More evidence on minimum wage effects

Minimum wage laws are bad for profits. That's the message of this new paper (pdf) from the CEPR. Steve Machin and colleagues estimate that the introduction of the UK minimum wage in 1999 led to a fall in profit margins of 23% in the average care home (an industry paying very low wages) and 8-11% for low-wage firms more generally.
This follows from a simple fact. The short-run employment effects of a minimum wage are small - that's small, note, not zero; see this paper (pdf).  This means a minimum wage raises the wage bill. Unless prices rise - and there's little evidence they do - it follows that profits must fall.
But here's the puzzle. Machin and colleagues say:

We could not find any evidence that low wage firms were forced out of business by the higher wage costs resulting from the minimum wage.

There are, they say, three possible reasons for this:
1. The time period they looked at was too short (two years after the introduction), and that in the long-run there's lots of exit.
2. Lower profit margins deter firms from entering the industry.
3. Firms were making "excess profits" from employing low wage workers, and the minimum wage led to cuts in these.
Personally, I find 1 and 2 more plausible. But consider point 3. It raises two questions.
First, how could low-wage firms be making excess profits? Such firms are usually small, and have few barriers to entry.
Second, what are the consequences of a shift in incomes from profits to wages?
Unreconstructed Keynesians would say they are positive. They raise aggregate demand because the marginal propensity to spend out of low wages is higher than that to spend out of profits.
However, this is by no means certain. The effect of profits on investment spending varies enormously, and can sometimes be high. And low wage workers might use their pay rises to cut their debts. For more on these effects - it's all about stagnationist and exhilarationist regimes - see this old paper (word doc) by Amit Bhaduri.
Given these problems, I'm with Tim and Don; a minimum wage is a terribly inefficient way to help the poor.
Another thing: Don ably discusses the argument about Card and Krueger's work which found that the minimum wage didn't destroy jobs. However, Card and Krueger also said that the effect of higher minimum wages upon poverty was "statistically undetectable" (Myth and Measurement, p280 in my copy.) Why do advocates of minimum wages cite the controversial aspect of Card and Krueger's research but not the uncontroversial one? Is this an example of Blinder's law - that economists have the least influence where they agree the most?

Comments

[rjw]

The time period seems too short. But I'm interested why you say prices would not rise. If all firms in a sector - say contract cleaning - have to raise their wages to pay for the minimum wage, then over time I'd expect prices to drift up. Why expect any of them to go bust? People will still need their offices cleaned - even if it's (say) 5% more expensive than before.

[dearieme]

rjw: because illicit "firms" using illegal labour will displace licit firms whose performance is observable?

My guess: minimum wage laws might do modest harm while things are thriving, but they will intefere mightily with recovery from recession. You could argue, I suppose, that the attempts of Hoover and FDR to obstruct wages from falling explain much of the length and severity of the Great Depression. I presume most schools of economists could agree on that?

[stu]

in all your economic analysis of profit margins etc, you seem to forget that there are people involved here and a minimum wage guarentees them a minimum return on their labour (or at least to be safeguarded from exploitation).

You mention that there are more efficient ways of helping the poor. I would be interested in hearing these at that is the point of having a minimum wage.

[Tim Worstall]

Stu,

With all of their associated problems things like the (US) EITC or the (UK) tax credits are more efficient at doing what we want, which is to help the working poor.

Even better would be a citizen’s basic income, or at least a doubling of the personal tax free allowance.

And Chris, of course you agree with me. All the interesting stuff in that TCS piece was me quoting great chunks of your blog.

Now, if I can only find a way to get paid for reprinting your Investor’s Chronicle stuff as well.....

[Brock Haussamen]

Thanks for calling attention to the Draca study. (I'll add it to my Web site, "Raising the National Minimum Wage: Information, Opinion, Research" at www.raiseminwage.org.) Despite the blogs about what's wrong with the minimum wage, the studies from England seem to me to confirm the recent liberal American view of the minimum wage: that disemployment fears have been exaggerated by standard-model economists, that a reasonable minimum wage does add to the wages of the working poor (the low cut-offs for the definition of "poor" in the U.S. have distorted this discussion), and, yes, that if prices don't rise, the money will come from profits.

I favor an American federal minimum wage that is raised regularly based on a commission that reviews inflation and other factors--very much what England has now. A small regular increase would seem to make sense for not only the working poor but also for business owners who can plan for it. And I'm sure it wouldn't get in the way of their profits for very long.

[Tim Auch]

Stockholders will not tolerate decreases in profit, so prices have to rise when costs, including wage costs, rise to maintain profit goals set for management by the boards of directors. Otherwise executives are replaced, which gives them plenty of motivation to make the shareholders happy. Prices rise, thus everybody's buying power decreases. The only ones who experience the wage increase are those at minimum wage, so they are neutrally affected. Everyone who is above minimum wage, who does not receive comparable wage increases, is negatively impacted. So instead of taking money from the rich to give to the poor, we take money from the slightly less poor to give to the poor so that they all stay poor.
Minimum wage is just an delusion that rich people buy into to make themselves feel better about buying $35,000 sunglasses while those around them die from disease and starvation. Those who aren't rich and ascribe to minimum wage only do so to convince the poor and uneducated that they sympathize and have their best interest at heart. They only do that to gain the support of the poor masses to push their own agendas at the polls.
In Oregon the minimum wage is set to increase every year in step with inflation, and anyone who thinks prices are not raised to keep up with costs can try living here for a while. Try making house payments, buying groceries and paying for health insurance, slowly slip further and further into debt, then tell me that minimum wage is a good thing.