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Poor Labor Economics From a Former Secretary of Labor

One of the few correct statements in one of Robert Reich’s recent minimum-wage videos (in which he argues in favor of raising the national minimum wage by 107%!) occurs at around the 1:50 mark.  Here, Reich says “Studies have also shown that when the minimum is raised, more people are brought into the pool of potential employees, so employers have more choice of whom to hire.”  Indeed – but Reich misses the real meaning and full importance of this point.  He (1) draws from it only a mistaken conclusion and (2) fails to draw from it an important correct conclusion.  In this post I’ll limit myself to discussing only (1); I’ll discuss (2) in a later post.

The mistaken conclusion that Reich draws is that the hike in wages “cuts down on turnover and helps employers save money.”  Higher wages do indeed, undoubtedly, cut down on employee turnover (although the important economic point made in the eighth paragraph here, in 1998, about this general matter by Paul Krugman ought to be kept in mind).  But cutting down on turnover, while a benefit, is not necessarily worth its costs to employers.  That is, the reduction in turnover caused by higher wages doesn’t necessarily help employers save money – given that the lower turnover is paid for by employers in the form of higher wages.  The benefit (lower turnover) must be weighed against its costs (a higher wage bill for employers).  The net result might well be that employers lose money.

Reich, however, illegitimately assumes that any reduction in employee turnover that results from raising the current U.S. minimum wage from $7.25 per hour to $15.00 per hour is worthwhile to employers.  (Reich here does what David Henderson might call “benefit analysis” – in contrast to cost-benefit analysis.  If you ignore costs, no benefit will ever appear to be too costly!)  But, again, it might well be that the benefit to employers of some additional reduction in employee turnover isn’t worth the additional cost, in the form of a higher wage bill, that is necessary to purchase that benefit.

If you doubt this last claim, consider that each employer right now could reduce its employee turnover by doubling the wages it pays.  That reduced turnover would be a benefit enjoyed by each firm that doubles its workers’ wages, but this benefit is also highly unlikely to be worth its cost to each firm.  The fact that we do not see employers daily and indiscriminately purchasing with higher wages a less-turnover-prone workforce implies that there comes a point for each employer at which the benefits of lowered employee turnover are not worth the costs of securing this lowered employee turnover.  (The point at which the benefits of additional lowered employee turnover are made equal the costs of securing this additional lowered turnover differs across industries and firms, and changes through time for all industries and firms – yet another reality that Reich can fairly be interpreted as missing.)

We can also infer from the fact that we do not see firms daily and indiscriminately purchasing, with wage-rate hikes, ever-more reductions in employee turnover that the existing rate of employee turnover for each firm is likely ‘optimal.’

The reason we can confidently draw this conclusion is that if this rate weren’t optimal – if the rate of employee turnover for each firm were (as Reich assumes) too high or (a possibility that Reich ignores) too low – then firms themselves have strong incentives to adjust the rates to their optimal levels.  If Wal-Mart learns that its employee turnover can be reduced at a cost to it (in the form of a higher wage bill) that is more than compensated by the benefits to it of this reduction in employee turnover, Wal-Mart – profit-seeking firm that it is – will, of course, take this step without having to be compelled by government to do so.  Ditto for every other private, profit-seeking firm in the economy.

It is plainly illegitimate to assume that the economy is so widely infected with failures of private firms to take profit-enhancing steps – steps that are easily within the capacity of each private firm to take – that government dictates are required to force firms to take such profit-enhancing steps.