Economics, Politics, Quick Fix

Why Linking The Minimum Wage To Inflation Can Backfire

Last week I explained how poor decisions by central bankers (specifically failing to spur inflation) can make recessions much worse and lead to slower wage growth during recovery.

(Briefly: inflation during recessions reduces the real cost of payroll, cutting business expenses and making firing people unnecessary. During a recovery, it makes hiring new workers cheaper and so leads to more being hired. Because central bankers failed to create inflation during and after the great recession, many businesses are scared of raising salaries. They believe (correctly) that this will increase their payroll expenses to the point where they’ll have to lay many people off if another recession strikes. Until memories of the last recession fade or central bankers clean up their act, we shouldn’t expect wages to rise.)

Now I’d like to expand on an offhand comment I made about the minimum wage last week and explore how it can affect recovery, especially if it’s indexed to inflation.

The minimum wage represents a special case when it comes to pay cuts and layoffs in recessions. While it’s always theoretically possible to convince people to take a pay cut rather than a layoff (although in practice it’s mostly impossible), this option isn’t available for people who make the minimum wage. It’s illegal to pay them anything less. If bad times strike and business is imperiled, people making the minimum wage might have to be laid off.

I say “might”, because when central bankers aren’t proving useless, inflation can rescue people making the minimum wage from being let go. Inflation makes the minimum wage relatively less valuable, which reduces the cost of payroll relative to other inputs and helps to save jobs that pay minimum wage. This should sound familiar, because inflation helps people making the minimum wage in the exact same way it helps everyone else.

Because of increasingly expensive housing and persistently slow wage growth, some jurisdictions are experimenting with indexing the minimum wage to inflation. This means that the minimum wage rises at the same rate as the cost of living. Most notably (to me, at least), this group includes my home province of Ontario.

I think decreasing purchasing power is a serious problem (especially because of its complicated intergenerational dynamics), but I think this is one of the worst possible ways to deal with it.

When the minimum wage is tied to inflation, recessions can become especially dangerous and drawn out.

With the minimum wage rising in lockstep with inflation, any attempts to decrease payroll costs in real terms (that is to say: inflation adjusted terms) is futile to the extent that payroll expenses are for minimum wage workers. Worse, people who were previously making above the minimum wage and might have had their jobs saved by inflation can be swept up by an increasingly high minimum wage.

This puts central bankers in a bind. As soon as the minimum wage is indexed to inflation, inflation is no longer a boon to all workers. Suddenly, many workers can find themselves in a “damned if you do, damned if you don’t” situation. Without inflation, they may be too expensive to keep. With it, they may be saved… until the minimum wage comes for them too. If a recession goes on long enough, only high-income workers would be sparred.

In addition, minimum wage (or near-minimum wage) workers who are laid off during a period of higher inflation (an in this scenario, there will be many) will suffer comparatively more, as their savings get exhausted even more quickly.

Navigating these competing needs would be an especially tough challenge for certain central banks like the US Federal Reserve – those banks that have dual mandates to maintain stable prices and full employment. If a significant portion of the US ever indexes its minimum wage to inflation, the Fed will have no good options.

It is perhaps darkly humorous that central banks, which bear an unusually large parcel of the blame for our current slow wage growth, stand to face the greatest challenges from the policies we’re devising to make up for their past shortcomings. Unfortunately, I think a punishment of this sort is rather like cutting off our collective nose to spite our collective face.

There are simple policies we could enact to counter the risks here. Suspending any peg to inflation during years that contain recessions (in Ontario at least, the minimum wage increase due to inflation is calculated annually) would be a promising start. Wage growth after a recession could be ensured with a rebound clause, or better yet, the central bank actually doing its job properly.

I am worried about the political chances (and popularity once enacted) of any such pragmatic policy though. Many people respond to recessions with the belief that the government can make things better by passing the right legislation – forcing the economy back on track by sheer force of ink. This is rarely the case, especially because the legislation that people have historically clamoured for when unemployment is high is the sort that increases wages, not lowers them. This is a disaster when unemployment threatens because of too-high wages. FDR is remembered positively for his policy of increasing wages during the great depression, even though this disastrous decision strangled the recovery in its crib. I don’t expect any higher degree of economic literacy from people today.

To put my fears more plainly, I worry that politicians, faced with waning popularity and a nipping recession, would find allowing the minimum wage to be frozen too much of a political risk. I frankly don’t trust most politicians to follow through with a freeze, even if it’s direly needed.

Minimum wages are one example of a tradeoff we make between broad access and minimum standards. Do we try and make sure everyone who wants a job can have one, or do we make sure people who have jobs aren’t paid too little for their labour, even if that hurts the unemployed? As long as there’s scarcity, we’re going to have to struggle with how we ensure that as many people as possible have their material needs met and that involves tradeoffs like this one.

Minimum wages are just one way we can do this. Wage subsidies or a Universal Basic Income are both being discussed with increasing frequency these days.

But when we’re making these kind of compassionate decisions, we need to look at the risks of whatever systems we choose. Proponents of indexing the minimum wage to inflation haven’t done a good job of understanding the grave risk it poses to the health of our economy and perhaps most of all, to the very people they seek to help. In places like Ontario, where the minimum wage is already indexed to inflation, we’re going to pay for their lack of foresight next time an economic disaster strikes.

Economics, Falsifiable

You Might Want To Blame Central Banks For Poor Wage Growth

The Economist wonders why wage growth isn’t increasing, even as unemployment falls. A naïve reading of supply and demand suggests that it should, so this has become a relatively common talking point in the news, with people of all persuasions scratching their heads. The Economist does it better than most. They at least talk about slowing productivity growth and rising oil prices, instead of blaming everything on workers (for failing to negotiate) or employers (for not suddenly raising wages).

But after reading monetary policy blogs, the current lack of wage growth feels much less confusing to me. Based on this, I’d like to offer one explanation for why wages haven’t been growing. While I may not be an economist, I’ll be doing my best to pass along verbatim the views of serious economic thinkers.

Image courtesy of the St. Louis Federal Reserve Bank. Units are 1982-1984 CPI-adjusted dollars. Isn’t it rad how the US government doesn’t copyright anything it produces?

 

 

When people talk about stagnant wage growth, this is what they mean. Average weekly wages have increased from $335 a week in 1979 to $350/week in 2018 (all values are 1982 CPI-adjusted US dollars). This is a 4.5% increase, representing $780/year more (1982 dollars) in wages over the whole period. This is not a big change.

More recent wage growth also isn’t impressive. At the depth of the recession, weekly wages were $331 [1]. Since then, they’ve increased by $19/week, or 5.7%. However, wages have only increased by $5/week (1.4%) since the previous high in 2009.

This doesn’t really match people’s long run expectations. Between 1948 and 1973, hourly compensation increased by 91.3%.

I don’t have an explanation for what happened to once-high wage growth between 1980 and 2008 (see The Captured Economy for what some economists think might explain it). But when it comes to the current stagnation, one factor I don’t hear enough people talking about is bad policy moves by central bankers.

To understand why the central bank affects wage growth, you have to understand something called “sticky wages“.

Wages are considered “sticky” because it is basically impossible to cut them. If companies face a choice between firing people and cutting wages, they’ll almost always choose to fire people. This is because long practice has taught them that the opposite is untenable.

If you cut everyone’s wages, you’ll face an office full of much less motivated people. Those whose skills are still in demand will quickly jump ship to companies that compensate them more in line with market rates. If you just cut the wages of some of your employees (to protect your best performers), you’ll quickly find an environment of toxic resentment sets in.

This is not even to mention that minimum wage laws make it illegal to cut the wages of many workers.

Normally the economy gets around sticky wages with inflation. This steadily erodes wages (including the minimum wage). During boom times, businesses increase wages above inflation to keep their employees happy (or lose them to other businesses that can pay more and need the labour). During busts, inflation can obviate the need to fire people by decreasing the cost of payroll relative to other inputs.

But what we saw during the last recession was persistently low inflation rates. Throughout the whole the thing, the Federal Reserve Bank kept saying, in effect, “wow, really hard to up inflation; we just can’t manage to do it”.

Look at how inflation hovers just above zero for the whole great recession and associated recovery. It would have been better had it been hovering around 2%.

It’s obviously false that the Fed couldn’t trigger inflation if it wanted to. As a thought experiment, imagine that they had printed enough money to give everyone in the country $1,000,000 and then mailed it out. That would obviously cause inflation. So it is (theoretically) just a manner of scaling that back to the point where we’d only see inflation, not hyper-inflation. Why then did the Fed fail to do something that should be so easy?

According to Scott Sumner, you can’t just look at the traditional instrument the central bank has for managing inflation (the interest rate) to determine if its policies are inflationary or not. If something happens to the monetary supply (e.g. say all banks get spooked and up their reserves dramatically [2]), this changes how effective those tools will be.

After the recession, the Fed held the interest rates low and printed money. But it actually didn’t print enough money given the tightened bank reserves to spur inflation. What looked like easy money (inflationary behaviour) was actually tight money (deflationary behaviour), because there was another event constricting the money supply. If the Fed wanted inflation, it would have had to do much more than is required in normal times. The Federal Reserve never realized this, so it was always confused by why inflation failed to materialize.

