Cowen and Cochrane are confused about price controls

Tyler Cowen and John Cochrane think that the minimum wage traces out a labor demand curve.  It does not.  There are many ways that a competitive labor market can comply with the minimum wage, and cutting employment is only one of them.  E.g., change the composition of compensation, change the work schedule, change the location of employment, etc.

So labor demand could be wage-elastic but a socially costly minimum wage have no effect (or even a positive effect) on employment in a competitive labor market.

For a more detailed analysis, see also The Upside Down Economics of Regulated and Otherwise Rigid Prices.

Judge the Federal Dept of Labor by Intentions, not Results

According to the Department of Labor, it is now adding 4.2 million workers and their employers to those required to obey detailed federal regulations on weekly pay and work hours. The stated intention is to help women and other relatively low-income employees.

Most of those 4.2 million workers are earning significantly above the straight-time minimum wage rate. For them, economic theory and evidence (e.g., Prof. Stephen Trejo, now of the University of Texas, wrote his dissertation on this at the University of Chicago) suggest that their straight-time wage rate will be lower than it would have been if the DOL had not changed the rules. This will make their income more cyclical -- making them poorer when their incomes are low and richer when their incomes are high -- with little effect on their average pay or hours.

Trejo's results suggest that there will be also some adjustment of employment and work schedules. Because the new regulations apply only to workers earning below about $48K per year, they create incentives to reallocate work from low-income workers to higher income workers. Another way of increasing income inequality!

This is a new cost for employers that disproportionately hire low-income workers, and ultimately for the customers that buy their products. This will cause some of those industries to shrink, perhaps leaving low-income people with less employment as well as less income while they are employed. It is possible that high-income workers benefit, as their industries are not harmed as much by the new rules. i.e., yet another way of increasing income inequality!

The new rules are about cash wages, and not fringe benefits, so another effect is fewer fringe benefits to help pay for the extra cash wages. The consolation for those of the affected workers that lose their health insurance: Obamacare! (No consolation for taxpayers, who will have to help pay for that problem).

You may have noticed that GDP per capita is hardly growing -- at a mere 1.3 percent per year over the past 3 years. An important reason for this is all of the new federal interference in how business is done. Obamacare already heavily distorts the workweek, especially for workers with incomes below $48K, and now these new regulations are adding to it. More and more, work schedules are being chosen to satisfy federal rules and less for creating value in the marketplace.

My promise: If you like your weak economy, you can keep it! Especially if you are a low-income worker.

The Labor Market and Labor Policy Since Kennedy

Copyright, The New York Times Company

Fundamental changes in economic performance since the John F. Kennedy presidency help explain why economic policy debates are so polarized these days.

In its 34 months, the Kennedy administration embraced a range of interesting federal economic policies. Kennedy proposed permanently cutting personal and corporate income tax rates to promote economic growth, and his cuts became law. During his administration, the maximum duration of unemployment benefits was temporarily extended only 13 weeks, less than in any other recession since then.

He expanded the federal space program. He wanted a strong peacetime military and was willing to use it to stand up to communism. His Department of Justice, led by his brother Robert F. Kennedy, was tough on labor unions.

President Kennedy pushed for national health reform, although he did not see any legislation passed during his term. As a candidate and then president, Kennedy was initially cautious on civil rights issues, but ultimately worked to put together a civil-rights bill that became the Civil Rights Act of 1964.

From today’s perspective, Kennedy looks like a hybrid of a Democrat and a Republican, and as America remembers his assassination in November 1963, journalists and scholars continue to debate whether Kennedy was a liberal.

In my view, Kennedy was entirely a Democrat, but that’s less visible today because Democrats and Republicans, and their respective economists, were a lot less different than they are now, especially on matters of microeconomics. Kennedy was advised by James Tobin of Yale, a Nobel laureate who advised other Democratic presidents, too.

Both Tobin and Milton Friedman, who subsequently advised several Republican candidates and was an adviser to President Richard M. Nixon, were concerned that antipoverty programs would perpetuate poverty by giving people too little reward for taking care of themselves. Tobin wrote that high marginal tax rates cause “needless waste and demoralization,” adding:

This application of the means test is bad economics as well as bad sociology. It is almost as if our present programs of public assistance had been consciously contrived to perpetuate the conditions they are supposed to alleviate.

Tobin thought public programs had gone seriously awry whenever program participants kept less than a third of what they earned on a job, rather than losing it to extra taxes or withdrawn benefits. Friedman thought that people should keep at least half of their earnings after taking into account taxes or lost benefits. Yet in modern times, Friedman and Tobin appear to be quibbling, because now we have millions of citizens who keep a quarter of what they make, or less, in net earnings beyond the benefits they forgo, yet few Democrats are concerned that federal antipoverty programs might be counterproductive.

In “Roofs or Ceilings?” Milton Friedman and George J. Stigler wrote about the economic damage done by minimum wages, rent controls and other restrictions on market prices. Tobin offered similar explanations, writing:

People who lack the capacity to earn a decent living need to be helped, but they will not be helped by minimum wage laws, trade union wage pressures or other devices which seek to compel employers to pay them more than their work is worth. The more likely outcome of such regulations is that the intended beneficiaries are not employed at all.

(Unlike Friedman, Tobin did subsequently support a minimum-wage increase, because he thought better antipoverty tools would not be used).

These days, Democrats push for higher minimum wages, without any apparent concern that poor people might have more trouble finding work.

