The Case for Raising the Minimum Wage to Address Labor Shortages

by Benjamin Studebaker

As we saw in the years following the 2008 recession, lots of business owners are frustrated by labor shortages. They argue that these shortages are caused by a lack of incentive to work, and propose to generate that incentive by making life more difficult for the unemployed. In this case, they argue for restoring work requirements for unemployment and eliminating the federal unemployment supplement enacted in the waning days of Trump administration. This is a highly punitive way of generating incentive, and those who support these measures often accuse our unemployed citizens of laziness. They could instead generate incentive by raising wages. A recent study from the Federal Reserve indicates that the vast majority of workers aren’t being discouraged. As long as workers anticipate that their unemployment benefits may eventually come to an end, they will accept work even when the work pays less than the benefits do. Only the workers at the very bottom of the wage distribution face an incentive problem. Today I want to discuss how the study works and what it means for the minimum wage debate.

The study argues that when a worker contemplates whether to take a job, there is a threshold wage that determines whether the job is attractive. The authors call this threshold the “reservation benefit”. They describe it this way:

An offer is accepted if the current level of benefits is below this reservation benefit. For a given wage offer, the level of reservation benefit to reject the job is determined by: (i) the expected duration of the employment spell – longer lasting jobs have a greater value and are rejected only for commensurately generous unemployment insurance (UI) payments; (ii) the rate of arrival of new job offers – in a depressed labor market, when job offers are few and far between, any job offer is costly to refuse. Higher (reservation) UI payments are needed to reject a job offer, and; (iii) the duration of benefits remaining – an additional week of benefits raises the opportunity cost of accepting an offer. In the limit of indefinite UI duration the reservation benefit converges to the wage offered. With one week remaining of UI payment, the reservation benefit is always above the wage offered.

They illustrate the different reservation benefits for workers in different occupations:

Here we can see that only food service workers and janitors have a reservation benefit low enough to reject work, and they are only likely to reject work if they anticipate they have more than 8 weeks of what the authors call “Pandemic Unemployment Compensation” (PUC). As soon as these workers are concerned they might lose the federal supplement in the next two months, even they resume accepting work.

It must be emphasized that this study considers the situation in 2020, under the Trump-era CARES Act, which initially offered workers a more generous federal supplementary payment ($600) than the Biden-era American Rescue Plan Act ($300). On its own, this benefit cut would significantly reduce reservation benefit levels. They could nonetheless be higher in theory if workers believe they won’t lose supplementary federal benefits for significantly longer than 12 weeks. But given that the federal unemployment supplement is set to expire in September, all unemployed citizens will be set to lose their pandemic unemployment compensation within 12 weeks from mid-June.

This means only workers at the very bottom of the wage distribution are potentially discouraged by the federal supplement, and even many of these workers are likely no longer discouraged because Biden’s supplementary benefit is so much smaller than Trump’s was. Of all the occupations included, the one that pays the worst is food service, at $464 per week. If a food service worker works for 40 hours per week, this works out to an hourly wage of $11.60.

The thing is, almost 40 states have a minimum wage that is lower than $11.60. In these states, the reservation benefit for food service workers is likely higher than it is across the country as a whole. Currently, an estimated 1.6 million workers still earn the federal minimum wage or less. The federal minimum wage is still just $7.25. The study doesn’t preclude the possibility that workers earning roughly in this range–between $7.25 and $12.00–might still be discouraged, especially in states where low minimum wages are nonetheless accompanied by comparatively high unemployment benefits.

As recently as 2016, a full 41.7 million Americans were found to earn less than $12 per hour. In 21 states, more than a third of the workforce fell into this category. In all but 6 states, more than a quarter of workers were earning less than $12. In Arkansas and Idaho, this percentage topped out at 39.6%. Some states have raised their minimums since 2016, but only a handful of states have gone past $12, and many have no state minimum wage at all. It is reasonable to think that there are still tens of millions of workers out there in this category, and a significant percentage of these workers probably prefer to collect unemployment.

Many of these workers were classified as “essential” not so very long ago. But they are now being denounced as lazy slackers, all because they are reluctant to accept jobs which pay less than $25,000 per year. These people are desperately poor, and for some of them the pandemic unemployment benefits are the most money they are likely to see for a very long time. It is enormously cruel to target this population with punitive measures when, as this study indicates, a minimum wage hike to as little as $12 would be enough to incentivize them to accept work.

It’s pathetic that this is where the national conversation is these days. Not so very long ago, the $15 minimum wage was in the Democratic Party platform. But this promise was swiftly abandoned within the first 100 days of the Biden administration. Biden made no effort to subject senate holdouts to public pressure, publicly doubting the policy’s ability to survive negotiations before those negotiations had properly begun.

Without a federal minimum wage hike to level the playing field, the companies that are large enough to support higher wages are picking off the workers in this range. Behemoths like Walmart pay a minimum of $11 an hour. Target and Amazon have recently gone to $15. Smaller businesses face smaller margins, and they often try to make up for those smaller margins by paying lower wages than the big firms. Right now, all this is doing is leaving them with fewer workers to choose from. The most talented and reliable employees are, rightfully, choosing to work for the companies where the pay is less appalling.

This creates something of a death spiral for small businesses. Their lower wages are leaving them understaffed. The employees they are attracting are those the big box stores are turning away. This means that very often the workers they do hire provide inferior service. Long wait times and poor service drive customers away and damage revenue, and poor revenue makes it even more difficult to raise wages. The problem is exacerbated during economic recoveries, when the labor market is especially tight and these extremely poor wages are especially unattractive.

Paradoxically, a minimum wage hike would help a lot of these small businesses by forcing them to abandon a business practice that is itself contributing to their decline. They could be further reassured by a new version of the Paycheck Protection Program, geared specifically to give small businesses time to adjust to a higher minimum wage.

The fears about inflation are largely unfounded. In countries with higher minimum wages, McDonalds’ employees are able to buy themselves Big Macs more quickly than they can in countries with lower minimum wages:

See the source image

This means that minimum wage hikes do not get passed straight on to consumers. Instead of raising the price of the Big Mac to cover the higher wage, McDonalds’ franchisees find other ways to make up the cost of wage hikes. It makes sense–if McDonalds doesn’t find a way to avoid raising the price of the Big Mac, Burger King may find a way to avoid raising the price of the Whopper. Market competition makes it very risky for McDonalds to try to pass the costs along without being undercut by a competitor.

Unfortunately, with Joe Biden neglecting this issue, small businesses will continue to be free to follow the failing strategy of paying too little and then complaining when they can’t find quality help. Biden has already indicated he supports dealing with the problem by subjecting these poor workers to onerous federal work requirements, imposing them even on the 21 states which currently don’t have them:

“We’re going to make it clear that anyone collecting unemployment who is offered a suitable job must take the job or lose their unemployment benefits.

These “suitable jobs” leave workers struggling with rent and debt, forced to move from one miserable job to the next year after year. Our welfare system forces hard-working people to live their lives running on a treadmill until they can’t run anymore. The pandemic unemployment benefits gave these people a cruel glimpse of life outside the hamster wheel, and now Joe Biden is commanding them to go back in.

I’m really tired of people telling me that I’m supposed to be impressed by this.