This set off the perfect storm that led to the long recovery after the recession. Inflation didn’t drive down wages, so it didn’t make economic sense to hire people (or even keep as many people on staff), so aggregate demand was low, so business was bad, so it didn’t make sense to hire people (or keep them on staff)…

If real wages had properly fallen, then fewer people would have been laid off, business wouldn’t have gotten as bad, and the economy could have started to recover much more quickly (with inflation then cooling down and wage growth occurring). Scott Sumner goes so far to say that the money shock caused by increased cash reserves may have been the cause of the great recession, not the banks failing or the housing bubble.

What does this history have to do with poor wage growth?

Well it turns out that companies have responded to the tight labour market with something other than higher wages: bonuses.

Bonuses are one-time payments that people only expect when times are good. There’s no problem cutting them in recessions.

Switching to bonuses was a calculated move for businesses, because they have lost all faith that the Federal Reserve will do what is necessary (or will know how to do what is necessary) to create the inflation needed to prevent deep recessions. When you know that wages are sticky and you know that inflation won’t save you from them, you have no choice but to pre-emptively limit wages, even when there isn’t a recession. Even when a recession feels fairly far away.

More inflation may feel like the exact opposite of what’s needed to increase wages. But we’re talking about targeted inflation here. If we could trust humans to do the rational thing and bargain for less pay now in exchange for more pay in the future whenever times are tight, then we wouldn’t have this problem and wages probably would have recovered better. But humans are humans, not automatons, so we need to make the best with what we have.

One of the purposes of institutions is to build a framework within which we can make good decisions. From this point of view, the Federal Reserve (and other central banks; the Bank of Japan is arguably far worse) have failed. Institutions failing when confronted with new circumstances isn’t as pithy as “it’s all the fault of those greedy capitalists” or “people need to grow backbones and negotiate for higher wages”, but I think it’s ultimately a more correct explanation for our current period of slow wage growth. This suggests that we’ll only see wage growth recover when the Fed commits to better monetary policy [3], or enough time passes that everyone forgets the great recession.

In either case, I’m not holding my breath.

Footnotes

[1] I’m ignoring the drop in Q2 2014, where wages fell to $330/week, because this was caused by the end of extended unemployment insurance in America. The end of that program made finding work somewhat more important for a variety of people, which led to an uptick in the supply of labour and a corresponding decrease in the market clearing wage. ^

[2] Under a fractional reserve banking system, banks can lend out most of their deposits, with only a fraction kept in reserve to cover any withdrawals customers may want to make. This effectively increases the money supply, because you can have dollars (or yen, or pesos) that are both left in a bank account and invested in the economy. When banks hold onto more of their reserves because of uncertainty, they are essentially shrinking the total money supply. ^

[3] Scott Sumner suggests that we should target nominal GDP instead of inflation. When economic growth slows, we’d automatically get higher inflation, as the central bank pumps out money to meet the growth target. When the market begins to give way to roaring growth and speculative bubbles, the high rate of real growth would cause the central bank to step back, tapping the brakes before the economy overheats. I wonder if limiting inflation on the upswing would also have the advantage of increasing real wages as the economy booms? ^

Economics, Politics, Quick Fix

Cities Are Weird And Minimum Wages Can Help

[6-minute read]

I don’t understand why people choose to go bankrupt living the most expensive cities, but I’m increasingly viewing this as a market failure and collective action problem to be fixed with intervention, not a failure of individual judgement.

There are many cities, like Brantford, Waterloo, or even Ottawa, where everything works properly. Rent isn’t really more expensive than suburban or rural areas. There’s public transit, which means you don’t necessarily need a car, if you choose where you live with enough care. There are plenty of jobs. Stuff happens.

But cities like Toronto, Vancouver, and San Francisco confuse the hell out of me. The cost of living is through the roof, but wages don’t even come close to following (the difference in salary between Toronto and Waterloo for someone with my qualifications is $5,000, which in no way would cover the yearly difference in living expenses). This is odd when talking about well-off tech workers, but becomes heartbreaking when talking about low-wage workers.

Toronto Skyline
Not pictured: Selling your organs to afford a one-bedroom condo. Image Credit: Abi K on Flickr

If people were perfectly rational and only cared about money (the mythical homo economicus), fewer people would move to cities, which would bid up wages (to increase the supply of workers) or drive down prices (because fewer people would be competing for the same apartments), which would make cities more affordable. But people do care about things other than money and the network effects of cities are hard to beat (put simply: the bigger the city, the more options for a not-boring life you have). So, people move – in droves – to the most expensive and dynamic cities and wages don’t go up (because the supply of workers never falls) and the cost of living does (because the number of people competing for housing does) and low wage workers get ground up.

It’s not that I don’t understand the network effects. It’s that I don’t understand why people get ground up instead of moving.

But the purpose of good economics is to deal with people as they are, not as they can be most conveniently modeled. And given this, I’ve begun to think about high minimum wages in cities as an intervention that fixes a market failure and collective action problem.

That is to say: people are bad at reading the market signal that they shouldn’t move to cities that they can’t afford. It’s the signal that’s supposed to say here be scarce goods, you might get screwed, but the siren song of cities seems to overpower it. This is a market failure in the technical sense because there exists a distribution of goods that could make people (economically) better off (fewer people living in big cities) without making anyone worse off (e.g. they could move to communities that are experiencing chronic shortages of labour and be basically guaranteed jobs that would pay the bills) that the market cannot seem to fix.

(That’s not to say that this is all the fault of the market. Restrictive zoning makes housing expensive and rent control makes it scarce.)

It’s a collective action problem because if everyone could credibly threaten to move, then they wouldn’t have to; the threat would be enough to increase wages. Unfortunately, everyone knows that anyone who leaves the city will be quickly replaced. Everyone would be better off if they could coordinate and make all potential movers promise not to move in until wages increase, but there’s no benefit to being the first person to leave or the first person to avoid moving [1] and there currently seems to be no good way for everyone to coordinate in making a threat.

When faced with the steady grinding down of young people, low wage workers, and everyone “just waiting for their big break“, we have two choices. We can do tut-tut at their inability to be “rational” (aka leave their friends, family, jobs, and aspirations to move somewhere else [2]), or we can try to better their situation.

If everyone was acting “rationally”, wages would be bid up. But we can accomplish the same thing by simple fiat. Governments can set a minimum wage or offer wage subsidies, after all.

I do genuinely worry that in some places, large increases in the minimum wage will lead to unemployment (we’ll figure out whether this is true over the next decade or so). I’m certainly worried that a minimum wage pegged to inflation will lead to massive problems the next time we have a recession [3].

So, I think we should fix zoning, certainly. And I think we need to fix how Ontario’s minimum wage functions in a recession so that it doesn’t destroy our whole economy during the next one. But at the same time, I think we need to explore differential minimum wages for our largest cities and the rest of the province/country. I mean this even in a world where the current minimum $14/hour wage isn’t rolled back. Would even $15/hour cut it in Toronto and Vancouver [4]?

If we can’t make a minimum wage work without increased unemployment, then maybe we’ll have to turn to wage subsidies. This is actually the method that “conservative” economist Scott Sumner favours [5].

What’s clear to me is that what we’re currently doing isn’t working.

I do believe in a right to shelter. Like anyone who shares this belief, I understand that “shelter” is a broad word, encompassing everything from a tarp to a mansion. Where a certain housing situation falls on this spectrum is the source of many a debate. Writing this is a repudiation of my earlier view, that living in an especially desirable city was a luxury not dissimilar from a mansion.

A couple of things changed my mind. First, I paid more attention to the experiences of my friends who might be priced out of the cities they grew up in and have grown to love. Second, I read the Ecomodernist Manifesto, with its calls for densification as the solution to environmental degradation and climate change. Densification cannot happen if many people are priced out of cities, which means figuring this out is actually existentially important.

The final piece of the puzzle was the mental shift whereby I started to view wages in cities – especially for low-wage earners – as a collective action problem and a market failure. As anyone on the centre-left can tell you, it’s the government’s job to fix those – ideally in a redistributive way.

Footnotes

[1] This is inductive up to the point where you have a critical mass; there’s no benefit until you’re the nth + 1 person, where n is the number of people necessary to create a scarcity of workers sufficient to begin bidding up wages. And all of the people who moved will see little benefit for their hassle, unless they’re willing to move back. ^

[2] For us nomadic North Americans, this can be confusing: “The gospel of ‘just pick up and leave’ is extremely foreign to your typical European — be they Serbian, French or Irish. Ditto with a Sudanese, Afghan or Japanese national. In Israel, it’s the kind of suggestion that ruins dinner parties… We non-indigenous love to move. We don’t just see it as just good economic policy, but as a virtue. We glorify the immigrant, we hug them at the airport when they arrive and we inherently mistrust anyone who dares to pine for what they left behind”. ^

[3] Basically, wages should fall in a recession, but they largely don’t, which means inflation is necessary to get wages back to a level where employment can recover; pegging the minimum wage to inflation means this can’t happen. Worse, if the rest of the country were to adopt sane monetary policy during the next bad recession, Ontario’s minimum wage could rise to the point where it would swallow large swathes of the economy. This would really confuse price signals and make some work economically unviable (to do in Ontario; it would surely still be done elsewhere). ^

[4] I think we may have to subsidize some new construction or portion of monthly rent so that all increased wages don’t get ploughed into to increased rents. If you have more money chasing the same number of rental units and everything else remains constant, you’ll see all gains in wages erased by increases in rents. Rent control is a very imperfect solution, because it changes new construction into units that can be bought outright, at market rates. This helps people who have saved up a lot of money outside of the city and what to move there, but is very bad for the people living there, grappling with rent so high that they can’t afford to save up a down payment. ^

[5] No seriously, this is what passes for conservative among economists these days; while we all stopped looking, they all became utilitarians who want to help impoverished people as much as possible. ^

Economics, Model

Against Job Lotteries

In simple economic theory, wages are supposed to act as signals. When wages increase in a sector, it should signal people that there’s lots of work to do there, incentivizing training that will be useful for that field, or causing people to change careers. On the flip side, when wages decrease, we should see a movement out of that sector.