My point is not that Democrats are more wrong about economics that they used to be, but that, regardless of who is right or wrong, the gaps between Democrats and Republicans in economic reasoning are greater now than they used to be.

The economy is different now than it was in the 1960s, especially in that the incomes of the poor have not kept up with national incomes. When the poor are prevented from working by minimum wages or high marginal tax rates, a lesser fraction of national income is lost than in Kennedy’s era, when the poor could produce a more significant piece of the national economic pie.

So proponents of big social programs have less reason to be cautious about program expansions.

As long as the American economy produces such a wide range of labor market outcomes, we may never see a president, who, like Kennedy, has such wide-ranging economic policies.

Hidden Costs of the Minimum Wage

Copyright, The New York Times Company

The current federal minimum wage of $7.25 an hour is increasingly creating economic damage that needs to be considered with the benefits it might offer the poor.

Democrats are now proposing to increase the federal minimum wage to $9 an hour. News organizations have repeatedly noted that economists do not agree on the employment effects of historical minimum-wage changes (the more recent federal changes in 2007, 2008 and 2009 have not yet been studied enough for us to agree or disagree on results specific to those episodes) and do not agree on whether minimum wage increases confer benefits on the poor.

That doesn’t mean that we economists disagree on every aspect of the minimum wage. We agree that minimum wages do some economic damage, although reasonable economists sometimes believe that the damage can be offset and even outweighed by benefits.

More important, we agree that the extent of that damage increases with the gap between the minimum wage and the market wage that would prevail without the minimum. A $10 minimum wage does less damage in an economy in which market wages would have been $9 than it would in an economy in which market wages would have been $2.

Moreover, elevating the wage $2 above the market does more than twice the damage of elevating the wage $1 above the market. (Employers can more easily adjust to the first dollar by asking employees to take more responsibility or taking steps to reduce turnover, steps that get progressively harder.) That’s why economists who favor small minimum wage increases do not call for, say, a $100 minimum wage, because at that point the damage would far outweigh the benefits.

Market wages normally tend to increase over time with inflation and as workers become more productive. As long as the minimum wage is a fixed dollar amount, the tendency for market wages to increase over time means that economic damage from the minimum wage is shrinking. That’s one reason that economists who see benefits of minimum wages would like to see minimum wages indexed to inflation, allowing the minimum wage to increase automatically as the economic damages fell.

But these are not normal times. The least-skilled workers are seeing their wages fall over time, largely because they are out of work and failing to acquire the skills that come with working. Moreover, the new health care regulations going into effect in January are expected to reduce cash wages, as many employers of low-skill workers are hit with per-employee fines of about $3,000 per employee per year, as the law mandates new fringe benefits for other employers and low-skill workers have to compete with others for the part-time jobs that are a popular loophole in the new legislation. (The minimum wage law restricts flexibility on cash wages, by establishing a floor, but makes no rule on fringe benefits.)

To keep constant the damage from the federal minimum wage, the federal minimum wage needs not an increase but an automatic reduction over the next couple of years in order for it to stay in parallel with market wages.

Pre-order your copies of The Redistribution Recession

In the next several days I will be reviewing the page proofs of my forthcoming book The Redistribution Recession.

You can pre-order a hard cover version with color charts, including shipping, for less than $35!! That's so cheap that you'll want to order one for home and another for the office.

Amazon.com

Barnes and Noble

Redistribution, or subsidies and regulations intended to help the poor, unemployed, and financially distressed, have changed in many ways since the onset of the recent financial crisis. The unemployed, for instance, can collect benefits longer and can receive bonuses, health subsidies, and tax deductions, and millions more people have became eligible for food stamps.

Economist Casey B. Mulligan argues that while many of these changes were intended to help people endure economic events and boost the economy, they had the unintended consequence of deepening-if not causing-the recession. By dulling incentives for people to maintain their own living standards, redistribution created employment losses according to age, skill, and family composition. Mulligan explains how elevated tax rates and binding minimum-wage laws reduced labor usage, consumption, and investment, and how they increased labor productivity. He points to entire industries that slashed payrolls while experiencing little or no decline in production or revenue, documenting the disconnect between employment and production that occurred during the recession. The book provides an authoritative, comprehensive economic analysis of the marginal tax rates implicit in public and private sector subsidy programs, and uses quantitative measures of incentives to work and their changes over time since 2007 to illustrate production and employment patterns. It reveals the startling amount of work incentives eroded by the labyrinth of new and existing social safety net program rules, and, using prior results from labor economics and public finance, estimates that the labor market contracted two to three times more than it would have if redistribution policies had remained constant.

In The Redistribution Recession, Casey B. Mulligan offers hard evidence to contradict the notion that work incentives suddenly stop mattering during a recession or when interest rates approach zero, and offers groundbreaking interpretations and precise explanations of the interplay between unemployment and financial markets.

---

I understand that physical copies are scheduled to ship from the press' warehouse on October 4 ... a week or two after that, the book should be available for immediate purchase.

Where a Minimum-Wage Increase Would Bite

Copyright, The New York Times Company

Last week I explained how I estimated that the July 2009 federal minimum-wage increase reduced national employment by about 800,000. That 800,000 is the sum of employment impacts for each of several demographic groups and can therefore be used to estimate which groups were most affected by the wage increase.

For each group distinguished by age and part-time status, I calculated “impact”: the percentage gaps between actual per capita employment after July 2009 and the employment I estimated to occur absent the minimum-wage increase.

