Don't dismiss the long-term unemployed

The long-term unemployed matter. That might be the conclusion from a trio of blog posts by New York Fed researchers, over at Liberty Street Economics. (The authors are Rob Dent, Samuel Kapon, Fatih Karahan, Benjamin W. Pugsley, and Ayşegül Sahin.)

In the first part they compare the observable characteristics of four groups of potential workers: the short-term unemployed, the long-term unemployed, nonparticipants who say they want a job, and nonparticipants who say they don't to work. In particular, they compare the distributions of gender, age, race, education, occupation and industry across groups (see the charts below).

The authors conclude that "on the basis of these observable characteristics, we find that long-term unemployed workers are not less attached to the labor market than short-term unemployed workers" (emphasis mine).

The emphasis on observable characteristics is important. There might be other, unobserved characteristics that affect the supply or demand of labor, and so it would be incorrect to imply that labor force attachment, employability, etc. is the same across groups. Motivation and family responsibilities are two examples, off the top of my head, of such unobserved characteristics (unobserved to us, not to job seekers or employers). The authors do acknowledge this: "While there may be unobservable characteristics of long-term unemployed workers that make them less attached to the labor force..."

In the second part the authors find that the short-term unemployed are more likely to find a job than the long-term unemployed, both within one month and within one year. At the one-month horizon, the long-term unemployed and nonparticipants who want a job have almost the same odds of finding a job, but at the one-year horizon long-term unemployed are more likely to find a job than nonparticipants. Finally, they estimate the dropout rate (fraction who leave the labor force) by group, with the expected results.

In the third part, they find little evidence that long-term unemployed exert less pressure on wages than short-term unemployed.

My take from those blog posts is that the long-term unemployed are not like non-participants, and shouldn't be dismissed as just "dropouts by another name." They are probably somewhere between short-term unemployed and nonparticipants, in terms of likelihood of getting a job, and not starkly different from other groups in terms of demographic characteristics.

How much slack is there in the labor market?

Economists at the Cleveland Fed compile different estimates of "labor market slack" and of the "normal unemployment rate." I think the most important sentence in their commentary is:

There is considerable uncertainty surrounding the estimates, so we cannot draw sharp conclusions about the amount of slack, or about differences between slack estimates. 

Also, look at the chart of the estimates of slack:

At least three of the metrics dip below zero during business cycle expansions (the green line, the purple line, and the blue line). That means job market slack turns negative, or that the market gets too tight. Is that something policymakers should shoot for? How about the risks associated with a monetary policy that, while it "gets more people employed," also creates distortions and imbalances elsewhere? 

The most recent data points are hard to read off the chart, but it seems to me that most measures are between 0% and 0.5%, if not below. So, whereas there is uncertainty, this evidence suggests that slack is somewhere between small and non-existent. What is the optimal monetary policy in the presence of this small but uncertain job market slack? Keep monetary conditions loose, just in case? 

More and more, it seems to me, the Fed is looking only at one side of the risk (i.e. the risk that monetary conditions are too tight).

What caught my eye

1. Labor under-utilization: We keep thinking, long and hard, about how much slack there is in the job market. Gavyn Davies brings our attention to a timely conference put on by the Peterson Institute. The "consensus" --at least as gauged by Davies-- is that the unemployment rate in the U.S. under-represents the true amount of slack, due to the effect of the participation gap and involuntary part-time employment. Moreover, because of long-term unemployment and the potential rise of productivity growth, a decline of labor slack need not be as inflationary as it normally would. Everybody, however, acknowledges the "great uncertainty" around these assessments.

The Peterson Institute has posted the videos and ppt files of all the conference presentations here.

2. "Grapho-tainment": Twenty-two maps and charts that will surprise you, by Vox.com. I love these: #1, #3, #7, #10, #15, #17, and #19.

3. Speech by Vítor Constâncio, vice-president of the ECB, on "understanding the yield curve." I liked this [emphasis mine]:

Moreover, high sovereign spreads in the euro area have raised the question of what is the appropriate yield curve to monitor. In an article in the July Monthly Bulletin we discussed this issue in the context of measuring the euro area risk-free rate. Should we use Bund yields, euro area average AAA rates or OIS rates, or does it depend on the matter at hand?

Incidentally, an intriguing question in a currency union is the following: if it is difficult to identify a risk-free rate in a currency union, this means that there is no risk-free asset either, besides the central bank's own liabilities, the currency. 

