The Poverty of Minimum Wage “Facts”

In a recent post, Tyler Cowen discusses my recent paper on minimum wages and poverty. Cowen acknowledges that “[my] paper, econometrically speaking, is a clear advance over [a 2010 paper by] Sabia and Burkhauser.”  However, he is more persuaded by “facts” such as simulation results from Sabia and Burkhuaser’s paper that claims “[o]nly 11.3% of workers who will gain from an increase in the federal minimum wage to $9.50 per hour live in poor households.”

Cowen concludes that my paper “pays little heed to integrating econometric results with common sense facts and observations about the economy.”

I’m pleased that Cowen thinks my paper represents a clear econometric advance. But I strongly disagree that the econometrics are at odds with common sense facts. Simulation studies are not facts, and when we interpret the relationship between wages and poverty properly, the econometric results appear eminently sensible.

Let’s start with the econometrics. First, both the weight of the existing studies, and my own econometric evidence that Cowen considers an advance, suggest that minimum wages have a modest impact on reducing poverty. I find minimum wage elasticities for the poverty rate ranging between -0.12 and -0.37.  This range of estimates is based on 16 different models, and the list includes just about every specification (or close to it) used in the literature. That includes specifications in Burkhauser and Sabia (2007), Sabia (2008), Sabia and Burkhauser (2010), and  Neumark and Wascher (2011)—except that I use more data.

Now, if this range does not include your preferred estimate, that’s fine. But, then you need to acknowledge that you also do not believe empirical results from regressions in the previous papers using one of the 16 models I do estimate. Another possibility is that you like one of the 16 models, but prefer earlier results that showed a weaker connection between the minimum wage and poverty. In that case, you need to explain why you believe a result from a smaller sample of data used to one that uses more data. This is especially important because many of the estimates in the literature are highly imprecise, in part due to use of small samples. You are not allowed to pick econometric results from a specification when you agree with the outcome, but dismiss results from the same specification when the results are not agreeable to you.

So is this type of econometric evidence—of the sort that has become the hallmark of applied micro-economics in the past few decades—out of touch with the “real world?” Instead, should we turn to simulations like those in Sabia and Burkhauser to get closer to reality?  As a believer in the credibility revolution in economics, I’m going to go ahead and say, no. Actually, the type of estimates that I have found both in my own work, and generally from the literature, is what you would expect based on the pattern of wages and family incomes if you also account for the commonsensical—and empirically supported—propositions that: (1) workers above the minimum get some raise too (“spillover effects”), and (2) reported wages in survey data is measured with error which makes the relationship between low wages and low family incomes weaker than it is in reality.  The simulation results like Sabia and Burkhauser do not in fact account for these, and they understate the association between minimum wages and low family incomes.

So let us go through these points more carefully. As I report in my paper, poor workers are  disproportionately low-wage workers. In 2013, 63 percent of workers under the poverty line reported earning less than $10.10/hour, as compared to 22 percent of workers overall. This is broadly consistent with my econometric findings: that minimum wages raise family incomes relatively more at the bottom of the family income distribution.  At the same time, I also explicitly state that the relationship between low wages and low family incomes (e.g., poverty) is indeed imperfect. In 2013, around 18.9 percent of workers who reported earning under $10.10/hour were in families under the poverty line, and around 46.0 percent were below two times the poverty line. So yes, the minimum wage is a “blunt” tool if the only goal were to reduce poverty. (Curious why my estimate of 18.9 percent differs from Sabia and Burkhauser’s estimate of 11.3 percent? Jump to the Postscript at the end.)

But, I also point out in my paper that using the distribution of reported wages to make predictions about minimum wage impact on poverty—like Sabia and Burkhauser do—will almost certainly under-estimate the true effects. To see why, consider the assumptions made by Sabia and Burkhauser in their simulations:

  1. They assume that most workers reporting a wage under the old minimum will not get a raise when the minimum wage goes up.
  2. They also assume that no one above the new minimum will see a raise.

These assumptions are inconsistent with a large body of evidence. First, there is almost certainly some wage spillover or “ripple effects”, as shown most recently by Autor Manning and Smith (2010)—a paper Cowen says is of “highest academic pedigree.” A minimum wage increase ripples up to the 20th percentile of the wage, which would simply not happen if there were no spillovers. Interestingly, a recent study by the Hamilton Project uses spillover estimates from a paper by Neumark et al. (2004) to estimate that a total of 35 million workers would get a raise from increasing the minimum wage to $10.10/hour, many more than number of workers directly affected by the policy.