For example, I found the part-time employment impact among teenagers to be negative 14 percent: that is, 14 percent fewer teenagers were working part time since July 2009 as a result of the federal minimum-wage increase.

The basic economics of the minimum wage suggests that employment impacts will be greatest among groups with the lowest hourly wages. Teenagers employed part time have particularly low hourly wages, and the hourly wages for teenagers employed full time are not much greater. The percentage impact on people 20 and over working full time should be essentially zero, because 98 or 99 percent of them would make more than the minimum wage anyway (see Table 1 of this paper).

The chart below compares, by group, the minimum-wage increase’s employment impact (vertical axis) to a measure of the hourly wages of the workers in the lowest-paid quarter, shown on the horizontal axis). The diagram shows that impacts are negative, or essentially zero, and that the size of the impact is progressively smaller for groups with higher wages – exactly as economic theory predicts.

Compare, for example, the minus 13 percent impact for teenagers in part-time jobs (25 percent of whom were earning less than $5.17 an hour in 2008 — note that a -0.13 log change is essentially a 13 percent reduction) with the zero percent impact for full-time workers 20 to 54 (75 percent of whom were earning more than $11.76 an hour).

Teenage employment rates have fallen to 25 percent from 35 percent over the last four years. Much of that drop cannot be attributed to the federal minimum wage, but my estimates show that the federal minimum wage was a significant factor.

Profs. William E. Even and David A. Macpherson also studied the recent minimum-wage increases for the Employment Policies Institute, using a different methodology. They focused on teenagers (not distinguishing part time and full time), and their state-level model included three federal minimum-wage increases (2007, 2008 and 2009).

They found that those three increases cost 114,000 teenage jobs (I found 800,000 for all age groups combined, only some of which were teenage employment effects; Prof. David Neumark had estimated that teenage and young-adult employment would be reduced 300,000 as a result of the July 2009 minimum-wage increase).

A minority of states were not affected by federal minimum-wage increases because their own state-legislated minimum wage would exceed even the new higher federal minimum (the federal minimum prevails over the state minimum whenever the former is greater).

Thus, whatever jobs were lost because of the federal increase would be lost in the states — 31, after the 2009 increase — and the District of Columbia (which sets its minimum to be $1 above the federal minimum, so when the federal minimum jumps, do does the district’s). Professors Even and Macpherson’s state-level estimates confirmed that this was, in fact, the case.

For the same reason that my model separately considered teenagers and part-time workers, Professors Even and Macpherson followed their teenagers study with a study of 16-to-24-year-old men with less than a high school diploma. They found that each 10 percent increase in a federal or state minimum wage decreased white employment by 2.5 percent, Hispanic employment by 1.2 percent and black employment by 6.5 percent.

For the time being, at least, it seems that increasing the federal minimum wage again would give a few workers a small raise — but at the cost of eliminating entire paychecks for the young, less educated and least skilled.

How to Create Jobs and Cut the Deficit

Copyright, The New York Times Company

Another federal minimum-wage increase would not, as some proponents promise, create jobs, but would reduce employment.

A few months ago, The New York Times editorialized that America’s minimum-wage workers “need a raise.” The Center for American Progress said a higher federal minimum wage “encourages spending, investment and economic growth.”

Many economists expect the minimum wage, if it has any effect, to raise employer costs and thereby reduce employment, especially among people who are likely to work in minimum-wage jobs, like part-time workers.

Federal and state minimum wages have changed a number of times over the years, and each of those instances provides an opportunity to test the employment-reducing hypothesis. For the episodes before 2007 (which I’ll refer to as the historical minimum-wage increases), many statistical studies of minimum-wage effects are summarized in books by David Neumark and William L. Wascher and David Card and Alan B. Krueger.

Not everyone interprets the historical evidence the same way. The New York Times and the Center for American Progress cited some of that evidence to alleviate concerns that a minimum-wage increase would reduce employment.

Even those who believe that historical minimum-wage increases did little, if anything, to reduce employment are still likely to appreciate that a minimum wage that was high enough — a hypothetical $100 an hour, for example — would significantly depress employment. The real disagreement is whether historical minimum wages were high enough, and the economic situations right, for those increases to destroy a large number of jobs.

The most recent federal minimum-wage increase, on July 24, 2009, had the potential to have different effects than its predecessors. Adjusted for inflation (and deflation), by 2009 the real federal minimum wage had been raised to a level 32 percent higher than it had been in 2006 — nowhere near our hypothetical height, which we all agree would be destructive — but perhaps high enough to have some of those effects.

In addition, during a recession hiring decisions may be especially sensitive to employment costs, though some economists say recessions make employment less sensitive to wages.

It’s also easy to exaggerate the effects, good or bad, of the federal minimum wage, because seasonal workers, employees who rely on tips and others are exempt from it, and a few states have minimum wages above the federal minimum.

For these reasons, I have been studying the 2009 federal minimum-wage increase by itself and trying to separate the effects of the recession from the effects of the wage increase (see this recent publication for more details; my next posts will point to some other findings from the 2009 increase).

Part-time and teenage employees are especially likely to have hourly wages near the federal minimum. The red line in the chart below displays seasonally adjusted national part-time employment by month, from the Census Bureau’s monthly household survey. Before July 2009, part-time employment increased by about three million during the recession and that month reached the peak level of part-time employment.