4. David Keohane at FTAlphaville shares a report by HSBC, on the uneven conditions for growth across states in India.

5. From this week's batch of NBER working papers [emphasis mine]:

We employ a model of precautionary saving to study why household saving rates are so high in China and so low in the US. The use of recursive preferences gives a convenient decomposition of saving into precautionary and non precautionary components. This decomposition indicates that over 80 percent of China’s saving rate and nearly all of the US saving arises from the precautionary motive. The difference in the income growth rate between China and the US is vastly more important for explaining saving rate differences than differences in income risk. We estimate the preference parameters and find that Chinese and US households are more similar in their attitude toward risk than in their intertemporal substitutability of consumption.

I find the statement in bold very, very hard to believe, given this.

The paper is by Horag Choi, Steven Lugauer, and Nelson Mark, and here's an ungated version.

What caught my eye

1. Brazilians turn against the canarinha (for now).

2. Bad dreams about Russia, China, and World War.

3. What do cancer and unemployment have in common?

4. NBER papers: phasing out paper currency, and permanent changes to monetary policy.

1. "I want Brazil to lose," says a Brazilian. I seldom hear good things about the World Cup, which makes me think the event will be a positive surprise. (By the way, remember the comments in the months prior to London's Olympics?)

2. Russia strengthening ties to China. Perhaps it's WWI centennial fever, but I can't erase from my mind the idea of a China-Russia military alliance, against the "oppression," "bullying," etc. from the U.S.-Western Europe-Japan trio. Articles like this, on China supposedly following Japan's prewar blueprint, don't help put me at ease.

3. The odds of developing certain cancers decline with age, just like the odds of escaping unemployment decline with the length of the jobless spell, by Jim Hamilton.

4. Two papers from this week's NBER crop:

4.1 Costs and benefits to phasing out paper currency, by Kenneth Rogoff.

Despite advances in transactions technologies, paper currency still constitutes a notable percentage of the money supply in most countries.  For example, it constitutes roughly 10% of the US Federal Reserve's main monetary aggregate, M2.  Yet, it has important drawbacks. First, it can help facilitate activity in the underground (tax-evading) and illegal economy. Second, its existence creates the artifact of the zero bound on the nominal interest rate.  On the other hand, the enduring popularity of paper currency generates many benefits, including substantial seigniorage revenue.  This paper explores some of the issues associated with phasing out paper currency, especially large-denomination notes.

4.2 Has the financial crisis permanently changed the practice of monetary policy?, by Benjamin Friedman.

I argue in this paper that one of the two forms of hitherto unconventional monetary policy that many central banks have implemented in response to the 2007 financial crisis - large-scale asset purchases, or to put the matter more generically, use of the central bank's balance sheet as a distinct tool of monetary policy -is likely to become part of the standard toolkit of monetary policymaking in normal times as well.  As intended, these purchases have lowered long-term interest rates relative to short-term rates, and lowered interest rates on more-risky compared to less-risky obligations.  Moreover, their introduction fills a conceptual vacuum that has long stood at the heart of monetary policy analysis and implementation. By contrast, forward guidance on the future trajectory of monetary policy has been less successful.  Public statements by central banks about their actions and intentions will no doubt continue, but transparency for the sake of transparency is not the same as the deliberate attempt to shape market expectations for purposes of achieving specific monetary policy objectives. Finally, there is a conceptual component to all this as well.  In contrast to the last century or more of monetary theory, which has focused on central banks' liabilities, the basis for the effectiveness of central bank asset purchases turns on the role of the asset side of the central bank's balance sheet. The implications for monetary theory are profound.

Well worth reading

1. Housing bubble department: Switzerland, Australia.

2. Deflation, the zero-lower-bound, and multiple inflation equilibria, eurozone edition (this is a straight application of James Bullard's earlier paper, which in turn is an application of a paper by Benhabib, Schmitt-Grohé, and Uribe). Hat tip to Gavyn Davies, at the FT, for the link.

3. Puerto Rico will default (most likely), by Felix Salmon.

4. U.S. labor market spider chart. Great visual tool by the Atlanta Fed. Don't miss the jobs calculator, and the inflation dashboard!

5. U.S. small businesses don't create jobs any more, from BloombergBusinessweek.

Universal income versus minimum wage

The concept of universal basic income (a.k.a. guaranteed minimum income) got a bit of traction in the media when the Swiss proposed in October to put it to referendum. The idea is to give a check every month to every adult citizen, regardless of age, income, wealth, job status, or health condition. The intention is ostensibly to put a floor on the standard of living. My question in this blog post is: how would universal basic income compare with raising the minimum wage? The key to either policy, I think, is: what do we do with the existing tax and welfare system?