This is all well and good. It explains why the United States has seen (over the past 45 years) little movement in the number of linguistics degrees, a precipitous falloff in library sciences degrees, some decrease in English degrees, and a large increase in engineering and business degrees [1].

This might be the engineer in me, but I find things that are working properly boring. What I’m really interested in is when wage signals break down and are replaced by a job lottery.

Job lotteries exist whenever there are two tiers to a career. On one hand, you’ll have people making poverty wages and enduring horrendous conditions. On the other, you’ll see people with cushy wages, good job security, and (comparatively) reasonable hours. Job lotteries exist in the “junior doctor” system of the United Kingdom, in the academic system of most western countries, and teaching in Ontario (up until very recently). There’s probably a much less extreme version of this going on even in STEM jobs (in that many people go in thinking they’ll work for Google or the next big unicorn and end up building websites for the local chamber of commerce or writing internal tools for the company billing department [2]). A slightly different type of job lottery exists in industries where fame plays a big role: writing, acting, music, video games, and other creative endeavours.

Job lotteries are bad for two reasons. Compassionately, it’s really hard to see idealistic, bright, talented people endure terribly conditions all in the hope of something better, something that might never materialize. Economically, it’s bad when people spend a lot of time unemployed or underemployed because they’re hopeful they might someday get their dream job. Both of these reasons argue for us to do everything we can to dismantle job lotteries.

I do want to make a distinction between the first type of job lottery (doctors in the UK, professor, teachers), which is a property of how institutions have happened to evolve, and the second, which seems much more inherent to human nature. “I’ll just go with what I enjoy” is a very common media strategy that will tend to split artists (of all sorts) into a handful of mega-stars, a small group of people making a modest living, and a vast mass of hopefuls searching for their break. To fix this would require careful consideration and the building of many new institutions – projects I think we lack the political will and the know-how for.

The problems in the job market for professors, doctors, or teachers feel different. These professions don’t rely on tastemakers and network effects. There’s also no stark difference in skills that would imply discontinuous compensation. This doesn’t imply that skills are flat – just that they exist on a steady spectrum, which should imply that pay could reasonably follow a similar smooth distribution. In short, in all of these fields, we see problems that could be solved by tweaks to existing institutions.

I think institutional change is probably necessary because these job lotteries present a perfect storm of misdirection to our primate brains. That is to say (1) People are really bad at probability and (2) the price level for the highest earners suggests that lots of people should be entering the industry. Combined, this means that people will be fixated on the highest earners, without really understanding how unlikely that is to be them.

Two heuristics drive our inability to reason about probabilities: the representativeness heuristic (ignoring base rates and information about reliability in favour of what feels “representative”) and the availability heuristic (events that are easier to imagine or recall feel more likely). The combination of these heuristics means that people are uniquely sensitive to accounts of the luckiest members of a profession (especially if this is the social image the profession projects) and unable to correctly predict their own chances of reaching that desired outcome (because they can imagine how they will successfully persevere and make everything come out well).

Right now, you’re probably laughing to yourself, convinced that you would never make a mistake like this. Well let’s try an example.

Imagine a scenario is which only ten percent of current Ph. D students will get tenure (basically true). Now Ph. D students are quite bright and are incredibly aware of their long odds. Let’s say that if a student three years into a program makes a guess as to whether or not they’ll get a tenure track job offer, they’re correct 80% of the time. If a student tells you they think they’ll get a tenure track job offer, how likely do you think it is that they will? Stop reading right now and make a guess.

Seriously, make a guess.

This won’t work if you don’t try.

Okay, you can keep reading.

It is not 80%. It’s not even 50%. It’s 31%. This is probably best illustrated visually.

Craft Design Online has inadvertently created a great probability visualization tool.

 

There are four things that can happen here (I’m going to conflate tenure track job offers with tenure out of a desire to stop typing “tenure track job offers”).

Ten students will get tenure. Of these ten, eight (0.8 x 10) will correctly believe they will get it (1/green) and two (10 – 0.8 x 10) will incorrectly believe they won’t (2/yellow). Ninety students won’t get tenure. Of these 90, 18 (90 – 0.8 x 90) will incorrectly believe they will get tenure (3/orange) and 72 (0.8 x 90) will correctly believe they won’t get tenure (4/red). Twenty-six students, those coloured green (1) and orange (3) believe they’ll get tenure. But we know that only eight of them really will – which works out to just below the 31% I gave above.

Almost no one can do this kind of reasoning, especially if they aren’t primed for a trick. The stories we build in our head about the future feel so solid that we ignore the base rate. We think that we’ll know if we’re going to make it. And even worse, we think that a feeling of “knowing” if we’ll make it provides good information. We think that relatively accurate predictors provide useful information against a small chance. They clearly don’t. When the base rate is small (here 10%), the base rate is the single greatest predictor of your chances.

But this situation doesn’t even require small chances for us to make mistakes. Imagine you had two choices: a career that leaves you feeling fulfilled 100% of the time, but is so competitive that you only have an 80% chance of getting into it (assume in the other 20%, you either starve or work a soul-crushing fast food job with negative fulfillment) or a career where you are 100% likely to get a job, but will only find it fulfilling 80% of the time.

Unless that last 20% of fulfillment is strongly super-linear [3][4], or you don’t have any value at all on eating/avoiding McDrugery, it is better to take the guaranteed career. But many people looking at this probably rounded 80% to 100% – another known flaw in human reasoning. You can very easily have a job lottery even when the majority of people in a career are in the “better” tier of the job, because many entrants to the field will view “majority” as all and stick with it when they end up shafted.

Now, you might believe that these problems aren’t very serious, or that surely people making a decision as big as a college major or career would correct for them. But these fallacies date to the 70s! Many people still haven’t heard of them. And the studies that first identified them found them to be pretty much universal. Look, the CIA couldn’t even get people to do probability right. You think the average job seeker can? You think you can? Make a bunch of predictions for the next year and then talk with me when you know how calibrated (or uncalibrated) you are.

If we could believe that people would become better at probabilities, we could assume that job lotteries would take care of automatically. But I think it is clear that we cannot rely on that, so we must try and dismantle them directly. Unfortunately, there’s a reason many are this way; many of them have come about because current workers have stacked the deck in their own favour. This is really great for them, but really bad for the next group of people entering the workforce. I can’t help but believe that some of the instability faced by millennials is a consequence of past generations entrenching their benefits at our expense [5]. Others have come about because of poorly planned policies, bad enrolment caps, etc.

These cover the two ways we can deal with a job lottery, we can limit the supply indirectly (by making the job, or the perception of the job once you’ve “made it” worse), or limit the supply directly (by changing the credentials necessary of the job, or implementing other training caps)   . In many of the examples of job lotteries I’ve found, limiting the supply directly might be a very effective way to deal with the problem.

I can make this claim because limiting supply directly has worked in the real world. Faced with a chronic 33% oversupply of teachers and soaring unemployment rates among teaching graduates, Ontario chose to cut in half the number of slots in teacher’s college and double the length of teacher’s college programs. No doubt this was annoying for the colleges, which made good money off of those largely doomed extraneous pupils, but it did lead to the end of the oversupply of teachers and a tighter job market for teachers and this was probably better for the economy compared to the counterfactual.

Why? Because having people who’ve completed four years of university do an extra year or two of schooling only to wait around and hope for a job is a real drag. They could be doing something productive with that time! The advantage of increasing gatekeeping around a job lottery and increasing it as early as possible is that you force people to go find something productive to do. It is much better for an economy to have hopeful proto-teachers who would in fact be professional resume submitters go into insurance, or real estate, or tutoring, or anything at all productive and commensurate with their education and skills.

There’s a cost here, of course. When you’re gatekeeping (for e.g. teacher’s college or medical school), you’re going to be working with lossy proxies for the thing you actually care about, which is performance in the eventual job. The lossier the proxy, the more you are needlessly depressing the quality of people who are allowed to do the job – which is a serious concern when you’re dealing with heart surgery ­– or the people providing foundational education to your next generation.

You can also find some cases where increasing selectiveness in an early stage doesn’t successfully force failed applicants to stop wasting their time and get on with their life. I was very briefly enrolled in a Ph. D program for biomedical engineering a few years back. Several professors I interviewed with while considering graduate school wanted to make sure I had no aspirations on medical school – because they were tired of their graduate students abandoning research as soon as their Ph. D was complete. For these students who didn’t make it into medical school after undergrad, a Ph. D was a ticket to another shot at getting in [6]. Anecdotally, I’ve seen people who fail to get into medical school or optometry get a master’s degree, then try again.