Second, many workers who report earning lower than the current minimum wage are in reality earning at or slightly higher than the minimum wage, and they will also see their wages rise. In general, the more measurement error there is in wages and other sources of incomes, the weaker the relationship between poverty and low wages will appear to be. Measurement errors don’t just “wash out”—they weaken correlations in what economists call an “attenuation bias.” The concern with measurement error in reported wages is also discussed in Autor, Manning and Smith 2010. And while measurement errors may lead to problems inferring exactly why we see spillover effects, they mean the kind of assumptions used by Sabia and Burkhauser will understate the true relationship between minimum wages and poverty.

Third, many of the workers who are truly being paid lower than the statutory minimum in the informal sector will see an increase, a phenomenon is sometimes called the “lighthouse effect.” There are different explanations for this, but consider the following analogy. There are people who drive at 70 miles an hour even when the speed limit is 65; now if the speed limit is lowered to 55, most people who were previously driving at 70 miles an hour will also lower their speed, while continuing to speed a bit. A similar logic applies to cases like the minimum wage where the probability of detection likely varies with the extent of violation.

So to take stock, if you consider the Sabia and Burkhauser simulation results  as “facts” you also are claiming that no worker reporting a wage below the old minimum will get a raise, and no one above the new minimum will get a raise. These are not very good assumptions, and they certainly are not facts.

Of course, you don’t have to make these assumptions. You could allow for spillovers. You could allow for wages to rise below the minimum. You could allow for measurement error in reported wages and other sources of income. But then you are not in a world where tabulating survey data gives you simple facts that are beyond reproach. You need to make additional assumptions to make causal claims. And we have not even begun to talk about behavioral effects—be they on labor demand side, or on labor supply side such worker search effort, etc. (And by the way those do not all go in the same direction.)  So you could add a lot more assumptions and continue with the simulation route, or you could use quasi-experimental approach used in almost all of applied micro-economics to empirically estimate the effect of minimum wages on poverty and other outcomes.  Of course, you would want to subject your identifying assumptions to specification checks and falsification tests to ensure you have reliable control groups; and you would account for possibly confounding policies such as state EITCs. And when you do all of that, and some more, you would probably end up with a paper like this one.

So where does this leave us?   As I said in my paper, policies like cash transfers, food stamps, and EITC are better targeted to help the poor, although even there minimum wages are better thought of as complements and not substitutes. More generally, however, motivations behind minimum wage policies go beyond reducing poverty. The popular support for minimum wages is in part fueled by a desire to raise earnings of low and moderate income families more broadly, and by fairness concerns that seek to limit the extent of wage inequality, or employers’ exercise of market power.  And the evidence suggests is that attaining such goals through increasing minimum wages is also consistent with a modest reduction in poverty, and moderate increases in family incomes at the bottom.  

Postscript. If you were paying close attention, you would have noticed a potential discrepancy. Sabia and Burkhauser argue that 11.3 percent of workers who will gain from an increase in the federal minimum wage to $9.50 per hour live in poor households, and 36.8 percent are under twice the poverty line.  I find that 18.9 percent of workers who will gain from an increase to $10.10 an hour are in families below the poverty line, and 46.0 percent under twice the poverty line. So what is going on here? Two things. First, Sabia and Burkhauser use the “household” as the unit to calculate poverty status, while I use “family.” While neither is clearly superior to the other, you should know that official Census definition of poverty uses the family as the unit. And for whatever reason, Sabia and Burkhuaser use a family based poverty measure when they run regressions, but use households when the do simulations. Second, low wage workers actually appear to be somewhat poorer today than they were in 2008, which is the period Sabia and Burkhauser were analyzing. I will have more to say on this in a future post, but the upshot is that even on this narrow count, it is more accurate to say the 19 (and not 11) percent of workers who report wages below the proposed $10.10/hour are in families that would be officially designated as being poor. And as I explained above, this number is almost certainly too small due to measurement error in both wages and other incomes. Return to the post.

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15 thoughts on “The Poverty of Minimum Wage “Facts”

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  2. kharris

    Cowen is big on “framing”. On the one hand, he tends to complain that issues are framed in ways that he doesn’t care for, and on the other, much of his blog writing about economic issues is heavy on “framing” to his own liking.