The likely first reaction to the basic-income scheme is to worry about disincentives to work. The likely second reaction is to mind the cost to taxpayers. If it comes down to a choice between universal income or our current patchwork of tax deductions and welfare schemes, universal income is clearly the winner. If I remember correctly from my undergrad econ, a lump sum tax or subsidy is not distortionary at the margin, whereas our ecosystem of taxes and welfare programs clearly is: it affects our decisions to work, save, and so on. Moreover, it costs a lot of money to administer all those welfare programs--clearly more than mailing a check to every adult every month. Universal minimum income would have an income effect, but if the level of the stipend is low enough it should not discourage most people from working. On the demand side of the labor market I do not see any meaningful effect.

To make universal income fiscally neutral (not to mention politically admissible) we would have to erase at least some of the current tax exemptions and deductions, and part of the welfare system. Suppose we started on a clean slate, we gave $10,000 a year to every adult, indexed for inflation, and we axed every existing welfare program (everything: disability, unemployment, food stamps, earned income tax credit, Medicaid, Medicare, subsidized housing, school vouchers, etc.). Tyler Cowen makes a very good point when he worries that we would quickly start amending such system, either on the grounds of social justice or public choice:

"Might there be circumstances when we would want to pay some individuals more than others?  Many critics for instance worry that a guaranteed income would excessively reduce the incentive to work.  So it might be proposed that the payment be somewhat higher if low income individuals go get a job.  That also will make the system more financially sustainable.  But wait — that’s the Earned Income Tax Credit, albeit with modifications. 

Might we also wish to pay more to some individuals with disabilities, perhaps say to help them afford expensive wheelchairs?  Maybe so.  But wait — that’s called disability insurance (modified, again) and it is run through the Social Security Administration.

As long as we are moving toward more cash transfers, why don’t we substitute cash transfers for some or all of Medicare and Medicaid health insurance coverage benefits, especially for lower-value ailments?  But then we are paying more cash to the sick individuals.  That doesn’t have to be a mistake, but it does mean that an initially simple, “dogmatic” payment scheme now has multiplied into a rather complex form of social welfare assistance, contingent on just about every relevant factor one might care to cite."

Adding to Tyler's list: Should we give a higher stipend to people living in New York than to those in New Orleans? The costs of living are quite different across locations. Should an adult with two children get a bigger payment than one with no dependents? Should we tack on a supplement when a natural disaster strikes? How about naturalized citizens? Should they start getting a check the day they get their U.S. passports, after a few years, or have a phase-in period? 

From a political standpoint it is clear to me that a pure universal income scheme is not feasible and that the only alternative is a modified program, in which case most of its benefits over the current system vanish. Political feasibility, on the other hand, is the main selling point of the minimum wage. We have lived with it since 1938, and it has been routinely raised with little controversy (at least compared to the Affordable Care Act or other novel schemes). The public opinion is that the minimum wage is a matter of social justice and that it does not cost the taxpayer a dime. Another contrast with the universal income idea is that it agrees with the hard-working-man ethic: raising the minimum wage might encourage people to work more. Convenient as these perceptions may be to politicians, they are partly wrong, because of the welfare and tax programs in place.

What happens to labor supply if we raise the minimum wage? Income taxes and the income and wealth thresholds for welfare programs start biting, so labor supply declines at the margin--and since minimum-wage jobs are hourly paid, many workers would have the flexibility to cut hours just below the point where they are still eligible for welfare. At very low levels of hours per day, workers would drop out of the labor force entirely and take up welfare payments.

On the demand side, economists often worry that a higher minimum wage will destroy jobs, or at least reduce the number of hours per worker. At least at the margin, I am not convinced that this is the main concern. Sixty-two percent of workers earning the minimum wage or less have service occupations (44% in food preparation and serving). Another 15% are in "sales and related" occupations, according to a 2012 report from the Bureau of Labor Statistics (table 4). By industry (table 5), 51% of minimum-wage earners are in the hospitality industry, and 16% in retail. It seems to me that replacing waiters, cooks, maids, and salespeople with technology is quite difficult (although not impossible: don't forget all those call center jobs outsourced to India, or the expanding use of self-checkout in supermarkets, or the introduction of robots to care for elderly people, for instance). 