To investigate the possibility that the July 2009 wage increase stopped further increases in part-time employment and perhaps affected other employment categories, I estimated a monthly model of national part-time and full-time employment per capita for each of 12 demographic groups distinguished by race, gender and age (white and nonwhite, male and female, and 16 to 19 compared with 20 to 54 and 55 and over), using data from before the increase.

I used the model to forecast part-time and full-time employment for each demographic group for August 2009 through December 2010. The aggregate deviation of the part-time predictions from the actual was added to the red line to arrive at the aggregate part-time prediction shown as the chart’s blue line.

After falling 9.3 million during the recession through July 2009, aggregate full-time employment fell another 1.8 million by the end of the year and remained below July 2009 levels at the end of 2010. Some people dismissed from their full-time jobs probably had trouble finding another suitable one, and some of them worked part time while they searched.

Consistent with this story, my estimates predicted that part-time employment would have continued to increase during the second half of 2009 because, before the increase, part-time employment tended to increase with full-time job losses.

The actual and predicted data depart dramatically beginning in September 2009, with actual part-time employment 1.2 million below predicted part-time employment by December and averaging 975,000 part-time positions below what was predicted over the months August 2009 to December 2010.

A small number of these job losses were offset by possible increases in full-time employment (relative to what it would have been – more on this next week). I find the total job loss from the July 2009 minimum-wage increase to be about 800,000.

If raising the minimum wage reduced employment by 800,000, cutting it back to its early 2009 level is likely to increase employment by 800,000. That would add a bit to government revenue as some of those people moved from unemployment benefits to tax-paying workers.

Summertime Blues for Teenagers

Copyright, The New York Times Company

Many teenagers cannot find work this summer, victims of a weak economy and a situation made worse by minimum-wage laws. Budget cuts for government youth-employment programs are a much less important factor.

Employment rates among teenagers are much lower now than they were before the recession began. While some people blame cuts to summer youth-hiring programs by state, local and federal governments, even in the best of times these provide only a small fraction of summer jobs for teenagers.

I used the Census Bureau’s monthly household surveys from January 2000 to December 2009 to calculate the amount that each industry’s employment of teenagers (measured as the sum of hours worked by all persons 16 to 19) during June, July, and August exceeded its average value in the months of April, May, September and October. For the economy as a whole, the average teenager worked 11 hours a week during the summer, compared with an average of eight hours a week during the academic year.

Not surprisingly, the arts, entertainment and recreation industries provided more of those extra work hours – about 16 percent of them — than any other industry group. Accommodation and food services — that is, hotels and restaurants — provided 15 percent.

Retail trade and construction were next among the job providers, with 11 and 9 percent, respectively. Local government was fifth, providing less than 9 percent of the extra summer work for teenagers. Even the combination of local, state and federal government hiring explained less than one-eighth of the extra summer work for teenagers (for the contributions of more industries, see Table 4 of this paper).

The vast majority of summer youth hiring is done by the private sector, and even if government eliminated its summer youth hiring, that would hardly dent the total.

(Employment rates for adults are also much lower than they were before the recession, although in lesser percentages than for youth. As with youth, private-sector employment reductions were much larger than the public sector reductions.)

Employment during recessions tends to drop disproportionately among low-skilled people like teenagers, so the latest recession has to be the biggest factor in explaining why teenage employment rates are so low today.

But minimum-wage laws also disproportionately affect teenagers — reducing their employment rates — and the federal minimum wage was increased three times in and around this recession. (Next week I will present more evidence on the number of jobs lost because of the most recent federal minimum wage hike.)

If the government wants to help raise teenage employment rates significantly, a good way to start would be by reducing labor market regulation rather than spending tax dollars on youth employment programs.

Did the Minimum Wage Increase Destroy Jobs?

Copyright, The New York Times Company

As I’ve discussed before, national trends suggest that the sharp fall in part-time work during the last five months of 2009 can be largely attributed to last summer’s federal minimum-wage increase. A look at job changes in individual states seems to confirm this conclusion.

Two months ago, I noted how national, seasonally adjusted part-time employment increased almost 2.5 million during this recession, but then it peaked in July 2009 and headed sharply downward. I thought that it was no coincidence that the federal minimum hourly wage was raised, on July 24, 2009, from $6.55 to $7.25 — especially since the inflation-adjusted federal minimum wage had already gotten pretty high.

I estimated that part-time employment would have been about 500,000 greater in the last couple of months of the year if it hadn’t been for that last increase in the federal minimum. Many of us view 500,000 job losses as a lot because they would, for example, make a sizable dent in the jobs that the White House claimed last year that it would create with its $787 billion stimulus law.

Some of the readers of this blog, as well as the Economic Policy Institute, wondered whether my conclusion about the federal minimum could be confirmed with regional data.

After all, 19 states were not directly affected by the July 2009 federal increase because they already had their minimum wage at least at $7.25 per hour (the federal minimum prevails over the state minimum whenever the former is greater). Thus, whatever jobs were lost because of the federal increase would be lost in the other 31 states and the District of Columbia (which sets its minimum to be $1 above the federal minimum, so when the federal minimum jumps, do does D.C.’s).

Testing the state-level hypothesis with the Census Bureau’s household survey is not so easy because 500,000 job losses, significant as they are, can easily be swamped by seasonal and statistical fluctuations in the state-level household surveys.

Indeed, I noted before that even changes in the seasonally adjusted national-level household survey look a bit random from month to month. So it is no surprise that seasonally unadjusted, state-level monthly measures of part-time employment are also pretty noisy. (To my knowledge, neither the Census Bureau nor the Bureau of Labor Statistics has seasonally adjusted, state-level monthly part-time employment data.)

