Is The Minimum Wage Stimulating?

According to Keynesian economic theory, an injection of funds into an economy will generate a multiple increase in overall economic activity.  My colleague, Dick Schiming, was quoted a month ago by the local television station:

Schiming says he's on the side that thinks raising the minumum wage is a good idea.Dick Schiming says, "It's going to stimulate more spending which will create more jobs in the long run."

And later in the story.

"The idea of economic stimulus is giving people more money to spend by putting money in the pocket of low income workers. They'll spend it. So in essence it can be viewed as a stimulus package."

So if you take the basic identity GDP = C+I+G+NX (spending on economic output is the sum of consumption, investment, government spending, and net exports), Dick is arguing the minimum wage will increase C. 

And it's not just Dr. Schiming making this argument (see here).  So, I ask them this:  why not set the minimum wage at $100 per hour?

A common finding in minimum wage studies is that the elasticity of demand for minimum wage workers is somewhere around -0.1 in the short run.  That is, a 10% increase in the minimum wage causes a 1% decrease in employment.  When demand is inelastic and the minimum wage increases, minimum wage workers as a group will realize higher incomes in the short run although some members of the group will have lower incomes. 

The problem with Dick's argument is that increased wage payments from businesses do not represent an injection of funds into an economy.  Think of it this way.  If I take the money out of my left pocket and put it in my right pocket, do I have more money in my pockets?  No.  I haven't changed the stock of cash in my pockets, only its distribution.  Likewise, the minimum wage workers will have more money, but business owners will have less money. 

So while that part of C driven by minimum wage workers is likely to increase, it will be offset by a likely decrease in that part of C driven by business owners and a decrease in business investment, I.

For a policy to be truly stimulating, it needs to encourage more voluntary trades.  Increases in the minimum wage causes unemployment.  That is, it discourages voluntary trades in the low skilled labor market.  Moreover, to the extent that an increase in the minimum wage increase prices of goods/services produced by minimum wage workers, it discourages voluntary trades of consumables. 

Comments

[Greg]

I like your example of the two pockets, but I would add that the net effect of the redistribution of wealth has more to do with the size of the hole at the bottom of two pockets which represents the rate at which each pocket releases money into the economy. Without any evidence, my guess would be that poorer people tend to spend rather than save leading to a larger boost in the economy in the short run. If they are not able to keep that pocket full the long term effect of the larger hole is not good. I am not sure the hole in the business owner’s pocket changes in size relative to the amount of cash in the pocket. The business owner is likely to find another pocket to put it in if it gets too full.

[Phil]

I don't have the numbers either, but my sense is that lower income folks may spend more but business people invest more. If so, this offsets the higher spending of lower income folks in the short run and harms the economy in the long run.