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.)

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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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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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