I suppose that some employers would be forced out of business if we raised the minimum wage. However, if it were a binding constraint, we should observe "bunching up" around the minimum wage in the distribution of wages. What I see is the opposite: workers at or below the minimum wage have been overall declining since 1979, both as a proportion of all workers and as a proportion of hourly paid workers (about 3% and 5%, respectively, in 2012, table 10). That is quite remarkable, especially considering that in real terms the minimum wage has been generally declining. My view, therefore, is that minimum wage jobs have been disappearing because of changes in the industry and occupation composition of the labor market and that, for the majority of employers and positions, the minimum wage is not a binding constraint.

When considered against the background of the current welfare and tax systems, neither universal income nor the minimum is a clear winner. Raising the minimum wage is probably the path of least resistance, but it would not do much to put a floor on the standard of living, for a couple of reasons. First, the poorest of the poor are those completely cut off from the labor market, either because of disability, age, having a criminal record, etc. As unemployable, they do not benefit from a higher minimum wage. Second, the minimum wage is becoming a binding constraint for a declining share of jobs. Besides, when considering the rising cost of health care, a marginal raise in the minimum wage is hardly a ticket out of poverty--at least not at the current level of the minimum wage.

The best, politically-constrained option* might be a combination of: a streamlined welfare system (fewer programs, fewer conditions, lower income replacement ratios, and lower implicit tax rates); a universal minimum income, at a subsistence level; and a higher minimum wage. Even then, opportunities for loopholes, patches and exceptions in the universal income scheme are too abundant and I suspect that, within a few years, the system would degenerate into the jumble that we have now, plus the universal income program--which by then would have ardent defenders.

*Even better, increase investment in public goods, such as education and infrastructure, that will increase the long-term potential growth rate of the economy, and change drug and incarceration policies. That should go a long way towards reducing poverty. I'm not sure, however, that this is possible, even under loose political constraints.

20130926 Links: debt ceiling; noses; interview with Spain's PM; why do we work so much; the Sagrada Familia

1. Americans think that the raising the debt ceiling should not be unconditional, by Bloomberg (hat tip to Tyler Cowen at MR). I agree with Tyler: it's time to elect a new people.

2. Man gets a new nose grown on his forehead, from BBC news. His original nose was damaged, so surgeons grew a new one. It will be transplanted to its usual location soon.

3. Rare interview of Spain's prime minister Rajoy with the media. Sara Eisen from Bloomberg speaks with him about the economy and about the corruption scandal facing his party.

Here's Bloomberg's highlights of the interview, mostly about the economy. El País zeroes in his comments (in Spanish) about the Bárcenas case.

4. The Economist interviews the Skidelskys (father and son). (Skidelsky Sr. is an authority on John M. Keynes). They talk about Keynes' prediction that by 2030, given reasonable expectations for economic growth, we would be productive enough that we only would need to work 15 hours a week. Although 2030 is still quite a few years ago, most people would agree that his prediction will be quite a bit off the mark. Why do we work so much? The Skydelskys, who published a book on the subject, point out to concern for relative wealth, as well as the fact that, even though the average standard of living has risen a lot since Keynes' day, the standard of living of a lot of people is still rather low. in a large chunk of the income distribution has risen at lot less (i.e. inequality has increased).



5. What will the Sagrada Familia temple look like when it's finished? By 2026, and if the construction workers work longer hours than Keynes thought they would, it might look like this:

The recent decline of the labor force participation rate

A striking feature of the last recession and present recovery has been the decline of the labor force participation (LFP). In January 2008, at the beginning of the recession, the LFP in the United States was 65.7%. By January 2011 it had dropped to 63.9%. That is the sharpest three-year decline ever observed in the history of this time series. The LFP is now at levels not seen since 1984. In this post I show that changes in the age distribution of the US population have been responsible for one third of the fall of the LFP; other factors (business cycle, structural forces) explain the remaining two thirds.

The LFP is the proportion of the population who is either working or looking for a job, relative to the size of the population eligible to work. More specifically, the numerator is the number of non-institutionalized civilians, ages 16 and older, who is either employed or looking for work. The denominator is the total civilian non-institutionalized population, ages 16 and older. The difference between numerator and denominator is the number of people who are not looking for work, either because they are in school, retired, staying at home as homemakers, or physically unable to work, for example.

Two groups of forces are responsible for the drop of the LFP. First, demographics. Different age groups have different LFP’s. People younger than 25 or older than 65, especially, are much less likely to participate in the labor market than the rest of the population. As the age distribution of the population changes, the total LFP also changes, even if the within-group LFP remains unchanged. Because the first baby boomers turned 65 in 2010, some observers may be wondering the new retirees are responsible for the precipitous decline of the LFP.

