The Cost of a "Living Wage"

Boston Globe: June 24, 2001

The Cost of a "Living Wage"

We can't ignore law of supply and demand

By N. Gregory Mankiw, 6/24/2001

If student movements are a leading indicator of social trends, and they often are, then the recent student takeover of the administration building at Harvard University is a troubling sign. The students wanted a ''living wage'' ($10.25 a hour, plus benefits) for all Harvard workers. Like the broader living wage campaign, which could culminate in a much higher national minimum wage, the students were laudable in their intentions but deficient in their analysis.

The appeal of the living wage is obvious. Life is hard for workers trying to support families on $7 or $8 an hour. If we could wave a magic wand and help those at the bottom of the economic ladder move up a rung or two, we should do it.

But enacting a social reform is not like waving a magic wand. It is more like prescribing a drug with a long list of side effects. Sometimes the side effects are worse than the disease.

Like most other prices, wages are set by the market forces of supply and demand. The major difference between high-wage workers and low-wage workers is not that the former are better organized or better liked by their employers - it's that their higher productivity enhances the demand for their services. Workers earning only $7 or $8 a hour are typically those with the fewest years of education and the least experience, which depresses the demand for their labor.

The living wage campaign wants to repeal the law of supply and demand and raise wages by fiat. The goal is to help low-wage workers. Unfortunately, it wouldn't work out that way. One effect of a higher wage is a reduction in the amount of labor that employers demand.

Take Harvard, for instance. How often does it need its janitorial staff to vacuum the classrooms and wash the blackboards? It's a judgment call. An increase in the wage from $8 to $10 a hour raises the cost of labor by 25 percent. It is wishful thinking to suggest that this won't affect the number of workers hired.

Living wage proponents say that Harvard, with its huge endowment, can afford to pay higher wages. Yes, that's true, but that's not the point.

Like all employers, Harvard is always making cost-benefit calculations, weighing the benefits of one project (hiring more janitors to clean blackboards more often) against others (hiring more professors to reduce class sizes). By raising the relative price of unskilled workers, the passage of a living wage shifts the tradeoffs in a way that means fewer of those workers will be hired.

Living wage advocates often point to a study by economists David Card and Alan Krueger, which claims that raising the minimum wage does not reduce employment. This research became prominent during the Clinton years, in part because Krueger was once chief economist in Clinton's Labor Department.

Although Card and Krueger are reputable economists, equally reputable economists have attacked their data, methods, and results.

Meanwhile, most research on the minimum wage finds that it reduces employment. Emphasizing the Card-Krueger evidence is like a doctor prescribing a drug relying on a single controversial study that finds no adverse side effects, while ignoring the many reports of debilitating results.

Moreover, the adverse effects of a high minimum wage go beyond its impact on total employment. In addition to reducing the amount of labor demanded, a high minimum wage compounds the problem by increasing the amount of labor supplied.

In other words, not only are there fewer jobs available for unskilled workers, but more people apply for those jobs. Studies have found that increases in the minimum wage encourage some teenagers to drop out of school earlier than they otherwise would. These teenagers take jobs that would go to unskilled adults, making it harder for those adults to make the transition from welfare to work.

The case against a high minimum wage is even more compelling once one realizes that it is not the only way to address the hardship of the working poor.

A better weapon to fight poverty is the Earned Income Tax Credit, a provision of the income tax system that supplements the income of low-wage workers. Like any spending program, this policy has the cost of higher taxes on everyone else. But those costs are smaller than the unemployment that results from high minimum wages.

Throughout history, students have been drawn to utopian social reforms. But history teaches that such social reforms often fail to yield what the reformers promised. The living wage campaign is the most recent example.


N. Gregory Mankiw is an economics professor at Harvard University and author of ''Principles of Economics.''

This story ran on page D8 of the Boston Globe on 6/24/2001.
© Copyright 2001 Globe Newspaper Company.