating that human interactions lead to a 4.6% increase in unemployment for every $1/hr increase in the minimum wage.  Unfortunately, this is only the first of numerous problems with econometrics.

Although such studies are only historical, are they even correct? Can we undoubtedly say that the effect of the increase of $1/hr in the minimum wage was a 4.6% increase on youth unemployment? Even this we cannot be sure about. There are a myriad of variables we simply cannot account for, or would even think to account for. How do we know it was the effect of the minimum wage that caused that unemployment? What about the business cycle? Maybe certain businesses coincidentally made poor decisions. Etc. etc.

We can show whatever we want with an econometric study. The methodology is completely flawed. The correct methodology of economics, of human action, is what Mises came up with: praxeology. The causal-realist approach allows us to look at human action and understand what specific causes lead to certain effects, rather than rolling around endlessly in a sandbox saying one grain of sand does this or that when there are millions of other grains that may actually be more important.

Let’s again look at the logic and think more about the absurdity of saying increases in the minimum wage don’t cause unemployment. If that’s true, why not raise the minimum wage to $20.00? Or $50.00? Or $100.00? If we can achieve prosperity with the wave of our magic legislation wand, why not do it on a bigger scale? Because it would cause massive unemployment. When people talk about raising the minimum wage by a smaller amount, they are only talking about increasing unemployment by a smaller amount. And this is probably why econometric studies on the minimum wage come to different conclusions so often. Because what they’re measuring isn’t very large, and a lot of other factors they don’t account for may be more important.

An anonymous commentor at a blog I found today makes another very important point:

So if increasing the minimum wage does not mean jobs will be destroyed and unemployment will go up, then does the contrapositive hold true that if you lowered or eliminated the minimum wage that jobs would not be created and unemployment wouldn’t decrease?

Liberals complain non-stop about job shipped overseas since 40% of the world lives on less than $2/day. Those jobs went overseas because they are illegal to create here and pay a wage that makes economical sense.

Many individuals that realize jobs go overseas because wages are cheaper over there don’t pursue the logic all the way. The reason we lose out on many of those jobs are  because those jobs are illegal here, thanks to the minimum wage.

An increase in the minimum wage will cause an increase in unemployment, all else equal. If Obama is successful in increasing the federal minimum wage, unemployment will be higher relative to whatever level it would have been otherwise. This means that you could see the unemployment rate even go down even with an increase in the minimum wage, not because of the minimum wage but in spite of it. This is precisely why empiricism is an incorrect method for discovering causal relationships.

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Posted on February 15, 2013, in Economics, Politics and tagged , , , , , , , , , , , , . Bookmark the permalink. 1 Comment.

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