Second, structural and cyclical factors. When job opportunities become scarcer, two things happen. New entrants in the labor market (recent graduates, for example) put off their job search. Also, former unemployed persons stop looking for work. In both cases, they are excluded from the ranks of the “active population,” depressing the LFP.

Whether the recent drop in the LFP is due to demographics or to structural/cyclical reasons is relevant because it will affect the future path of the unemployment rate. If the LFP has fallen so much over the last three years because of demographic factors, we should expect the LFP to continue declining at about the same rate, without affecting much the unemployment rate. If the crash of the LFP is due to structural/cyclical factors, many of those who are currently out of the labor force may come back to the job market at some point, raising the LFP. This phenomenon will also keep the unemployment rate elevated even if the economy is creating jobs, as those who were formerly out of the labor force join the ranks of the unemployed. In other words, a low LFP may be hiding a large “shadow army” of labor, waiting to join the labor force.

In reality, a combination of demographic and cyclical/structural factors is at work. I did the legwork to find out what fraction of the LFP crash is attributable to each.

My calculations reflect two simple counter-factual experiments. First, suppose that the LFP within each age group did not change, but the age structure of the population changed as it actually did. What would the LFP be now? Second, suppose that the age structure of the US population had not changed between 2008 and 2011, but the LFP within each group changed as it did. What aggregate LFP would we be observing now? The following chart shows the answer:

The LFP fell 1.8 percentage points between January 2008 and January 2011. Using the first experiment, we see demographic factors would have lowered the LFP by 0.6 percentage points. The second experiment tells us that factors other than demographic forces cut the LFP by 1.2 percentage points.

The table below shows a breakdown of by age group (NSA data, corresponding to the month of January):

	Share of civilian population		LFP		Contribution to total LFP
Age group	2008	2011	2008	2011	2008	2011
16-24	0.161	0.160	57.2	53.3	9.2	8.5
25-34	0.171	0.172	83.3	81.5	14.2	14.0
35-44	0.180	0.166	83.7	82.8	15.1	13.7
45-54	0.188	0.184	82.3	81.0	15.5	14.9
55-64	0.142	0.153	64.5	64.2	9.2	9.8
65+	0.158	0.165	16.2	17.5	2.6	2.9
					65.7	63.9

Notice that the LFP rose within the 65+ age group, that it fell for all the other age groups, and that the population share of those older than 54 rose substantially, whereas the population share of the 34-44 groups declined significantly.

To make a long story short: the large drop in the LFP during 2008-2010 is mostly due to a collection of cyclical and structural factors, not to demographics.

Update (March 24, 2011): The Congressional Budget Office published their labor force participation projections through 2021. They estimate that between 2007 and 2010 demographic effects reduced the LFP by 0.5 percentage points (p. 10 of the report, last paragraph). My estimate between Jan. 2008 and Jan. 2011 was 0.6%. A very interesting feature of this study is that the CBO projects the within-group LFP, something which I did not even try to explain.

That pesky LFP

“Americans delay retirement as housing, stocks swoon” was the headline of a recent story in the Wall Street Journal (WSJ). As a description of what's going on, it should be taken with a rock of salt.

According to the front-page article, “millions of retirement-age Americans, stung by the recent economic pall, suddenly are having to reassess their plans —with many forced to quickly change course,” (emphasis mine). The Journal itself provides evidence to the contrary. They print a chart (left) that shows that the proportion of people ages 55 to 64 in the work force has been increasing since at least 1990. Seniors have been postponing retirement for 17 years now! And recent numbers do not indicate a switch of gears, but a continuation of a long-run tendency.

It is still possible that the thick-lined graph can’t capture recent changes adequately. Or maybe what the writer meant is that the time series is above its trend. After all, the labor force participation (LFP) of people in that age group did increase steadily between August 2007 and February 2008. To examine this possibility, I calculate the trend (for the nerds: I use the Hodrick-Prescott filter). Chart 1 below shows the trend along with the raw time series. If my calculations are correct, observed LFP in February was indeed about 0.5 percentage points too high.

Chart 1 (click to enlarge)

The writer tells us that the LFP in February was up 1.5 percentage points from last April. But that month the participation rate was 0.6 percentage points below trend. In other words, she is comparing a point that is well below expected values with one that is well above, leading to an overstatement of the facts.

She goes on to say that the surge in participation “translates to more than an additional million people in the job pool” since April 2007. After a few simple calculations I find that an accurate statement would be: “In April 2007 there were 197,000 fewer seniors than expected in the labor force, whereas in February 2008 there were 172,000 more than expected. Population aging plus the growth of trend LFP mean that between April and February we should have expected an increase of 659,000. But because of deviations from the trend on both ends, the actual increase was 829,000.” But that won’t draw many eyeballs.