    You were restrained enough to cite only one instance of Cowen doing his dirty work through dishonest framing – “pays little heed to integrating econometric results with common sense facts and observations about the economy.” There were plenty of others. Cowen’s post reads, to me, like nothing more than an effort to undermine the results of your work by way of various unsupported assertions about the current state of research. I can’t think of too many worse things an academic economist can do.

  3. Denis Drew

    I wish you progressive economists could develop a sense of scale — that’s where you depart from what you call the “real world.” I get the feeling that no matter what the numbers are (raising from $7 to $10 — or what year — 1978 or 1998) the words would be the same. Thoma did this the other day, wondering the best balance between a “moderate” increase in the minimum wage and the E.I.T.C.

    If you foretold to Americans of 1968 that by, early 2007, a quarter of the American workforce would be earning less than LBJ’s 1968 minimum wage, what would they have guesses: a comet strike, a limited nuclear exchange, global freeze over? We are not suffering “inequality”; we are suffering a “Great Wage Depression.” A very long to wit:

    Progressive economists should readily admit — shout, scream — that a “moderate” federal wage increase, typically 10% cited in conservative studies, should indeed have little or no effect on poverty rates. Why would an extra 1/4 of one percent of GDP added to low wage pay checks be expected to clear a broad swath through poverty? That is what a $1 an hour increase in the federal minimum wage equates to — about $40 billion out of a $16 trillion economy. (E.I.T.C. shifts $55 billion.)

    A $15 an hour minimum wage OTH would send about 3.5% of GDP the way of 45% of American workers — about $560 billion (much of it to bottom 20 percentile incomes who today take only 2% of overall income).
    * * * * * *
    Could raising the wages of 45% of the workforce actually raise demand for the goods and services they produce? Sounds sensible at some level; raising wages so much ought to add demand somewhere – but, is it all smoke and mirrors? Before the 45% — who would get a wage hike to $15 an hour — can raise demand anywhere, they would need to get the extra cash from somewhere else – meaning the 55%. (Bottom 45 percentile incomes – not wages – currently take 10% of overall income – so, at no time are we talking giant chunks of the economy here.)

    The 45% can get higher pay even as “numerical” (to coin a phrase?) demand for their output declines due to higher prices — as long as labor gets an bigger enough slice of the new price tags. This can be compared to a leveraged buyout or buying stocks on margin.

    Products produced by low-wage labor tend to be staples whose demand tends to be inelastic. Demand for food is inelastic – maybe even fast food. If the price of your Saturday family jaunt to McDonald’s rises from $24 to $30, are you really going to eat at home (the kiddies haven’t forgotten the fundamental theorem of economics: money grows on trees :-])? And fast food should be the most worrisome example: lowest wages to start with; even so, highest labor costs, 25%.

    Wal-Mart is the lowest price raising example (surprise) with 7% labor costs. Jump Wal-Mart pay 50% and its prices go up all of 3.5%.

    If low wage labor costs average 15% across the board and go up 50%, overall prices increase only 7.5% — and that is for low wage made products only; nobody’s car note, mortgage payment or health premium is affected. If demand drops just enough for price increases to maintain the same gross receipts (conservative, even without inelasticity), low wage income should improve appreciably.

    Allow me to cite: from a 1/ll/14, NYT article “The Vicious Circle of Income Inequality” by Professor Robert H. Frank of Cornell:
    “… higher incomes of top earners have been shifting consumer demand in favor of goods whose value stems from the talents of other top earners. … as the rich get richer, the talented people they patronize get richer, too. Their spending, in turn, increases the incomes of other elite practitioners, and so on.”

    The same species of wheels-within-wheels multiplier ought to work the at both ends of the income spectrum — and likely in the middle. A minimum wage raise to $15 an hour is not going to send most low-wage earners in pursuit of upper end autos, extra bedrooms or gold seal medical plans. Wal-Mart and Mickey D’s should do just fine, OTH – which in turn should keep Wal-Mart and Mickey D’s doing even better.
    * * * * * *
    Did I forget to mention … ? The poverty line that a “moderate” minimum wage could not help anybody cross — $20,000 for a family of three – is only about half as high a hurdle as a realistically worked out minimum needs line should be. .

    A practical line would be more like $40,000 a year. Today’s official federal formula is an early 1960s creation: multiplying the price of an emergency diet by three (dried beans only, please; no expensive canned) – no current basket of goods. For a reasonable basket of goods consult page, 44, of the, 2001 (2008), MS Foundation book “Raise the Floor.”