Another problem is that high-minimum-wage states have different labor markets than the others.

I try to alleviate this problem by comparing part-time to full-time employment, and considering just the months immediately after the federal move. (Combining a study of the federal change with studies of state minimum-wage increases could make the problem worse, because each state most likely reacts to its own economy when considering the timing of its increase; see Professor David Card’s paper on this point.)

With these cautionary notes, consider the chart below. It shows how the ratio of part-time workers to full-time workers has changed since its level in July 2009 (the last month that the federal minimum wage of $6.55 was in effect). For example, a value of “0.02” for December means that the ratio of part-time workers to full-time workers in a group of states in December was 2 percent greater than it was in July. (If you’re curious: Nationwide, there is one part-time worker for every four or five full-time workers).


The ratio increased in both the “unaffected” states (blue series) and the affected states (solid red series). As we know from the national seasonally adjusted data, the ratio did not increase nationally, so seasonality tended to increase both series. My claim is not that the federal increase would halt seasonality, but merely that it would put the ratio lower in the affected states than it would have been.

The red series for the affected states is below the blue series for the unaffected states four out of five months, which is consistent with the hypothesis that the federal increase caused part-time job losses in the affected states, but not in the others.

With all of this recession’s significant labor market problems, and the expensive federal efforts to offset them, it’s too bad that the minimum-wage law added so many people to the list of those who today cannot find jobs.

[TECHNICAL NOTE: There are a couple of ways to measure part-time in the CPS monthly files, and a couple of ways to extrapolate the sample totals to state-wide totals. Shown above are the results from the most conservative (showing the least gap between red series and blue seris) of these alternatives]

A Perfect Storm for the Minimum Wage

Textbook economic theory says that the minimum wage reduces employment according to (a) the gap between the minimum and the equilibrium wage and (b) the wage elasticity of labor demand.

By 2009, the perfect storm had formed that might even make the minimum wage noticeable from an aggregate point of view:

• The equilibrium wage likely fell due to deflation (about -2.1% July 2008 - July 2009)
• The equilibrium wage likely fell due to an increased supply of part-time workers, such as persons fired from their full-time jobs. Supply increased at least 10 percent in the quantity dimension, which pushed down the equilibrium real wage roughly 3 percent
• The nominal federal minimum wage had gotten high thanks to two recent previous hikes
• The nominal federal minimum wage was hiked again another 11 percent (from $6.55 to 7.25 per hour).

Thus, by June 2009 the federal minimum probably already exceeded the equilibrium wage for a significant number of workers, especially those part time. For example, the BLS estimates that 2.3 million part-time workers were at or below the federal minimum in 2009 (BLS does not specify which month or months, but I presume March gets a lot of weight), as compared to 1.4 million a year earlier.

So let's say that 2 million workers were affected by the 11 percent hike on July 24, 2009. With a labor demand elasticity of -3 (that's what Cobb-Douglas would predict), the textbook theory says that a half a million part-time workers would lose their jobs (or fail to be hired) due to the July 24, 2009 hike (525,177 = [1-(6.55/7.25)^3]*2,000,000).

Interestingly, the national data do suggest that about 500,000 part-time jobs were lost.

Without this perfect storm, the minimum wage would not be something of interest to macroeconomists, but "just" to observers of low-skill labor markets. Conversely, don't expect to see aggregate effects of the minimum wage unless the storm is as perfect as this one.

David Brooks' 170 degree turn

Take a look at this video of a discussion between Milton Friedman and David Brooks (and two others). Turn to the 38:15 mark.

Wow! Has he changed! I'm not talking about looking younger (we all looked different in 1990) ... I'm talking about statements like:

• "regulations must be minimal"
• "The FDA has made outcomes worse, not better"
• "Everyone agrees that the minimum wage destroys employment opportunities for poor people"
  
  

I suppose this change is correlated with switching his employment from WSJ to NYT?

The Government Spending Multiplier and Other Keynesian Paradoxes

The Great Recession of 2008-9 has brought forth some intriguing claims about public policy and the nature of factor supply. Using “New Keynesian” models to guide the discussion, a number of economists suggest that government purchases might stimulate private spending, rather than crowd it out, thereby increasing total spending more than dollar-for-dollar (Christiano, Eichenbaum, and Rebelo, 2009; Eggertsson, 2009; Woodford, 2010). At the same time, few have evaluated current macroeconomic policies on the basis of the incentives they provide to supply labor and other factors of production. Is it possible that factor supply does not matter during a recession? Or even worse, that our economy suffers from a “paradox of toil:” expansions in factor supply actually reduce aggregate output (Eggertsson, 2010)?

Economic theory suggests that the government spending multiplier and the paradox of toil are related, because both involve the (general equilibrium) relationship between factor supply conditions and private sector factor demand. Models with crowding out predict that a reduction in the supply of factors to the private sector – either because the government is using some of those factors or because a distortion causes some of the supply to be withheld – ultimately reduces private sector output and factor usage. One mechanism achieving this result is that private sector employers pass on their higher factor costs into output prices, which causes their customers to demand less. In “Keynesian” models, this pass through doesn’t happen and perhaps even the high factor rental rates feed back to increased demand for private sector goods.