Another reason to downplay the recent numbers is that blips like this are frequent and short-lived (see Chart 1).

The central point of the WSJ article, however, is that some seniors have been putting off retirement because “falling real-estate and stock markets are erode their savings.” Historically, falling asset prices are not strongly correlated to the LFP of people on the verge of retirement. In 1990-92 home prices fell and stocks barely grew, but participation did not go up. Falling asset prices is thus not a sufficient condition. Or perhaps, as the WSJ insinuates, it takes a double whammy to throw older workers off the retirement track.

Falling markets is not a necessary condition either. Since 1990, the LFP of people ages 55 to 64 has risen in three bursts: 1995-98, 2002-2003, and 2005-2007 (see charts above). Now, 1995-98 and 2000-2003 were periods of rising home prices. And a bull stock market dominated 1995-98. I guess that back then journalists would have written that folks were waiting for the markets to peak before retiring. You gotta explain things somehow.

Of course, all the historical data in the world cannot refute that this time falling asset prices may be postponing retirement. As I showed above, though, the change in LFP so far is quite small.

And now that I’m here: the business cycle cannot explain the LFP of senior workers either. For most demographic groups participation in the workforce is pro-cyclical. It should fall —at least below trend— in periods of high unemployment and low wages. Retiree wannabes do not conform to the pattern. Their LFP rose above trend during the 1990-91 recession, as well as during the weak labor market of 2002-2003 (see Chart 1). That LFP has a mind of its own, I tell you.

What I’ve learned from all this is that the fraction of working seniors has been rising for many years. I’m not sure whether the main driving force is better health or the increase in longevity risk —that is, people work longer because they need to fund longer periods of retirement. Another possibility is that the LFP figures are inflated because they include workers in semi-retirement, i.e. people who have a paid job but do not do it for a living. For example, part-timers or people doing partially pro-bono work. Those pesky senior workers…

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Alien arguments

It’s again that time of the year when some people fill out a lot of forms and everyone gets mad at the government. No, it’s not taxes; it’s the visa program for skilled workers.

April 1st marks the beginning of the annual application period. The government sets a general quota of 65,000 H-1B visas, plus 20,000 for people with a graduate degree from a U.S. institution. Last year over 100,000 applications swamped the immigration service on the very first day. This year people are expecting an even bigger excess demand. A lottery will decide who gets to live and work in the U.S.

Over the next two weeks we shall witness a repetition of last year’s debate. On one side, businesses and pro-immigration groups advocate lifting the cap. Skilled labor, they say, gives the U.S. an edge in high human-capital sectors, particularly science and technology, and contributes to faster growth. The country should, therefore, welcome as much skilled labor as employers will bear. On the other corner, some professionals in the IT industry and protectionists would like to restrict the hiring of foreigners, if not kill the program altogether. Their main complaint is that employers just want to hire foreign computer programmers and engineers on the cheap.

I have been indoctrinated to believe in the virtues of the free movement of goods, capital and labor. But if we’re going to make any progress in this quarrel, both sides should come clean. Free-traders must acknowledge that immigrants will lower wages in some sectors; some Americans will lose their jobs to foreign nationals. And any system is susceptible to abuse from greedy employers. Failing to mention the negatives does little service to the cause. And simply stating that “the country is better off on the whole” won’t cut it.

Protectionists should accept that the job market is not always a zero-sum game. In many instances, a job “lost” to a foreigner generates several other complementary positions, whether horizontally or vertically. Immigration detractors must also admit that, if skilled people don’t move in, capital and entire companies will move out. Don’t forget that Canada and the UK, just to mention two close rivals, have much friendlier immigration policies than the U.S.

Evidence of the effects of immigration is tenuous, which keeps skepticism alive. For example, a 2007 study by Ottaviano and Peri reported that immigrant and native workers are not perfect substitutes within skill groups —their study included all education levels. Their conclusion, another paper discovered, hinges on a disputable assumption, and has been promptly proven wrong. (George Borjas briefs us in his blog. The paper also provides a short review of the literature on the substitutability of immigrants and natives.)

About.com: political humor
Even more recently, a study by the National Foundation for American Policy, featured by the Wall Street Journal and the Washington Post, found that “there is a positive and statistically significant association between the number of positions requested in H-1B labor condition applications and the percentage change in total employment. The data show that for every H-1B position requested, U.S. technology companies increase their employment by 5 workers.” As the authors admit, it is possible that the hiring of H-1B’s and natives are both driven by business conditions. The study does not prove causation, just correlation —of course this “detail” didn’t make it to the newspapers.

