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Demand. That’s All that People Who Don’t Understand Economics See As Being Relevant

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Ms. Fielder wrote back.  So did I:

Ms. Caroline Fielder

Dear Ms. Fielder:

In your follow-up e-mail you say that “the strongest reason” to raise the minimum wage is that it will “lift spending….  [I]t’s self-sustaining by giving employers more business.”  For support you cite Robert Reich.

You get Reich right, but you and he get economics wrong.  In a follow-up e-mail I’ll send you links to some essays that explain the flaws in this theory.  But for now let’s look at some numbers. A couple of years ago the Congressional Budget Office predicted [2] that a hike in the minimum wage to $10.10 per hour would affect 17 million workers.  Assuming that all 17 million of these workers get raises, how much additional spending would result?  Answer: Not much.

Even if we make assumptions unreasonably generous to the case for greater spending – such as that all of the extra money paid to minimum-wage workers would have been hoarded as cash by employers or consumers in the absence of a wage hike; that all workers who get a raise will have their hourly wages rise to $10.10 from $7.25 rather than from some wages in between $7.25 and $10.10; that minimum-wage workers spend every cent of their higher incomes; that the higher minimum wage causes no reduction in the number of hours worked by minimum-wage workers or in the value of their fringe benefits; that all workers who get a raise work 40 hours weekly, 52 weeks annually; etc. – we find, using the CBO’s estimate of the number of workers affected, that the annual increase in base spending would be $100.8 billion.  That’s about one half of one percent of U.S. GDP.  It’s insignificant.  It’s a rounding error.  It’s an increase in spending far too small to give you any reason to suppose that it will pay for itself by so boosting employers’ demand for low-skilled workers that the CBO is proven wrong in its estimate that 500,000 of those 17 million workers will in fact be rendered unemployable by a minimum wage of $10.10 per hour.

True, you can conjure up a sizeable potential increase in spending with an even larger hike in the minimum wage – say, to $15 – and assert that the resulting greater spending will ensure that there will be no resulting unemployment.  But if significantly more spending is sufficient to keep all workers employed at higher wages, why generate this spending in the roundabout and rather uncertain way of hiking the minimum wage?  Why not instead use helicopters to dump one or two trillion dollars of cash onto the economy, or onto low-income neighborhoods, and watch the economy, employment, and wages boom as a result?  Do you really believe that lasting prosperity can be created by such simplistic means?

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

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