Banning extra education before medical school cuts against the idea that people should be able to better themselves, or persevere to get to their dreams. It would be institutionally difficult. But I think that it would, in this case, probably be a net good.

There are other fields where limiting supply is rather harmful. Graduate students are very necessary for science. If we punitively limited their number, we might find a lot of valuable scientific progress falling to a stand-still. We could try and replace graduate students with a class of professional scientific assistants, but as long as the lottery for professorship is so appealing (for those who are successful), I bet we’d see a strong preference for Ph. D programs over professional assistantships.

These costs sometimes make it worth it to go right to the source of the job lottery, the salaries and benefits of people already employed [7]. Of course, this has its own downsides. In the case of doctors, high salaries and benefits are useful for making really clever applicants choose to go into medicine rather than engineering and law. For other jobs, there’s the problems of practicality and fairness.

First, it is very hard to get people to agree to wage or benefit cuts and it almost always results in lower morale – even if you have “sound macro-economic reasons” for it. In addition, many jobs with lotteries have them because of union action, not government action. There is no czar here to change everything. Second, people who got into those careers made those decisions based on the information they had at the time. It feels weird to say “we want people to behave more rationally in the job market, so by fiat we will change the salaries and benefits of people already there.” The economy sometimes accomplishes that on its own, but I do think that one of the roles of political economics is to decrease the capriciousness of the world, not increase it.

We can of course change the salaries and benefits only for new employees. But this somewhat confuses the signalling (for a long time, people will still have principle examples of the profession come from the earlier cohort). It also rarely alleviates a job lottery, because in practice people set this up for new employees to have reduced salaries and benefits for a time. Once they get seniority, they’ll expect to enjoy all the perks of seniority.

Adjunct professorships feel like a failed attempt to remove the job lottery for full professorships. Unfortunately, they’ve only worsened it, by giving people a toe-hold that makes them feel like they might someday claw their way up to full professorship. I feel that when it comes to professors, the only tenable thing to do is greatly reduce salaries (making them closer to the salary progression of mechanical engineers, rather than doctors), hire far more professors, cap graduate students wherever there is high under- and un- employment, and have more professional assistants who do short 2-year college courses. Of course, this is easy to say and much harder to do.

If these problems feel intractable and all the solutions feel like they have significant downsides, welcome to the pernicious world of job lotteries. When I thought of writing about them, coming up with solutions felt like by far the hardest part. There’s a complicated trade-off between proportionality, fairness, and freedom here.

Old fashioned economic theory held that the freer people were, the better off they would be. I think modern economists increasingly believe this is false. Is a world in which people are free to get very expensive training ­– despite very long odds for a job and cognitive biases that make understanding just how punishing the odds are – expensive training, in short, that they’d in expectation be better off without, a better one than a world where they can’t?

I increasingly believe that it isn’t. And I increasingly believe that having rough encounters with reality early on and having smooth salary gradients is important to prevent this world. Of course, this is easy for me to say. I’ve been very deliberate taking my skin out of job lotteries. I dropped out of graduate school. I write often and would like to someday make money off of writing, but I viscerally understand the odds of that happening, so I’ve been very careful to have a day job that I’m happy with [8].

If you’re someone who has made the opposite trade, I’m very interested in hearing from you. What experiences do you have that I’m missing that allowed you to make that leap of faith?

Footnotes:

[1] I should mention that there’s a difference between economic value, normative/moral value, and social value and I am only talking about economic value here. I wouldn’t be writing a blog post if I didn’t think writing was important. I wouldn’t be learning French if I didn’t think learning other languages is a worthwhile endeavour. And I love libraries.

And yes, I know there are many career opportunities for people holding those degrees and no I don’t think they’re useless. I simply think a long-term shift in labour market trends have made them relatively less attractive to people who view a degree as a path to prosperity. ^

[2] That’s not to knock these jobs. I found my time building internal tools for an insurance company to be actually quite enjoyable. But it isn’t the fame and fortune that some bright-eyed kids go into computer science seeking. ^

[3] That is to say, that you enjoy each additional percentage of fulfillment at a multiple (greater than one) of the previous one. ^

[4] This almost certainly isn’t true, given that the marginal happiness curve for basically everything is logarithmic (it’s certainly true for money and I would be very surprised if it wasn’t true for everything else); people may enjoy a 20% fulfilling career twice as much as a 10% fulfilling career, but they’ll probably enjoy a 90% fulfilling career very slightly more than an 80% fulfilling career. ^

[5] It’s obvious that all of this applies especially to unions, which typically fight for seniority to matter quite a bit when it comes to job security and pay and do whatever they can to bid up wages, even if that hurts hiring. This is why young Canadians end up supporting unions in theory but avoiding them in practice. ^

[6] I really hope that this doesn’t catch on. If an increasing number of applicants to medical school already have graduate degrees, it will be increasingly hard for those with “merely” an undergraduate degree to get in to medical school. Suddenly we’ll be requiring students to do 11 years of potentially useless training, just so that they can start the multi-year training to be a doctor. This sort of arms race is the epitome of wasted time.

In many European countries, you can enter medical school right out of high school and this seems like the obviously correct thing to do vis a vis minimizing wasted time. ^

[7] The behaviour of Uber drivers shows job lotteries on a small scale. As Uber driver salaries rise, more people join and all drivers spend more time waiting around, doing nothing. In the long run (here meaning eight weeks), an increase in per-trip costs leads to no change whatsoever in take home pay.

The taxi medallion system that Uber has largely supplanted prevented this. It moved the job lottery one step further back, with getting the medallion becoming the primary hurdle, forcing those who couldn’t get one to go work elsewhere, but allowing taxi drivers to largely avoid dead times.

Uber could restrict supply, but it doesn’t want to and its customers certainly don’t want it to. Uber’s chronic driver oversupply (relative to a counterfactual where drivers waited around very little) is what allows it to react quickly during peak hours and ensure there’s always an Uber relatively close to where anyone would want to be picked up. ^

[8] I do think that I would currently be a much better writer if I’d instead tried to transition immediately to writing, rather than finding a career and writing on the side. Having a substantial safety net removes almost all of the urgency that I’d imagine I’d have if I was trying to live on (my non-existent) writing income.

There’s a flip side here too. I’ve spent all of zero minutes trying to monetize this blog or worrying about SEO, because I’m not interested in that and I have no need to. I also spend zero time fretting over popularizing anything I write (again, I don’t enjoy this). Having a security net makes this something I do largely for myself, which makes it entirely fun. ^

Economics, Politics

You’re Doing Taxes Wrong: Consumptive vs. Wealth Inequality

When you worry about rising inequality, what are you thinking about?

I now know of two competing models for inequality, each of which has vastly different implications for political economy.

In the first, called consumptive inequality, inequality is embodied in differential consumption. Under this model, there is a huge gap between Oracle CEO Larry Ellison (net worth: $60 billion), with his private islands, his yacht, etc. and myself, with my cheap rented apartment, ten-year-old bike, and modest savings. In fact, under this model, there’s even a huge gap between Larry Ellison with all of his luxury goods and Berkshire Hathaway CEO Warren Buffett (net worth: $90.6 billion), with his relatively cheap house and restrained tastes.

Pictured: Warren Buffett’s house vs. Larry Ellison’s yacht. The yacht is many, many times larger than the house. Image credits: TEDizen and reivax.

Under the second model, inequality in new worth or salary is all that matters. This is the classic model that gives us the GINI coefficient and “the 1%”. Under this model, Warren Buffett is the very best off, with Larry Ellison close behind. I’m not even in contention.

I’ve been thinking a lot about inequality because of the recent increase in the minimum wage in Ontario. The reasons behind the wage hike – and similar economic justice proposals (like capping CEO pay at some double-digit multiple of worker pay) – seem to show a concern for consumptive inequality.

That is to say, the prevailing narrative around inequality is that it is bad because:

  1. Rich people are able to consume in a way that is frankly bananas and often destructive either to the environment or norms of good governance
  2. Workers cannot afford all basic necessities, or must choose between basic necessities and thinking long term (e.g. by saving for their children’s education or their own retirement)

Despite this focus on consumptive inequality in public rhetoric, our tax system seems to be focused primarily on wealth inequality.

Now, it is true that wealth inequality can often lead to consumptive inequality. Larry Ellison is able to consume to such an obscene degree only because he is so obscenely wealthy. But it is also true that wealth inequality doesn’t necessarily lead to consumptive inequality (there are upper middle-class people who have larger houses than Warren Buffett) and that it might be useful to structure our tax policy and other instruments of political economy such that there was a serious incentive for wealth inequality not to lead to consumptive inequality.

What I mean is: it’s unlikely that we’re going to reach a widely held consensus that wealth is immoral (or at what level it becomes immoral). But I think we already have a widely held consensus that given the existence of wealth, it is better to wield it like Mr. Buffett than like Mr. Ellison.