Lotteries, which the government started using last year to allocate visas, provide economists with a natural experiment. If we could get company-level data on number of visas obtained, salaries, and payrolls, we could take advantage of the randomization scheme to get clean estimates of the effects of foreign hires.

Sometimes the evidence is just manipulated. For example, immigration skeptics like to point out that in many industries aliens’ salaries are below market rates. But according to a report by the U.S. Citizenship and Immigration Services (USCIS), 82 percent of first-time visa applicants are below 35 years old, so their work experience is also significantly shorter than average. Even among applicants for renewals, 65 percent are below 35. Comparing their wage with the overall industry average is misleading, if not malicious.

Closer monitoring would warm up protectionists to the H-1B program too. Employers are supposed to pay aliens no less than the prevailing salary. But USCIS examines the employers’ stated offers, and doesn’t have the resources to properly monitor actual salaries. Access to Social Security records and government payroll surveys would go some way towards preventing fraud.

A closer correspondence between supply and demand numbers should please everyone too. The visa limit of 65,000 —effectively a cap on the supply of skilled foreign labor—bears little relationship to demand. It was already 65,000 back in 1990, and it didn’t change through 1998. In 1999 the cap was finally raised to 115,000, perhaps because of the rapid growth of the IT sector in the late 1990s. Then, just as the dot-com bubble was imploding, it was raised again to 195,000 in 2002 and 2003. Employers filed fewer than 80,000 applications each of those years. In 2004, as the job market recovered, the limit was cut to 65,000, plus 20,000 for aliens with U.S.-earned graduate degrees. USCIS could coordinate with the Department of Labor and issue a number of visas that is related to payroll forecasts.

And reform of the green card program should appeal to immigration opponents and enthusiasts alike. Nowadays, a “temporary” work visa lasts three years and is renewable for three more. During that time, many H-1B aliens in their 20s and 30s grow roots in the country, whether they are supposed to or not. It’s only natural that they eventually seek to stay permanently. That process sometimes lasts longer than the work visa, especially for Chinese and Indian citizens. While the green card application is pending, most workers don’t switch jobs because that would push them to the end of the waiting line. As a result, they’re bound to one employer, reducing their bargaining power and putting downward pressure on industry wages.

Two things could, therefore, narrow the chasm between anti- and pro-immigration groups. First, a healthy dose of honest economics. We economists are in the best position to offer an accurate and dispassionate answer to the questions of which and how many Americans are displaced by educated foreign nationals, how much they affect salaries, and how a shortage of skilled labor fosters outsourcing and company relocation. Once we settle that, Congress can decide whether we need 20,000, 200,000, or two million visas. Second, give more resources to USCIS, to prevent fraud and reassure protectionists.

Toning down language would help too. The Economist qualified the system as an “idiocracy.” That is the kind of attitude that polarizes public opinion and stalls reform. And if nothing is done, next year we’ll be having this discussion again, while thousands of high-skill jobs trickle overseas —along with their employers.

UPDATE (4/3/2008): Felix Salmon, Dean Baker and Free Exchange take on the issue.

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economics, immigration, H-1B visa, skilled immigrants, labor

The minimal effect of the minimum wage

Some economists and journalists say that it will increase joblessness among the poor, some others that it will help those same poor to make a decent living, and politicians cite whatever professional opinion that agrees with the views of their constituency. The likely truth, however, is that raising the minimum wage does not make almost any difference.

Economics textbooks tell you that minimum wages reduce employment among low-wage workers and increase the prices of final goods and services. (Gary Becker and Richard Posner include a summary of these arguments in their Wall Street Journal article.) When employers are forced to pay higher wages they substitute machines for labor, as when they mechanize assembly lines in factories or install self-checkout stations in supermarkets. They also substitute skilled labor -the engineers and computer programmers who operate the new machines- for unskilled labor.

Additionally, when the minimum wage increases, the cost of the new optimal mix of capital and labor becomes higher -otherwise employers would have made the substitution of capital for labor already. Some firms try to keep up their profits by passing the wage increase on to consumers, in the form of higher prices of their goods and services. A few unlucky ones do not remain profitable and either close down or move their operations abroad, further reducing employment. Some firms are never established, and their jobs never created.

The alternative view on the subject is that a minimum wage raise increases the earnings of working families. Moreover, it benefits families at the bottom of the income distribution, thus reducing income inequality.