    So, a so-called “moderate” increase in the minimum wage will not even clear a half-height hurdle.

    Final thought: Why does everyone obsess so over the “hazards” of raising one price in our economy — low wage labor’s. Nobody shudders when the Teamsters Union raises its price. It is not like the price of low wage labor has been habitually tested against market willingness to pay and been barely holding its own. It is more — it is exactly — like the price of low wage labor has sunk further and further below market willingness — precisely for lack of testing — as the ability to pay has grown and grown — for almost half a century now. Click for my everything-adjusted-for-everything minimum wage history chart.

  4. Denis Drew

    My personal experience with the “disaster” — not the saccharine “inequality” of the American labor market as a Chicago cab driver.

    The city allowed one 30 cent increase in the mileage rate on the meter between 1981 and early 1997 — at which 1990 midpoint the city started building subways to both airports, allowing unlimited limos, putting of free trolleys between all the hot spots downtown (the Aquarium used to be our busiest pick-up after O’Hare — AND — 40% more taxicabs.

    In New York City (where I came from) the mileage charge was (in 2004 dollars) $2.25 a mile after the last successful taxi strike in 1974. By early 2004 the meter was $1.50 a mile. Since the union was broken by the lease system (private contractors) the entire 75 cent deficit came out of the drivers’ side. Guys were going back to India for a better life. This in the only place on earth where wealth is a plateau not a pinnacle.

    If we get a $15 an hour minimum wage the meter will have to go up a dollar and hour in Chicago, at least — if you want any cabdriver. Our job has been outsourced at home just like fast food — from an income that could buy a house and send kids to college (maybe for an 84 hour week — I’ve done it — to four guys sharing an apartment. If no one showed up for $8 an hour — no American born workers (too busy selling crack to survive) at McDonald’s you’d learn to pay 25% more fast.

    I remember the summer before the New York meter was finally raised to $2 a mile — someone from the city was quoted as too many empty cabs built up in the garages: “Maybe we’ll add A LITTLE SOMETHING TO THE METER.” [Emphasis mine.]

    Maybe you progressive ought to start to get real with your sense of proportion and think past — way past — adding “a little something” to les miserable’s wage (40 years after New York’s last successful taxi strike).

    And don’t forget about the ultimate answer to our labor woes: legally mandated centralized bargaining. The specter of that might really focus you better on the scale of the “real world” that you talk about in your pieces. I wrote something about it a while back, here:

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  6. peter thom

    Base earnings are not measurably worse in the US despite the decades long de-unionization of US workers. To illustrate, let’s compare US inequality to that in OECD countries, as measured by the GINI coefficient BEFORE taxes and transfers. Turns out that on that measure we are very close to the OECD average: US = 0.46, OECD average = 0.45. There are about 10 countries in that group with higher inequality. So market forces over the last three decades have produced rises in inequality in most advanced countries. However, AFTER taxes and transfers we are at the highest level of inequality, 0.38, while the OECD average is lowered to 0.32. By these data it would appear that amelioration of inequality in the US would best be accomplished through a tax regime that is more progressive or some combination of that and a higher minimum wage.

  7. Bryan Willman

    I not grok the leanings or biases of anybody here, but I have three questions which do not APPEAR to have been answered by anybody (perhaps have I failed to read or understand something.)

    1. To what extent will various sorts of inflation or other repricing wipe away the effects of the minimum wage over some reasonable period? Don’t think CPI, think price of an apartment, price of gasoline, etc.

    2. Does it not bother those who wish to argue for changing the balance of returns to capital and labor, either pre or post tax, that raising the minimum wage is likely to in effect “tax” the 20% to 50% to raise the share of the 0% to 20%? You are really not redistributing or remotely adjusting source income from the 1% to the bottom 20%. The 1% don’t eat at McDonald’s or shop at WalMart. The EITC has rather better effect here, at least on post-tax/post-transfer distribution.

    3. Assume the forces of automation and the spectacular cost leverage powers they bring cannot be held off forever – and so by 2040 there are no cabbies in Chicago or New York because automated free services with robot drivers have totally displaced them. It is hard to see how mechanisms such as a minimum wage will be of any help in such an environment. (And remember, economies with horrendous official unemployment rates do exist. Don’t think it cannot happen, it does…)

    1. Mary

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