To a certain extent, we already acknowledge this. In Canada, there are substantial tax advantages to investing up 18% of your yearly earnings (below a certain point) and giving up to 75% of your income to charity. That said, we continue to bafflingly tax many productive uses of wealth (like investing), while refusing to adequately tax many frivolous or actively destructive uses of wealth (large cars, private jets, private yachts, influencing the political process, etc.).

Many people, myself included, find the idea of large amounts of wealth fundamentally immoral. Still, I’d rather tax the conspicuous and pointless use of wealth than wealth itself, because there are many people motivated to do great things (like curate all of the world’s information and put it at our fingertips) because of desire for wealth.

I’m enough of a post-modernist to worry that any attempt to create a metric of “social value” will further disenfranchise people who have already been subject to systemic discrimination and fail to reflect the tastes of anyone younger than 35 (I just can’t believe that a bunch of politicians would get together and agree that anyone creates social value or deserves compensation for e.g. cosplay, even though I know many people who find it immensely valuable and empowering).

That’s the motivation. Now for the practice. What would a tax plan optimized to punish spurious consumption while maintaining economic growth even look like? Luckily Scott Sumner has provided an outline, the cleverness of which I’d like to explain.

No income tax

When you take money from people as taxes, then give it back to them regardless of how hard they work, you discourage work. It turns out that this effect is rather large, such that the higher income taxes are, the more you discourage people from working. People working is a necessary prerequisite for economic growth and I view economic growth as largely positive (in that it is very good at engendering happiness and stability, as well as guaranteeing those of us currently working the possibility of retiring one day and generating revenues for a social safety net) and therefore think we should try and tax in a way that doesn’t discourage this.

No corporate tax

Another important component of economic growth is investment. We can imagine a hypothetical economy where absolutely everything that is produced is consumed, such that much is made, but nothing ever really changes. The products available this year will be the products available next year, at the same price and made in the same factory, with any worn-down equipment replaced, but no additional equipment purchased.

Obviously, this is a toy example. But if you’ve bought a product this year that didn’t exist last year, or noticed the cost of something you regularly buy fall, you’ve reaped the rewards of investment. We need people to deliberately set aside some of the production they’re entitled too via possession of money so that it can instead be used to improve the process of production.

Corporate taxes discourage this by making investment less attractive. In fact, they actively encourage consumptive inequality, by making consumption artificially cheaper than investment. This is the exact opposite of what we should be aiming for!

Interestingly, there have been a variety of report positive results of the recent cut in corporate tax rates in the US, from repatriation of money for US investment to bonuses for workers.

Now, I know that corporate taxes feel very satisfying. Corporations make a lot of money (although probably less than you think!) and it feels right and proper to divert some of that for public usage. But there are better ways of diverting that money (some of which I’ll talk about below) that manage to fill the public coffers without incentivizing behaviour even worse than profit seeking (like bloated executive pay; taxing corporate income makes paying the CEO a lot artificially cheap). Corporate taxes also hurt normal people in a variety of ways – like making saving for retirement harder.

No inheritance tax

This is another example of artificially making consumption more attractive. Look at it this way: you (a hypothetical you who is very wealthy) can buy a yacht now, use it for a while, loan it to your kids, them have them inherit it when it’s depreciated significantly, reducing the tax they have to pay on it. Or you can invest so that you can give your children a lot of money. Most rich people aren’t going to want to leave nothing behind for their children. Therefore, we shouldn’t penalize people who are going to use the money for non-frivolous things in the interim.

A VAT (with rebates or exemptions)

A VAT, or value added tax, is a tax on consumption; you pay it whenever you buy something from a store or online. A “value-added” tax differs from a simple sales tax in that it allows for tax paid to suppliers to be deducted from taxes owed. This is necessary so that complex, multi-step products (like computers) don’t artificially cost more than more simple products (like wood).

Scott Sumner suggests that a VAT can be easily made free for low-income folks by automatically refunding the VAT rate times the national poverty income to everyone each year. This is nice and simple and has low administrative overhead (another key concern for a taxation system; every dollar spent paying people to oversee the process of collecting taxes is a dollar that can’t be spent on social programs).

An alternative, currently favoured in Canada, is to avoid taxing essentials (like unprepared food). This means that people who spend a large portion of their money on food are taxed at a lower overall rate than people who spend more money on non-essential products.

A steeply progressive payroll tax

If income inequality is something you want to avoid, I’d argue that a progressive payroll tax is more effective than almost any other measure. This makes companies directly pay the government if they wish to have high wage workers and makes it more politically palatable to raise taxes on upper brackets, even to the point of multiples of the paid salary.

While this may seem identical to taxing income, the psychological effect is rather different, which is important when dealing with real people, not perfectly rational economics automata. Payroll taxes also make tax avoidance via incorporating impossible (as all corporate income, including dividends after subtracting investment would be subject to the payroll tax) and makes it easy to really punish companies for out of control executive compensation. Under a payroll tax system, you can quite easily impose a 1000% tax on executive compensation over $1,000,000. It’s pretty hard to justify a CEO salary of $10,000,000 when it’s costing investors more than a hundred million dollars!

Scott Sumner also suggests wage subsidies as an option to avoid the distortionary effect of a minimum wage [1], a concept I’ve previously explored in depth and found to be probably workable.

A progressive property tax

Property taxes tend to be flat, which makes them less effective at discouraging conspicuous consumption (e.g. 4,500 square foot suburban McMansions). If property taxes sharply ramped up with house value or size, families that chose more appropriately sized homes (or could only afford appropriately sized home) would be taxed at lower rates than their profligate neighbours. Given that developments with smaller houses are either higher density (which makes urban services cheaper and cars less necessary) or have more greenspace (which is good from an environmental perspective, especially in flood prone areas), it’s especially useful to convince people to live in smaller houses.

This would be best combined with laxer zoning. For example, minimum house sizes have long been a tool used in “nice” suburbs, to deliberately price out anyone who doesn’t have a high income. Zoning houses for single family use was also seized upon as a way to keep Asian immigrants out of white neighbourhoods (as a combination of culture and finances made them more likely to have more than just a single nuclear family in a dwelling). Lax zoning would allow for flexibility in housing size and punitive taxes on large houses would drive demand for more environmentally sustainable houses and higher density living.

A carbon tax

Carbon is what economists call a negative externality. It’s a thing we produce that negatively affects other people without a mechanism for us to naturally pay the cost of this inflicted disutility. When we tax a negative externality, we stop over-consumption [2] of things that produce that externality. In the specific case of taxing carbon, we can use this tax to very quickly bring emissions in line with the emissions necessary to avoid catastrophic warming.

I’d like to generalize this to Pigovian taxes beyond carbon. Alcohol (and other intoxicants), sugary drinks, and possibly tobacco should be taxed in line with their tendency to produce costs that (in countries with public risk pooling of health costs) are not borne by the individual over-consuming. I do think it’s important to avoid taking this too far – it’s reasonable to expect people to cover their negative externality, but not reasonable to punitively tax things just because a negative externality might exist or because we think it is wrong or “unhealthy” to do it. Not everything that is considered unhealthy leads to actual diseases, let alone increased healthcare costs.

A luxury goods tax

This comes from a separate post by Scott Sumner, but I think it’s a good enough idea to mention here. It should be possible to come up with a relatively small list of items that are mostly positional – that is to say that the vast majority of their cost is for the sake of being expensive (and therefore showing how wealthy and important the possessor is), not for providing increasing quality. To illustrate: there is a significant gap in functionality between a $3,000 beater car and a $30,000 new car, less of a gap between a $30,000 car and a $300,000 car and even less of a gap between the $300,000 car and a $3,000,000 car; the $300,000 car is largely positional, the $3,000,000 car almost wholly so. To these we could add items that are almost purely for luxury, like 100+ foot yachts.

It’s necessary to keep this list small and focus on truly grotesque expenditures, lest we turn into a society of petty moralizers. There’s certainly a perspective (normally held by people rather older than the participants) in which spending money on cosplay or anime merchandise is frivolous, but if it is, it’s the sort of harmless frivolity equivalent to spending an extra dollar on coffee. I am in general in favour of letting people spend money on things I consider frivolous, because I know many of the things I spend money on (and enjoy) are in turn viewed as frivolous by others [3]. However, I think there comes a point when it’s hard to accuse anyone of petty moralizing and I think that point is probably around enough money to prevent dozens of deaths from malaria (i.e. $100,000+) [4].

Besides, there’s the fact that making positional goods more expensive via taxation just makes them more exclusive. If anything, a strong levy on luxury goods may make them more desirable to some.


As I’ve read more economics, my positions on many economics issues have shifted in a way that many people parse as “more conservative”. I reject this. There are a great many “liberal” positions that sound good on paper, but when you actually do the math, hurt the poor and benefit the rich. Free trade makes things cheaper for all of us and has created new jobs and industries. A lot of regulation allows monopolies and large companies to crush any upstart rivals, or shifts jobs from blue collar workers making things to white collar workers ensuring compliance.

It is true that I care about the economy in a way that I never cared about it before. I care that we have sustainable growth that enriches us all. I care about the stock market making gains, because I’ve realized just how much of the stock market is people’s pensions. I care about start-ups forming to meet brand new needs, even when the previous generation views them as frivolous. I care about human flourishing and I now believe that requires us to have a functioning economic system.