One approach to these questions would be to use historical data to measure the government spending multiplier (Barro, 1981; Alesina and Ardagna, 2009; Barro and Redlick, 2009; Mountford and Uhlig, 2009; Ramey, 2009) or to measure output effects of factor supply growth. But it has been claimed that historical output responses to government spending impulses ought to be atypical of those that occur today, because today we are in a deep recession, and monetary policy is fundamentally different than it was in the past (Christiano, Eichenbaum, and Rebelo, 2009; Eggertsson, 2009; Woodford, 2010).

Even without the added burden of estimating a separate multiplier for deep recessions, clear and significant shifts in government demand that are economically similar to the kinds of spending proposed in government “stimulus” laws are difficult to find, and thereby difficult to translate into an accurate estimate of the government spending multiplier. The purpose of this paper is to exploit the close relation between the government spending multiplier and the paradox of toil, and the ready availability of obvious factor supply shifts during this recession, to test the paradox of toil hypothesis. The empirical analysis can be interpreted as a test (of whether government spending stimulates private spending) that is admittedly indirect, but not reliant on the historical data.

Section V of this paper examines three events that happened during this recession, for the purpose of determining whether the outcomes confirm the paradoxes rather than showing significant resource reallocation among competing uses of the economy’s output. Those events are: the labor supply shifts associated with the annual seasons, the minimum wage hike of July 24, 2009, and the collapse of residential construction spending.

The academic year concluded twice during this recession, and both times over a million teens entered the labor market. Well over a million of them found employment, and as a result total employment for the economy was significantly higher in July than it was in April. This pattern reversed itself the two times that the academic year resumed during this recession. The real federal minimum wage was hiked at the end of July 2009 from an already high level relative to the CPI. Employers of part-time workers appeared to respond by significantly cutting part-time employment after July 2009, despite the fact that part-time employment had trended strongly up prior to the hike. Finally, the collapse of housing construction served to shift resources into non-residential building.

Despite the presence of perhaps the deepest recession of our lifetime, and nominal interest rates on government securities that were essentially zero, these three episodes show how factor markets seemed to behave as if output prices were flexible at the margin. In particular, markets absorb an increased supply of factors of production – even during a recession like this one – and do so by increasing output. It would seem, then, that government spending crowds out private spending: the government spending multiplier is less than one.

Nothing about my results implies that this recession was efficient, or that government spending necessarily reduces efficiency. Indeed, my “flexible price model” includes a distortion in the output market and a distortion in the labor market. As noted by Woodford (2010), the presence of distortions by itself does not tell us whether government spending stimulates private spending, or how output responds at the margin to factor supply shifts.

This is not to say that output prices were actually flexible during the recession, because producer entry and exit and a variety of other market mechanisms could have many of the qualitative effects of flexible prices. Moreover, even if it were shown that output prices actually were flexible during this recession, that does not preclude the possibility that those prices would be inflexible in response to smaller shocks. But, for the purposes of this recession, models that feature fixed output prices have been a poor description of actual events in the real economy.

Addition to the Long List of Employment-Reducing Policies

The list of employment-reducing public policies grows yet again:

• Extra taxes for multi-national corporations (see yesterday's Wall Street Journal; HT Greg Mankiw)
• mandating the employers with large payrolls provide health insurance, but that employers with small payrolls do not,
• minimum wage hike
• means-tested mortgage modification (presenting millions of workers with implicit tax rates in excess of 100% (sic)),
• means-tested new home buyer credit,
• mean-tested student loan modification,
• unemployment insurance extensions,
• state income tax hikes,
• IRS means-tested enforcement of prior tax debts,
• planning for new-hiring-tax-credits,
• marginal federal tax rate hikes on the "rich"!

Politically Incorrect Proclamation on 60 Minutes

As part of my playoff-watching hangover, I saw 60 Minutes for the first time in years. The show featured a story about American Somoa, with the headline of the extraordinary number of Somoans who play in the NFL.

But 60 Minutes also mentioned (admitted!) that American's Somoa's recent experience vividly demonstrates how the minimum wage reduces employment.

Blog reader Jim Colburn pointed me to some fascinating commentary by Peter Schiff on the Somoan economy and the minimum wage:



If it weren't true, and harming so many people, minimum wage advocacy would be truly comical!

Attack of the Minimum-Wage Increase

Copyright, The New York Times Company

After initially increasing by almost three million during this recession, part-time employment fell sharply during the last five months of 2009. The federal minimum wage hike on July 24, 2009, is probably to blame.

The red series in the chart below is the number of people employed part time, as measured by the Census Bureau’s monthly survey of United States households. Part-time employment increased for nine months in a row from September 2008 until July 2009, for a total increase of almost 2.5 million positions over that time. (The household survey is small enough that the month-to-month fluctuations can look a bit random, but economists find it the best measure of labor-force trends that last more than a month or two.)



At first glance, any employment increase seems at odds with the basic current of this recession, which has been month after month of heavy job losses. In fact, full-time employment fell by 11 million, and much of the part-time employment can be understood as a partial offset to those losses.

For example, some people laid off from their full-time jobs are having trouble finding another suitable full-time job, so they are working part time while they wait. Part-time jobs pay less than full-time jobs — even on an hourly basis — so some employers may be using part-time employees to accomplish tasks where they formerly might have used full-time jobs.

From December 2007 until July 2009, for every five full-time jobs lost, part-time employment increased by one job. The blue series shown in the chart aims to predict the creation of part-time jobs from the data on full-time jobs alone, by assuming that each five full-time job losses created one part-time job. The series shows how this approach closely fits not only the overall increase, but also several of the changes in trend over that period.

