Wednesday, April 19, 2017

Maybe Jazz Shaw and John Hinderaker Should Read Papers Before Promoting Their Results

Yesterday, the conservative blogsphere was on fire with a new report from the Harvard Business School that supposedly proved raising the minimum wage is forever damaging to the local restaurant industry.  Rather than reading the actual report themselves, both Mr. Shaw and Mr. Hinderaker relied on the Washington Examiner as their media filter.  This was a big mistake.  In the words of the Princess Bride, "I don't think that report says what you think it says..

First, let's start with the following stunning rebuke of Mr. Shaw and Mr. Hinderaker, both of whom argue that simple economics shows raising the minimum wage is damaging:

Mr. Shaw:

There is an entire body of work in the progressive sphere dedicated to nothing but this particular propaganda effort. The premise makes no sense in terms of basic economics (or simply math, for that matter) but it keeps on being repeated. And yet, when the experiment is moved off of the chalkboard and out into the real world the opposite always seems to happen.

Mr, Hinderaker:

A number of cities across the country have enacted dramatic increases in the minimum wage. This has caused a great deal of harm, but on the plus side, it has enabled research on the economic consequences of mandating wages at higher than market rates.

However, the new report directly contradicts both statements.  From page 6 of 33 of the report:

Our results contribute to the existing literature in several ways. First, our findings relate to a large literature seeking to estimate the impact of the minimum wage, most of which has focused on identifying employment effects. While some studies find no detrimental effects on employment (Card and Krueger 1994, 1998; Dube, Lester & Reich, 2010), others show that higher minimum wage reduces employment, especially among low-skilled workers (see Neumark & Wascher, 2007 for a review). However, even studies that identify negative impacts find fairly modest effects overall, suggesting that firms adjust to higher labor costs in other ways. For example, several studies have documented price increases as a response to the minimum wage hikes (Aaronson, 2001; Aaronson, French, & MacDonald, 2008; Allegretto & Reich, 2016). Horton (2017) find that firms reduce employment at the intensive margin rather than on the extensive margin, choosing to cut employees hours rather than counts. Draca et al. (2011) document lower profitability among firms for which the minimum wage may be more binding

The emboldened sentences are very clear.  First, there is a large amount of academic support for arguing that raising the minimum wage to certain levels has no negative effect.  But here's the kicker: the reports that supposedly support Mr. Shaw and Mr. Hinderaker don't provide the support they thought.  The negative effects are "modest, suggesting that firms adjust in other ways."  This is a point I made last spring

Shaw's and Perry's reasoning run into two primary microeconomic problems.  Both assume labor demand is elastic (a term I doubt Mr. Shaw is familiar with) -- that a change in cost will have a disproportionate impact on demand.  However, this simply isn't true.  For example, let's assume that a restaurant owner currently has 10 employees when wages increase.  Let's assume he fires 4 people due to increase cost.  At some point, he'll cut off his economic nose to spite his face -- that is, he'll lower his payroll to such an extent that he'll hurt customer service, lowering overall revenue.  Given the profit maximizing principal underlying cost theory (again, I doubt Mr. Shaw is aware of this concept, either), the current level of 10 employees is probably already peak efficiency, which means he'll either, absorb the cost, cuts costs elsewhere, raise prices, or do some combination of all three. 

     And then there's the inherent problem of the production function graph:

As anyone who knows micro (which, it is painfully obvious Mr. Shaw doesn't) would note, when you lower your primary short-term variable cost (labor) you also lower your output.   Now, it's possible you might not do too much damage, depending on a number of different factors, but the bottom line is that you're moving in the wrong direction.

     In my next post, I'll look at the results.  Because, like the above points, they don't support Mr. Shaw or Mr. Hinderaker nearly as much as either thinks.