A lot of how we do tax policy is bad. It’s based on making us feel good, not on encouraging good behaviour and avoiding weird economic distortions. It encourages the worst excesses of wealth and it’s too easy to avoid.

What I’ve outlined here is a series of small taxes, small enough to make each not worth the effort to avoid, that together can easily collect enough revenue to ensure a redistributive state. They have the advantage of cutting particularly hard against conspicuous consumption and protecting the planet from unchecked global warming. I sincerely believe that if more people gave them honest consideration, they would advocate for them too and together we could build a fairer, more effective taxation system.

Footnotes:

[1] A minimum wage can make it impossible to have Pareto optimal distributions – distributions where you cannot make anyone better off without making someone else worse off. Here’s a trivial example: imagine a company with two overworked employees, each of whom make $15/hour. The employees are working more than they particularly want to, because there’s too much work for the two of them to complete. Unfortunately, the company can only afford to pay an additional $7/hour and the minimum wage is $14/hour. If the company could hire someone without much work experience for $7/hour everyone would be better off.

The existing employees would be less overworked and happier. The new employee would be making money. The company could probably do slightly more business.

Wage subsidies would allow for the Pareto optimal distribution to exist while also paying the third worker a living wage. ^

[2] Over-consumption here means: “using more of it than you would if you have to properly compensate people for their disutility”, not the more commonly used definition that merely means “consuming more than is sustainable”.

An illustration of the difference: In a world with very expensive carbon capture systems that mitigate global warming and are paid for via flat taxes, it would be possible to be over-consuming gasoline in the economics sense, in that if you were paying a share of the carbon capture costs commensurate with your use, you’d use less carbon, while not consuming an amount of gasoline liable to lead to environmental catastrophe, even if everyone consumed a similar amount. ^

[3] For example, I spent six times as much as the median Canadian on books last year, despite the fact that there’s a perfectly good library less than five minutes from my house. I’m not particularly proud of this, but it made me happy. ^

[4] I am aware of the common rejoinder to this sort of thinking, which is basically summed up as “sure, a sports car doesn’t directly feed anyone, but it does feed the workers who made it”. It is certainly true that heavily taxing luxury items will probably put some people out of work in the industries that make them. But as Scott Sumner points out, it is impossible to meaningfully fix consumptive inequality without hurting jobs that produce things for rich people. If you aren’t hurting these industries, you have not meaningfully changed consumptive inequality!

Note also that if we’re properly redistributing money from taxes that affect rich people, we’re not going to destroy jobs, just shift them to sectors that don’t primarily serve rich people. ^

Economics, Falsifiable, Politics

Franchise Economics: Why Tim Hortons Has Become A Flashpoint In The Minimum Wage Fight

Since the minimum wage increase took effect on January 1st, Tim Hortons has been in the news. Many local franchisees have been clawing back benefits, removing paid breaks, or otherwise taking measures to reduce the costs associated with an increased minimum wage.

TVO just put out a piece about this ongoing saga by the Christian socialist Michael Coren. It loudly declares that “Tim Hortons doesn’t deserve your sympathy“. Unfortunately, Mr. Coren is incorrect. Everyone involved here (Tim Hortons the corporation, Tim Hortons franchisees, and Tim Hortons workers) is caught between a rock and a hard place. They all deserve your sympathy.

This Tim Hortons could be literally anywhere in suburban or rural Canada. Image Credit: Marek Ślusarczyk via Wikipedia Commons

It is a truism that a minimum wage increase must result in either declining profits, cuts to other costs, or rising prices. While supporters of the minimum wage increase would love to see it all come out of profits, that isn’t reasonable.

Basic economics tell us that as we approach a perfect market, profits should fall to zero. The key assumptions underpinning this are global perfect information (so no one can have any innovations that allow them to do better than anyone else) and zero start-up costs (so anyone can enter any market at any time). Obviously, these assumptions aren’t true in reality, but when it comes to fast food, they’re fairly close to true.

It is relatively cheap to start a fast-food restaurant (compared to say opening a factory). The start-up costs for a McDonalds, KFC, or Wendy’s are $1,000,000 to $2.3 million, while a Subway costs about $100,000 to $250,000 to start. This means that whenever someone sees fast-food restaurants making large profits in an area, they can open their own and take a fraction of the business, driving everyone’s profits down.

They’re probably driven down much lower than you think. If you had to guess, what would you say the profit margins for a fast-food restaurant are? If you’re anything like people in this study, you probably think something like 35%. The actual answer is 6% [1].

In addition to telling me that the average fast food restaurant has a 6% profit margin, that link helpfully told me that 29% of operating expenses in a fast-food restaurant come from labour costs. Raising those labour costs by 20% by increasing wages 20% increases total costs by 6% [2]. The minimum wage isn’t making fast-food restaurant owners make do with a little less in the way of profits. It’s entirely wiping out profits.

Now maybe your response to that is “well my heart doesn’t really bleed for that big multinational losing its profits”. But that’s not how Tim Hortons works. Tim Hortons, like almost all fast-food restaurants is a franchise. Tim Hortons the corporation makes money by collecting fees and providing services to Tim Hortons the restaurants, which are owned by the mythical small business owners™ that everyone (even the proponents of the minimum wage increase) claim to care so much about.

Most of these owners aren’t scions of wealthy families, but are instead ordinary members of their communities who saw opening a Tim Hortons as an investment, a vocation, or as a way to give back. They need to eat as much as their workers.

Faced with rising labour costs and no real profit buffer to absorb them, these owners can only cut costs or raise prices.

Except they can’t raise prices.

That’s the rub of a franchise system. The corporate office wants everything to be the exact same at every store. They set prices and every store must follow them. But there’s divergent incentives here. Tim Hortons the corporation makes a profit by selling supplies to its franchises; critically, they make a profit on supplies whether those franchisees turn a profit or not. They really don’t want to raise prices, because raising prices will hurt their bottom line.

It’s well known that (in general) the more expensive something is, the less people want it. Raising prices will hurt the sales volume of Tim Hortons franchises, which will decrease the profits at corporate Tim Hortons. The minimum wage hike affects Tim Hortons the corporation very little. They might see slightly increased shipping costs, but their costs are far less dependent on Canadian minimum wage labour. Honestly, the minimum wage increase probably is a net good for Tim Hortons the corporation. More money in people’s pockets means more money spent on fast-food.

Tim Hortons the corporation probably won’t say it, because they don’t want to antagonize their franchisees, but this minimum wage hike is great for them.

So, Tim Hortons franchisees have to cut costs or run charities. Given that they are running restaurants and not charities, we can probably assume that they’re going to cut costs. Why does it have to be labour costs that get cut? Can’t they just get their supplies for cheaper?

Here the franchise system bites them again. If they were independent restaurateurs, they might be able to source cheaper ingredients, reduce the ply of the toilet paper in their bathrooms, etc. and get their profits back this way.

But they’re franchisees. Tim Hortons the corporation has a big list of everything you need to run a Tim Hortons and you are only allowed to buy it from them. They get to set the prices however they want. And what they want is to keep them steady.

The only cost that Tim Hortons the corporation doesn’t control is labour costs. So, this is what franchisees have to cut.

There are two ways to decrease your labour costs. You can “increase productivity”, or you can cut wages and benefits. “Increase productivity” is the clinical and uninformative way of saying “fire 20% of your workers and verbally abuse the others until they work faster” or “fire 20% of your workers and replace them with machines”. While increased productivity is generally desirable from an economics point of view, it is often more ambiguous from a moral point of view.

Given that the minimum wage was just raised and it is illegal to pay any less than it, Tim Hortons franchisees cannot cut wages. So, if they’re against firing their employees and want to keep making literally any money, they have to cut benefits.

This might make it seem like corporate Tim Hortons is the bad guy here. They aren’t. The executives at Tim Hortons labour under what is called a fiduciary duty. They have a legal obligation to protect shareholder interests from harm and to act for the good of the corporation, not their own private good or for their private moral beliefs. They are responding to the minimum wage hike the way the government has told them to respond [3].

Minimum wage jobs suck. For all that economists claim there is no moral judgement implied in a wage, that it merely shows the intersection of the amount of supply of a certain type of labour and the demand for that labour, it can be hard to believe that there is no moral dimension to this when people making one wage struggle to make ends meet, while those earning another can buy fancy cars they don’t even need.

It is popular to blame business owners and capitalists for the wages their workers make and to say that it shows how little they value their workers. I don’t think that’s merited here. Corporate Tim Hortons has crunched the numbers and decided that if they raise prices, fewer people will buy coffee, their profits will decrease, and they might be personally liable for breach of fiduciary duty. In the face of rising prices, franchisees try and do whatever they can to stay afloat. We can say that caring about profits more than the wages their workers make shows immense selfishness on the part of these franchisees, but it’s little different than the banal selfishness anyone shows when they care more about making money for themselves than making money and giving it away – or the selfishness we show when we want our coffee to be cheaper than it can be when made by someone earning a wage that can comfortably support a family.