Since July 2009, full-time employment has continued to fall, but we no longer see the partly offsetting part-time employment increase. The July 24 minimum-wage increase most likely changed that pattern.

In other words, if the minimum wage had stayed at $6.55, part-time employment probably would have closely followed the blue series in the chart, as it did until July 2009.

The federal minimum wage prohibits employment that compensates (not including fringe benefits) the employee less per hour than the federal minimum — $6.55 before July 24, and $7.25 since then. Thus, a $7-an-hour job was legal for most of July, but has been illegal since then.

Many economists expected that the new prohibition on jobs paying between $6.55 and $7.24 would disproportionately affect part-time jobs. After all, recall that part-time employment typically pays less per hour than full-time employment does.

Some of those employers raised their pay to conform to the new minimum, but others were expected to eliminate some of their part-time positions. That’s likely why the data show that, starting with August 2009, part-time employment began to reverse its prior trend.

With all of this recession’s significant labor market problems, it’s too bad that an ill-conceived and unnecessary minimum-wage law added hundreds of thousands of people to the list of those who today cannot find jobs.

Not Your Father's Recession

Copyright, The New York Times Company
Our recession predictably continues to be one in which real gross domestic product and spending outperform the labor market. This pattern differs from the 1980-82 recession and suggests that public policy could be doing a better job this time of raising employment.

At this time a year ago, with the three quarters of G.D.P. data that was available, I explained how this recession had followed a pattern described decades ago by Paul Douglas, the senator and economics professor.

Professor Douglas said that a labor crisis would hurt spending but only in a ratio of 7 to 10. That is, for every 10 percentage points that employment and hours worked fell, total output and spending would fall 7 percentage points. Equivalently, one side effect of a labor crisis would be to raise employee productivity and real hourly wages, because productivity is the ratio of output to labor.

Since then, four more quarters of data have become available to further test this theory. From the fourth quarter of 2007 to the third quarter of 2009 (the most recent quarter with data available, and some say the trough of the recession), employment and hours worked fell 8.6 percent, while real spending and output declined 5.8 percent (both relative to trends).

The declines are almost exactly in the proportions predicted by Professor Douglas decades ago (an earlier discussion of this approach can be found here.)

By definition, the fact that real G.D.P. performed better than labor means that productivity rose. As a result, we expect hourly labor costs (that is, the amount employers spend on payroll and benefits for each hour that employees work) to have risen too.

The chart below displays private sector productivity and real wage series for this recession. Both rose a couple of percentage points, especially over the last year.



Many readers of last year’s article thought that it was only obvious that real G.D.P. should fall less than employment — employers, they said, would force more work upon the workers who kept their jobs. Employers may in fact be acting this way (although why are they paying more per hour?), but this pattern is not found in all recessions. During the 1980-82 recession, which has often been compared to this one, real G.D.P. and spending fell significantly more than employment and hours.

Many economists would agree that the causes of the current recession are different than in 1980-82, and that some of the differences can be seen in the productivity data. Some would say that high real wages are part of the problem — that employers would be hiring more if labor were cheaper. If that’s right, public policy so far in this recession seems to have gone in exactly the wrong direction by raising the minimum wage and otherwise increasing employment costs.

A 'Paradox of Toil'?

Copyright, The New York Times Company

Some economists have been recently discussing a “paradox of toil,” meaning that an increased willingness to work actually depresses the economy. But evidence from this recession clearly shows that the paradox of toil is of little practical importance.

Paul Krugman explained Monday on his blog:

when you’re in a liquidity trap … If you cut taxes on labor income, this expands labor supply — which puts downward pressure on wages and leads to expectations of deflation, which increases the real interest rate, which leads to lower output and employment. [emphasis added]

This paradox of toil is of interest because it turns standard economics on its head, and helps rationalize the view that active fiscal policy can boost the economy even while it reduces incentives to work. Professor Krugman and other fiscal stimulus advocates tell us that the paradox of toil describes our economy during this recession.

Fortunately, the relevance of the paradox does not have to be taken on faith, but can be examined with data from 2008 and 2009.

For example, if the paradox described this recession, then the expansion of labor supply that occurs at the beginning of every summer as students become available to work would lead to lower employment. Or on the other hand, an increase in the minimum wage would increase employment as it raises prices and costs and leads to inflation.

In fact, the 2009 labor market reacted to these events in the conventional way, with no paradox.

When school let out for the summer of 2009, teenage employment increased by over a million, and total employment increased by about 700,000 (these May-July comparisons are necessarily seasonally unadjusted, because the school year is part of the seasonal cycle). The expansion in labor supply did not reduce total employment, as Professor Krugman would have us believe would have happened in a “paradoxical” year like 2009. Total employment expanded seasonally as it did in previous years.

The federal minimum hourly wage was increased from $6.55 to $7.25 at the end of July 2009. It did not have the stimulating effect that Professor Krugman assumes.

Teenage employment fell 1.5 million after that increase, as compared to the 1 million that teenage employment typically falls at the end of summers that do not have minimum-wage increases. Total employment also fell more than the usual seasonal patterns would suggest.

The evidence shows that the laws of economics remain in full force, despite the present “liquidity trap.”

One Minimum Wage Increase With a Side of Fries, Please

Copyright, The New York Times Company

Economists have debated the employment effects of the minimum wage. A recent study of obesity now weighs in on this debate.

Many economists expect the minimum wage, if it has any effect, to (among other things) raise employer costs and therefore reduce employment, especially among people who are likely to work in minimum wage jobs like teenagers and restaurant workers.

