Tuesday, November 18, 2014

Guest Blogger Chuck Trzcinka The Psychology of the Minimum Wage

Chuck Trzcinka is Professor of Finance and James and Virginia Cozad Faculty Fellow of the IU Kelley School of Business.

The political support for raising the minimum wage stems from psychology not economics. The economics is abundantly clear-the minimum wage cuts jobs. The higher the minimum the more the harm. The Congressional Budget Office released a survey of economic studies last year and concluded that raising the minimum wage to $10.10 will reduce employment by between 500,000 to 1,000,000 jobs. When you increase the cost of something, business will find ways to reduce its contribution. For example, McDonalds has added 7,000 touch-screen kiosks in its European stores. Furthermore, the survey showed that over 70% of those receiving the minimum wage are not from poor families. The CBO argued that a better way to help is to raise the “earned income tax credit” would have little effect on jobs.

So raising the minimum wage, even having a minimum wage in the first place, makes no economic sense, but it is unquestionably politically popular. Voters soundly rejected Democrats in Tuesday's election but embraced a visible plank in the party's platform by backing minimum wage hikes in four Republican-leaning states and two cities. By January, more than half the states will have higher wage floors than the federal government. Voters in Alaska, Arkansas, Nevada and South Dakota passed ballot initiatives raising the minimum wage to $9.75 an hour even as they swept Republican Senate and gubernatorial candidates into office. All told, the initiatives will raise minimum hourly earnings for 609,000 low-wage workers, according to the National Employment Law Project.

            Why is it so popular if it doesn’t help the poor? The reason is that it makes us feel better. Psychologists use a concept called “cognitive dissonance” to describe a situation where facts confront our most basic views. For example, young people are reluctant to save for retirement because this means accepting that they will grow old. Similarly, when we interact with low wage workers it makes most of us uncomfortable. They only have skills that command a wage below what we think is below a “living wage”. It is certainly below our living wage. The low wage confronts our belief that we are living in a “fair” economy.  Our response is psychologically to reduce the source of dissonance. If we raise the minimum wage we will either eliminate the job or have a higher wage worker. We will not ever meet a low wage worker and we will believe that the economy is more fair and just. The minimum wage is really about making those who are wealthier feel better.

The problem of course is the economics. The poor would be far better off if the minimum wage was lowered or eliminated and we expanded the earned income tax credit. But then our idea of “fairness” would be challenged by low wage workers. We would never think to ask any of these people why they were willing to work for a low wage since this conversation is uncomfortable. It’s better to get government to impose a wage floor and never meet them. 


  1. As an employer we hire just the people we need at a wage that is commensurate with their contribution to our bottom line and in accordance with the economics of the region. We are not a low wage business. However, in my community of 500,000 people who 60% who work earn below what is considered to be the lower middle class household wage. We have a poor community and the distribution is somewhat unbalanced but that is what one could expect from a service based area dependnen on tourist.

    Let's take that a step further. A large portion of these people get wages just above minimum and have educations just above minimum excluding the local students we have from four colleges. The normal employer for these service jobs is rapidly doing what McDonald's has done but not just in ordering food but in many other things. I often refer to this as IT Takeover. IT is much more efficient, cost less and does not have benefits. It is happening all over the country where once it was only in manufacturing. So here are the questions:

    Where do these people go for work...the black market? Start ups? Welfare? What can we expect as this trend slowly moves into the middle class? Will the value / contribution of the middle class worker be the same to justify middle class wages?

    I read an article about three college roommates operating a computer gaming business in 8 hour shifts and doing

    I was taught that a thriving economic system is one where the money transfer from point to point to increase or at least sustains employment. However, that was in the 60's and that economic structure is long gone.

  2. Dear Chuck. Your comment that raising the wage would make us feel better is consistent with liberalism. Liberals generally don’t have pertinent facts to buttress their arguments and can’t convince folks who rely on and understand facts, particularly economics, to join their causes. There are many reports/analyses on raising the wage and anyone can find one to support their side—it would be a daunting task to read them all and derive an objective conclusion. So I won’t offer one. However, food industry stats—the largest employer of minimum/low wage earners—show employment at about 1.35 million with sales of $683.4 billion, averaging about $50,600 per employee. Assuming a raise to $10.10 from $7.25 on 2,000 hours per year increases an employee’s labor cost $5,700. Most food service companies employ less than 50 so it’s easy to see the impact on profit per employee if prices can’t be raised to offset the wage—plus payroll taxes.

    Many of the aforementioned reports’ stats show wide ranging demographics of gender, age, family income, race, etc. of minimum/low earners—they are not a homogenous group—so an increase would affect individuals’ situations differently: Liberals’ mantra that an increase would provide a “living wage” is quintessential hyperbole. A $5,700 wage bump would affect a 16-year old living at home differently than a mother in a two-earner $40,000/yr. household.

    I think the potential for increased labor costs without price increases for many small businesses along with the opaqueness of the overall effect on individuals’ situations makes a compelling argument to increase the unearned tax credit.

    I think liberals would welcome that option since half of workers don’t pay federal income tax anyway—Libs would have won another socialized entitlement. Hooray!—Libs would feel much better—oh, joy!

    1. Thanks for your comments. The CBO report is really just a summary of 61 studies. It is not itself a study. The bottom line is that the economic case for any minimum wage is weak but the psychological case is very strong. It really does make wealthier people feel better...

  3. I believe we all forget that the impetus behind minimum wage hikes comes predominantly from unions. The SEIU has been stirring the fast-food employee pot recently. Any increase in the min wage raises the floor for the start of contract negotiations,and increasing that point means more filthy lucre for those in union leadership when the new contract goes into effect. Union membership is declining, and the money pot is getting low. I hate to be so cynical, but I watched it happen in person.

  4. Current research of what rich people are really feel call into question the conclusion of guilt felt by rich people. “As you move up the class ladder”, says University of California of Berkley psychology department professor Dacher Keltner, “you are more likely to violate the rules of the road, to lie, to cheat, to take candy from kids, to shoplift and to be tightfisted in giving to others. Straightfoward economic analysis have trouble making sense of this pattern of results.” The problem is the inequality itself: it triggers and chemical reaction in the brain of the privileged few. It tilts their brain. It causes them to be less likely to care about anyone but themselves or experience moral sentiments needed to be a decent citizen.

    Heralded Harvard economist Dr. John Kenneth Galbraith suggests that the Congressional Budget Office staff is selected by the privileged who deliberately bias any work products in favor of the wealth. Galbraith was also in favor of an indexed minimum wage that would rise in proportion to GDP growth.

    So clearly, not all esteemed economists’ agree with the minimum wage premise.

    1. This comment is from Chuck Trzcinka...I just posted it for him...."Thanks for your response. There is no question that jobs which are available to the moderately skilled have been declining in pay. As technology shifts, people need to shift with it. This is not a fact that the minimum wage can address though. It is really about investment in education."