Footnotes

[1] As long as there are other available investments approximately as risky as opening a fast-food restaurant that return at least 6%, profits shouldn’t drop any lower than that. In this way, inefficiencies in other sectors could stop fast food restaurants from behaving like they were in a perfectly free market even if they were. ^

[2] This calculation is flawed, in that there are probably other costs making up total labour costs (like benefits) beyond simple wage income. On the other hand, it isn’t just wages that are going up. Other increased costs probably balance out any inaccuracies, making the conclusions essentially correct. This is to say nothing for corporate taxes, which further reduce profits. ^

[3] We can’t blame fiduciary duty, because fiduciary duty is how investing at all can happen. You might not like investing, but without investing, saving for retirement or having a national pension plan is impossible. If your response to this is to say “well let’s just tear down capitalism and start over”, I’d like to remind you that people tried that and it led to a) famine, b) gulags, c) death squads, d) more famine, and e) persistent shortages of every consumer good imaginable, including food ^

Economics, Politics

Why Don’t we Subsidize Higher Wages? Or: Public Policy is Expensive

[7 Minute Read]

Epistemic Status: Started as a reduction ad absurdum.

It used to be a common progressive grumbling point that the social safety net subsidized the low wages of McDonald’s and Walmart (and many less famous and less oft grumbled about enterprises). The logic went that employees at those companies just weren’t paid enough; they wouldn’t be able to survive – a necessary prerequisite to showing up at work – without government assistance. The obvious fix for this would be forcing these companies to pay their employees more – raising the minimum wage.

In my last piece on the minimum wage, I said the existing evidence pointed towards minimum wage hikes having few negative consequences. Recent evidence from Seattle suggests this may not be the case (although there are dueling studies, further complicated by accusations of academic misconduct against the scientists who found the hike had no effect). If my earlier prediction proves false, it will be because $15/hour is much higher – and a much larger percentage increase, then any of the past studies looked at.

If a $15/hour minimum wage “fails” [1] then we will face a choice. Do we give up on higher minimum wages? Do we accept higher unemployment (and all of its associated disconnection, wrenching poverty, and mental health costs)? Do we try something radically different?

Certainly, there exist other potential programs that we can use to accomplish some of the goals of a minimum wage increase if an increase itself proves untenable. A guaranteed basic income (GBI) [2], while expensive, would accomplish many of the same economic security goals as a higher minimum wage, but it wouldn’t fix the fact that some people see their wage as a reflection on their moral value, instead of a commentary on the supply and demand of various skills. This could become quite the sticking point; one reason that libertarians get behind a GBI is that it would allow us to abolish minimum wage laws.

Eliezer Yudkowsky (don’t groan, this really is relevant) has an interesting theory about the left. He thinks that the left doesn’t hate capitalism – they just hold it to the same ethical standards they hold people to. It might be people on the right who claim that corporations are people, but it’s the left who treat corporations like people.

If we accept Yudkowsky’s theory, there are a lot of people for whom paying someone $8/hour is an unacceptable slur on that person’s value as a human being [3]. This seems to match what I see from time to time on Facebook or in editorials. Here’s one out of Seattle; it ends with: “Finally, let’s be mindful that a minimum wage is about more than keeping the poor from starving. It’s also about attaching dignity to a person’s labor”.

Dignity being on the line changes the minimum wage debate. People can squabble over the economic pie endlessly. But make it about dignity and workers can’t back down. Even if a higher minimum wage leads to price increases or lost jobs.

And the Seattle Times article I linked is far too sanguine about price increases [4]. It is correct when it points out that well-off people can eat price increases with nary a change in behaviour, but I don’t know how it can so calmly ignore how much of a struggle it is for low-income families to deal with price increases.

Of course, raising the minimum wage might give people some breathing room. But that breathing room is wasted if prices immediately increase to match the new incomes. Have you ever watched someone on a treadmill?

The real effect of increased prices will be felt by people living on fixed incomes. Price increases are especially rough on seniors, who often can’t work even if they wanted to. Although I suppose we could use inflation to deal with the truly scary unfunded pension liabilities that many governments now have to deal with.

Raising the minimum wage will have to result in higher prices if it doesn’t lead to improved productivity (and therefore laying off the least productive workers). Retailers can absorb wages up to about $11/hour and still turn a profit. Beyond that, they can only raise prices, raise productivity, or run a charity. They won’t do the third.

But look, steadily rising wages are nice. They’re an excellent anesthetic for discontent. They alleviate poverty. If it was worth the cost, the government could make the complaints of subsidization true by literally subsidizing wages.

For the government to carry out this subsidization in Ontario, the cost would be something like $9 billion dollars [5]. This is equivalent to about 6% of the current budget – a bit less than the amount Ontario pays to service its debt. It wouldn’t be impossible to raise revenue for this – a progressive 1-5% tax increase would cover it handily [6], with the median Ontario worker seeing about $10.00 come off each paycheque with the new taxes.

There would obviously need to be some pretty strict rules in place here. What company would chip in $13 or $14 when their worker would be paid the same if they instead chipped in $11.60 (the current minimum wage)? We might get around this by making subsidization depend on the number of workers you employ (although this will tend towards monopolization and give the big retail giants quite an advantage) or their low productivity (but this has terrible incentives).

We still don’t know if the minimum wage hike will result in lost jobs. It’s also an open question how much we should (at a policy level) be aiming for full employment. But raising the minimum wage is a massive, $9 billion undertaking. Who pays for it (and if it happens at all) is deeply tied into questions about fairness, dignity, good governance and regressiveness. The least regressive way to do it is probably via subsidies; unfortunately, subsidies are the most corruptible of all options.

I previously mentioned the guaranteed basic income. My crude calculations give a (no doubt slightly high) estimate of $37 billion [7] for a GBI in Ontario, much higher than I’ve seen in the estimates from proponents. I’m personally worried that a GBI would be absorbed into raised rents [8], another example of a treadmill effect.

Economics policy is difficult enough as a scientific discipline. But tied up in ancillary questions (like “what is fair?”) as it is, it is uniquely susceptible to corruption by what people wish, rather than what is true [9]. When it can’t be corrupted, it is often ignored. Public policy has a cost. Resources are still limited. For every dollar spent, there must be a dollar raised (if not now, then eventually).

When we focus only on what we feel is fair or justified and not on what is achievable, we aren’t doing anyone any favours. Raising the minimum wage to $15/hour might cause job losses or spiralling inflation, or it might require subsidies and tax raises. These aren’t the consequences of greedy corporations. They’re the predictable results of people making reasonable decisions in a massively complicated system.

Disturb it at your own peril.

Footnotes:

[1] Failure (to me) means increased unemployment. A decrease in labour force participation would probably represent a return to single income families, unless preceded by high unemployment of the sort that drives people to give up looking for work. There’s also the failure mode of “causes spiralling inflation”, but that seems more likely to end the whole experiment prematurely. ^

[2] Unanswered questions I still have about a guaranteed minimum income include: “how can we pay for?”, “are you sure it won’t cause massive inflation in rents?”, and “no seriously, just saying it was fine when the Fed did QE isn’t good enough! Why won’t all that money chasing the same desirable housing cause the housing to become more expensive?” ^

[3] It’s weird to see the left capitulating here and more or less agreeing that a person’s value is at all tied to their wage. I think it’s important to strongly reject all attempts to link the intrinsic human value of a person with their economic value. Economic value maps to supply and demand, not intrinsic worthiness, so it’s an inherently fragile thing to base any moral worth on. ^

[4] It also makes a horrendous false equivalence between worker pay and CEO pay. Walmart’s CEO makes $21.8 million. Walmart has 2.3 million “associates”. Let’s say they average 20 hours per week, 50 weeks per year, for 2.3 billion employee hours per year. Removing the CEO’s salary would free up enough cash to pay the workers one extra cent per hour ($10/year). CEO salaries are a very tiny drop in the bucket compared to total compensation for companies with huge workforces. ^

[5] 1.7 million people make less than $15/hour. Assume they all make $11.60/hour, that they all work 40 hour weeks, 50 weeks a year and we end up with $11.6 billion. Since all of these are overestimates, this gives us an upper bound. $9 billion is my guess at a more realistic number. ^

[6] Here’s my calculations, based on the really excellent Statistics Canada data available here. I’ve made some simplifying assumptions (e.g. that everyone in each bracket makes the exact centre value of the bracket, that higher taxes won’t make people look for more ways to avoid them), but this should be broadly accurate. If you want to play around with the workbook, leave a comment with your email address and I’ll send it your way.

Note that “Total Revenue”, “Total Tax”, and “Tax as percent of income” are calculated by adding the “Tax at Midpoint” value to the “Taxes For Entire Bracket” values for all previous brackets. This is how the taxman does it. ^

[7] Calculations:

Not pictured: any adjustment for the percent of people who are married. The simplest approach (50% of Ontarians are married and couples receive 30% less, so the cost should be 15% lower) brings the cost down to a “mere” $37 billion. This is the cost I quote above. ^

[8] Rent control is the only possible solution, but it might be worse than what it seeks to cure. The economist Assar Lindbeck claimed that “In many cases rent control appears to be the most efficient technique presently known to destroy a city—except for bombing.” This was falsified by communist Vietnam, according to a speech by its onetime foreign minister: “The Americans couldn’t destroy Hanoi, but we have destroyed our city by very low rents. We realized it was stupid and that we must change policy”. ^

[9] On all sides. For every Bernie bro convinced we need socialism right now, there’s someone who believes in the explicitly anti-empirical assertions of the Austrian School. ^

Economics, Politics

Whose Minimum Wage?