However, inspired by a study of a 1992 minimum wage increase in New Jersey, some economists have suggested that minimum wages can increase employment, by helping to cure pre-existing problems in the labor market. In their view, a higher minimum wage could increase employment and output at employers of low-wage workers, and a lower minimum wage would reduce them.

The typical example is a fast-food restaurant.

The minimum-wage-cures-labor-markets view says that a higher wage level causes fast-food restaurants (like other employers of low-wage workers) to hire more workers, produce more fast food and sell more fast food.

More fast food sold also probably means more obesity. Thus, if the minimum-wage-cures-labor-markets view was correct, a higher minimum wage would, all things being equal, probably result in higher obesity rates.

More conservative economists would argue, though, that high minimum wages restrict employment by fast-food restaurants, which means less fast food produced, which means less obesity.

In other words, the traditional economics view implies a lower minimum wage would, all things being equal, result in more obesity.

As you may know, Americans have indeed been getting more obese over the last couple of decades, with increased consumption of fast foods contributing to that enlargement. During most of that period, the inflation-adjusted federal minimum wage had been falling.

A recent study by the researchers David Meltzer from the University of Chicago and Zhuo Chen from the Centers for Disease Control and Prevention now finds that low inflation-adjusted minimum wages are partly to blame for increased obesity.

If their study is correct, it suggests that a higher minimum wage indeed reduces employment and output at fast-food restaurants, and makes it a bit easier for Americans to adopt healthier eating habits.

As with any new study, time is needed to digest the methodology and results, and integrate them with the previous literature. But expect the fight against obesity to weigh in on the debate about low-wage labor markets.

The Minimum Wage and Teenage Jobs

Copyright, The New York Times Company

Teenage employment has fallen sharply since July. The most recent minimum wage hike may be an important factor.

Many economists expect the minimum wage, if it has any effect, to (among other things) raise employer costs and therefore reduce employment, especially among those who are likely to work in minimum-wage jobs, like teenagers and restaurant workers.

In July 2007, the federal minimum hourly wage was increased for the first time in 10 years, from $5.15 to $5.85. It was increased again a year later to $6.55, and increased yet again this July to $7.25.

Because the minimum-wage law still permits employers to pay more than the minimum, economists agree that a low minimum wage has smaller effects than a high minimum wage. The inflation-adjusted federal minimum wage had gotten to its lowest in decades by early 2007, so the July 2007 increase should have had the smallest effects of the three.

The July 2009 increase should have the largest effect, because the combination of the two previous hikes and some deflation ($6.55 bought more in June 2009 than it did the previous summer) had already gotten the inflation-adjusted minimum wage relatively high.

The chart below shows a seasonally adjusted index of the percentage of 16- to 19-year-olds with jobs. That group is especially likely to be affected by minimum-wage legislation. Of course, this is a recession period in which employment has been falling for essentially all groups, so for reference the teenage percentage has been converted to an index by dividing by the percentage for all people, with July 2009 set as the benchmark (i.e., the teenage employment rate that month has been set to 100).

The chart shows teenage employment index values greater than 100 early in the recession, which means that employment rates fell in greater percentages for teenagers even before the July 2009 increase, as it did in prior recessions (even recessions without minimum-wage increases). With the index falling somewhat less than 1 percent a month before July 2009, we would expect the index to be somewhat below 100 after July 2009 even if the minimum wage hike had no effect.



But the teenage employment after July 2009 seems sharply lower. By October 2009, the index had fallen to 92.1 — a drop of about 8 percent in just three months — whereas the prior 8 percent drop had taken more than a year. This suggests that the 2009 minimum-wage increase did significantly reduce teenage employment.

Before this recession, economists hotly debated the employment effects of the minimum wage, with special attention to a 1992 minimum-wage increase in New Jersey (this book got it started, and this book is a good source for the opposing view).

More work is needed to determine whether the 2009 experience is fundamentally different from the earlier episodes that have been studied, but next week I will describe a new study that “weighs in” on those episodes.

Minimum Wage Regrets?

A couple of years ago, a number of "leading economists" endorsed the federal minimum wage law that legislated the current minimum of $7.25/hr:

Henry Aaron The Brookings Institution
Kenneth Arrow Stanford University
William Baumol Princeton University and New York University
Rebecca Blank University of Michigan
Alan Blinder Princeton University
Peter Diamond Massachusetts Institute of Technology
Ronald Ehrenberg, Cornell University
Clive Granger University of California, San Diego
Lawrence Katz Harvard University (AEA Executive Committee)
Lawrence Klein University of Pennsylvania
Frank Levy Massachusetts Institute of Technology
Lawrence Mishel Economic Policy Institute
Alice Rivlin The Brookings Institution (former Vice Chair of the
Federal Reserve and Director of the Office of Management and Budget)
Robert Solow Massachusetts Institute of Technology
Joseph Stiglitz Columbia University

[read the longer list here. Interestingly, the University of Chicago does not appear on the list.]

They all said: "we believe the Fair Minimum Wage Act of 2005’s proposed phased-in increase in the federal minimum wage to $7.25 falls well within the range of options where the benefits to the labor market, workers, and the overall economy would be positive."

and

"the weight of the evidence suggests that modest increases in the minimum wage have had very little or no effect on employment."

An ambitious journalist might ask them whether they still believe these things, and in particular whether that they believe this July's increase had "positive" effects.