In this article I will not argue against any of the arguments above. Instead, I will point out certain facts about the US labor market and laws that diminish the impact of a minimum wage hike, to the extent of making it negligible.

1. Low-wage workers in the service industry.

It is very costly, if not outright impossible, to substitute capital for labor in many service industries. Think about how to substitute machines for cooks, waiters and waitresses, teachers, or window cleaners.

The Economic and Policy Institute (EPI) has tabulated the characteristics of the workers that would be affected by the minimum wage increase. (“Affected workers” are all those earning a wage between the state minimum wage and $7.25.) They find that 29 percent of the affected employees work in the leisure and hospitality industries (accommodation and restaurants); another 24 percent work in retail trade. An undisclosed proportion of them work in other service industries.

Because of the high concentration of low-wage workers in service industries, a minimum wage increase will make businesses increase prices or reduce their profit margins, rather than reduce their number of employees.

2. The size of the wage increase and state minimum wage laws.

The increase just approved by the Senate will raise the minimum wage from $5.15 to $7.25, in three increments of 70 cents between 2007 and 2009. Even in inflation-adjusted dollars, the increase appears to be the largest in the last 25 years. The blue line in Figure #1 illustrates this point. (To construct that graph I assume that inflation stays constant at 2.5 percent per year between now and 2010.)


But the actual increase will be much smaller: state minimum wage rates are higher than the current $5.15 in 29 states; and 7 states have, or will have by 2010, minimum wages which are higher than $7.25.

Using the state minimum wage laws and the recently approved federal increase, I have calculated how much the effective minimum wage will have increased in each state, by January 1st of 2010. The EPI has calculated the number of workers who would be affected, by state. Combining my calculations with EPI’s, I have come up a distribution of wage increases. Figure #2 shows this distribution. I find that 49 percent of all affected workers would experience a wage increase of less than 10 percent, and 22 percent would not benefit at all. The wage would increase by less than 20 percent for about 63 percent of all the affected workers.


Because of the effectively small effect on the cost of labor, and the declining fraction of the workforce that is affected by the minimum wage, the wage increase will have moderate effects on prices, unemployment, and business closedowns.

3. Part-time and young employees.

According to the EPI figures, 58 percent of the affected employees work part-time; a 30 percent are teenagers; 75 percent are not parents.

For the most part, teenagers and part-timers are not breadwinners; these are people who work either to supplement the income of a first earner or to partially support themselves while in school. Therefore, the claim that “minimum wage increases benefit working families” is mostly false.

Part-time and teenager workers do not conform to the standard definition of “the poor” either. A very large fraction of minimum wage workers are not full-timers who do not have enough earnings to support the basic needs of their families. So the statement that “a minimum wage increase is part of a broad strategy to end poverty” is quite misleading. In this point, I largely coincide with professors Becker and Posner.

As a policy instrument, a minimum wage hike has become a blunt instrument. It does not address its stated objective of helping the poor, discourages entrepreneurial activity, and reduces employment among the unskilled. True enough, all those effects are small, but if the overall effect is negative, why should we increase the minimum wage?

The minimum wage is a recurrent policy instrument for politicians because most voters are not opposed to it. Part of its popularity stems from the fact that, as opposed to the Earned Income Tax Credit (EITC) or the various welfare programs, the direct benefit of a minimum wage raise is easy to understand: people will earn more dollars per hour. Also, as opposed to welfare programs, it rewards hard work, which is a socially respected behavior.

On the other hand, one of the main costs of the minimum wage –higher prices of goods and services- is spread out over a giant, voiceless mass of consumers, and sometimes even forgotten. Raising the minimum wage will drive up the price of your restaurant meals and your dry cleaning by just a few bucks. Added over millions of people, that’s many millions of bucks, but no particular individual gets hurt too much. The other main cost –lower employment rates among unskilled workers- also goes unnoticed, because the thousands of people who cannot find a job as a result of the higher minimum wage are not organized; in fact, they do not even perceive that their joblessness is partially a result of the minimum wage hike.

If the government wants to redistribute income towards the poor, it should adopt a linear negative tax. This is what I mean: choose a level of tax-exempt earnings, say $20,000; any taxpayer earning less than $20,000 receives a transfer equal to the lowest tax rate, say 15 percent, times the difference between their income and the tax-exempt threshold. Taxpayers who do not work full time would not be eligible. This scheme transfers money to low-income families, just like the EITC, but it does not discourage work, because the tax rate is constant.

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minimum wage, labor, wage laws, unemployment