[Epistemic Status: I am not an economist, but…]

ETA (October 2018): Preliminary studies from Seattle make me much more pessimistic about the effects of the Ontario minimum wage hike. I’d also like to highlight the potential for problems when linking a minimum wage to inflation.

There’s something missing from the discussion about the $15/hour minimum wage in Ontario, something basically every news organization has failed to pick up on. I’d have missed it too, except that a chance connection to a recent blog post I’d read sent me down the right rabbit hole. I’ve climbed out on the back of a mound of government statistics and I really want to share what I’ve found.

I

Reading through the coverage of the proposed $15/hour minimum wage, I was reminded that the Ontario minimum wage is currently indexed to inflation. Before #FightFor15 really took off, indexing the minimum wage to inflation was the standard progressive minimum wage platform (as evidenced by Obama calling for it in 2013). Ontario is actually aiming for the best of both worlds; the new $15/hour minimum wage will be indexed to inflation. The hope is that it will continue to have the same purchasing power long into the future.

In Canada, inflation is also called the “consumer price index” or CPI. The CPI is based on a standard basket of goods (i.e. a list that includes such things as “children’s sneakers” and “French fries, curly”), which Statistics Canada assesses the price of every few months. These prices are averaged, weighted, and compared to the previous year’s prices to get a single number. This number is periodically reset to 100 (most recently in 2002). The CPI for 2016 is 128.4; in 2016, it cost $128.40 to buy a basket of goods that cost $100.00 in 2002.

The problem with the CPI is that it’s just an average; when you look at what goes into it category by category, it becomes clear that “inflation” isn’t really a single number.

Here’s the last few years of the CPI, with some of the categories broken out:

Table Source: The Canadian Consumer Price Index Reference Paper > Summary Tables; click the table to view the data in Google Sheets.

Every row in this table that is shaded green has decreased in price since 2002. Rows that are shaded blue have increased in price, but have increased slower than the rate of inflation. Economists would say that they’ve increased in price in nominal (unadjusted for inflation) terms, but they’ve decreased in price in real (adjusted for inflation) terms. Real prices are important, because they show how prices are changing relative to other goods on the market. As the real value of goods and services change, so too does the fraction of each paycheque that people spend on them.

The red, yellow, and orange rows represent categories that have increased in price faster than the general rate of inflation. These categories of goods and services are becoming more expensive in both real and nominal terms.

There’s no other way to look at the CPI that shows variation as large as that between categories. When you break it down by major city, the CPI for 2016 varies from 120.7 (Victoria, BC) to 135.6 (Calgary, AB). When you break it down by province, you see basically the same thing, with the CPI varying from 122.4 in BC to 135.2 in Alberta.

Looking at this chart, you can see that electronics (“Home Entertainment”) have become 45% cheaper in nominal (unadjusted for inflation) terms and a whopping 58% cheaper in real (adjusted for inflation) terms. Basically, electronics have never been less expensive.

On the other hand, you have education, which has become 60.8% more expensive in nominal terms and 25% more expensive in real terms. It costing more and more to get an education, in a way that can’t just be explained by “inflation”.

Three of the four categories with the biggest increases in prices rely on the labour of responsible people. The fourth is tobacco; prices increases there are probably driven by increased taxation and its position is a bit of a red herring. It’s potentially worrying that the categories where things are getting cheaper (e.g. electronics, clothes) are in the industries that are most amenable to automation. This might imply that tasks that cannot be automated are doomed to become increasingly expensive [1].

II

I’m certainly not the first person to make the observation that “inflation” isn’t a single number. Economists have presumably known this forever, related as it is to the important economics concept of “cost disease“. More recently, you can see this point made from two different directions in Scott Alexander’s “Considerations on Cost Disease” (which tries to get to the bottom of the price increases in healthcare and education) and Andrew Potter’s “The age of anti-consumerism has passed” (which looks at the societal changes wrought by many consumer goods becoming much cheaper). As far as I know, no one has yet tied this observation to the discussion surrounding the new Ontario minimum wage.

Like I said above, the new minimum wage will still be indexed to inflation; the “$15/hour” minimum wage won’t stay at $15/hour. If inflation follows current trends (this is a terrible assumption but it’s all I’ve got), it will rise by about 1.5% per year. In 2020 it will be (again, bad extrapolation alert) $15.25 and in 2021 it will be $15.50.

Extrapolating backwards, the current Ontario minimum wage ($11.40/hour) was equivalent to $8.88/hour in 2002 (when the CPI was last reset). If instead of tracking inflation generally, the minimum wage had tracked electronics, it would be $4.84 today. If it tracked education, it would be $14.28. Next year, the minimum wage will be $14/hour (it will take until 2019 for the $15/hour wage to be fully phased in), which will make 2018 the first time that students working minimum wage are getting paychecks that will have increased as much as the cost of education.

This won’t last of course. The divergence in prices shows no signs of decreasing. The CPI will continue to climb upwards at a steady rate (the target is 2%, last year it only rose 1.4%), buoyed up by large increases in education costs (2.8% last year) and held down by steady decreases in the price of electronics (-1.6% last year). Imagine that the $15/hour minimum wage allows a student to pay a year’s tuition with a summer’s worth of work. If current trends continue, in 15 years, it would only cover 75% of tuition. Fifteen years after that it would cover about 60%.

III

There’s a funny thing about these numbers. The stuff that’s getting more expensive more quickly is largely stuff that younger people have to pay for. If you’re 50, have more or less raised your kids, and own a house, then you’re golden even if you’re working a minimum wage job (although by this point, you probably aren’t). Assuming your wage has increased with inflation over your working lifetime, a lot of the things you’re looking to buy (travel, electronics, medical devices) will be getting cheaper relative to what you make. Healthcare service costs (e.g. the cost of seeing a doctor) might be increasing for you in theory, but in practice OHIP has you covered for all your doctor’s visits [2].

It’s younger people who are really shafted. First, they’re more likely to be earning minimum wage, with nearly 60% of minimum wage earners in Canada in the 15 to 24 age bracket. Second, the sorts of things that younger people need or aspire to (education, childcare, home ownership) are big ticket items that are increasing in cost above the rate of inflation. Like with the tuition example above, childcare and home ownership are going to slip out of the grasp of young workers even if you index their wage to inflation.

I happen to like the idea of a $15/hour minimum wage. There’s a lot of disagreement among economists as to whether they’ll be ill effects, but this meta-analysis (complete with funnel plot!) has me more or less convinced that the economy will do just fine [3]. Given that Ontario will still have an economy post wage-hike, I think increasing the minimum wage will be good for workers.

But a minimum wage increase leaves the larger problem of differing rates of inflation unsolved. Even with a minimum wage indexed to inflation, we’re going to have people waking up twenty-five years from now, realizing that their minimum wage job doesn’t pay for university/food/utilities/childcare/transit the same way their parents’ minimum wage job did. This will be a problem.

I’m game to kick the can down the road for a bit if it means we can make the lives of minimum wage workers better right now. But until we’ve solved this problem for good, it will keep coming back [4].

Footnotes:

[1] I’m not sure this is exactly a bad thing, per se. Money is a means of signalling that you’d like your preferences satisfied. It becoming more expensive to pay actual humans to do things could mean that actual humans have so many good options that they’re only going to waste their time satisfying your preferences if you really make it worth their while. Looked at this way, this means we’re steadily freeing ourselves from work.

On the other hand, this seems to apply mainly to responsible/competent/intelligent people and not everyone is responsible/competent/intelligent, so this could also imply that we have a looming crisis, with a huge number of people simply becoming economically unnecessary. This is really bad, because high-quality life should be possible for everyone, not just those who’ve lucked into economically valuable traits and under capitalism it is really hard to have a high-quality life if you aren’t economically valuable. ^

[2] For readers outside of Ontario, OHIP is the Ontario Health Insurance Plan. It covers all hospital and clinic care for all legal residents of Ontario, as well as dental and ophthalmological care for minors. OHIP is a non-actuarial insurance program; premiums come from provincial income tax and payroll tax revenues, as well as transfer payments of federal tax revenues. All Ontarians enrolled in OHIP (i.e. basically all of us) have a health card which allows us to access all covered services free of charge (beyond the taxes we’ve already paid) any time we want to. ^

[3] No effect on the unemployment rate does not mean no effect on the employment of individual people. A $15/hour minimum wage will probably tempt some people back into the labour force (I’m thinking here that this will mostly be women), while excluding others whose labour would not be valued that highly (unfortunately this will probably hit people with certain mental illnesses or disabilities the hardest). ^

[4] I think it’s especially pernicious how the difference in inflation rates between types of goods is kind of by default a source of inter-generational strife. First, it makes it more difficult for each succeeding generation to hit the same landmarks that defined adulthood and independence for the previous generation (e.g. home ownership, education, having children), with all the terrible think-pieces, conflict-ridden Thanksgiving dinners, and crushed dreams this implies. Second, it can pit the economic interests of generations against each other; healthcare for older people is subsidized by premiums from younger ones, while the increase in the cost of homes benefit existing players (who skew older) to the determinant of new market entrants (who skew younger). ^