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…]

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). ^