Monday, June 22, 2015

Labor force participation rate still down and that's bad for all of us

The U.S. unemployment rate is down to 5.5% but the labor force participation rate for prime age workers (age 25 - 54) is also still down: In 2002 it was 83.3% and in May, 2015 it was only 81%. But what does this mean in terms of actual workers?

A decline of 2.3 percentage points doesn't seem like a lot, but when the eligible working population is over 100 million people it makes a big difference as the chart below shows (click to enlarge). (2015 data here, other data here)

The first line in the chart is the age 25 - 54 labor force participation rate. The second line is the 25 -54 civilian non-institutionalized population. This population number excludes people who are incarcerated or on active duty in the armed forces and is the one used by the Bureau of Labor statistics to calculate the labor force participation rate. The third row is the population in the labor force in that year e.g. in the 1992 column row 3 is the population in the labor force in 1992. The 4th row is the population in the labor force for all years using the 1992 rate e.g. in the 2012 column, if the labor force participation rate had been 83.6% instead of 81.4%, 103,960,780 people would have been in the labor force instead of 101,224,970 (2012 column, row 3). The 5th row does the same thing as the fourth only it uses the 2002 rate for all years and the last row takes the difference between the potential amount of workers at the 2002 rate and the actual amount of workers (5th row minus 3rd row for all columns, which is why it is 0 in the 2002 column).

What this chart shows is that if the labor force participation rate had been 83.3% in May, 2015 instead of 81% there would have been an additional 2,875,345 people in the labor force. Now perhaps not all of these people would have been employed since the labor force includes both employed and unemployed people who are looking for work. But if even 75% of them had a job that would be an additional 2,156,508 workers!

Those additional workers would be making cars, making airplanes, making hamburgers, serving food, driving trucks, cleaning houses, teaching kids, working at a bank or any number of other things. They would be actively engaged in the economy, producing stuff for others and earning a paycheck. So where are they?

Hopefully they are working in the underground economy. Perhaps they are being paid under the table to do yard work, freelance construction work, business consulting, or some other job that allows them to earn a living but keeps them out of the official statistics. This is still not good for the rest of us, since in the underground economy workers don't pay taxes, which means they don't contribute to the goods and services provided by the government, which means a higher tax burden for the rest of us.

In an even worse scenario those workers are not working at all. Instead they are relying on family members or friends to support them or they are receiving government aid in the form of food-stamps and other benefits. Either way, they are not supporting themselves but instead relying on other productive people to support them.

This makes us all worse off. The people who aren't working don't get the satisfaction of feeling useful and contributing to society while the rest of us not only have to support them, but we also miss out on the opportunity to purchase the goods and services that they could have produced. It's a lose-lose situation.

Now if some of these people left the labor force for private reasons e.g. they won the lottery and simply retired there is nothing wrong with that. But remember that this is the prime working age labor force participation rate, people age 25 - 54, so widespread early retirement should not be a big factor. If instead there are too many regulations and taxes and just general economic uncertainty, hindering entrepreneurs ability to create and produce their products which drags down job growth, then that is a serious problem that is hidden by low unemployment numbers. I think that this latter explanation is what is happening and I think it is a problem for the economy and will continue to be going forward, despite what the unemployment figure suggests.

Wednesday, June 17, 2015

Eugenics and the minimum wage

One of the more tragic ideas to catch on during the progressive era (late 19th and early 20th century) was eugenics. According to Diane Paul (2001) “Eugenics” describes a movement to improve human heredity by the social control of human breeding, based on the assumption that differences in human intelligence, character and temperament are largely due to differences in heredity.

Many prominent economists were supporters of eugenics. Thomas C. Leonard wrote an article that was published in the Journal of Economic Perspectives in 2005 that re-introduced some of the most prominent economists who supported eugenics. For example:

     “If we could leave out of account the question of race and eugenics,” Irving Fisher (1921, pp. 226–227) said in his presidential address to the Eugenics Research Association, “I should, as an economist,be inclined to the view that unrestricted immigration . . . is economically advantageous to the country as a whole . . . .” But, cautioned Fisher, “the core of the problem of immigration is . . . one of race and eugenics,” the problem of the Anglo-Saxon racial stock being overwhelmed by racially inferior “defectives, delinquents and dependents.”


     “Social progress is a higher law than equality,” said Simon Patten, economist at the Wharton School and American Economics Association (AEA) president in 1908, and the only way to progress was the “eradication of the vicious and inefficient.” Frank Fetter (1899, p. 237), who was to serve as president of the AEA in 1912, also worried that “the benefits of social progress are being neutralized by race degeneration” owing to the “suspension of the selective process.”

And even though the moral character of these economists was dubious, their understanding of economic theory was sound. In fact, it was better than many of the progressive economists of today. For though their ends were detestable, they recognized the appropriate means for getting there; make the lower classes unemployable. After all, if a person can't work they can't afford to raise a family. What is a good way to ensure that the least productive, lowest class of people are unemployable and can thus be recognized by society as such? Increase the lowest wage at which people are allowed to be hired. From the article:

     Sidney and Beatrice Webb (1897 [1920], p. 785) put it plainly: “With regard to certain sections of the population [the “unemployable”], this unemployment is not a mark of social disease, but actually of social health.” “[O]f all ways of dealing with these unfortunate parasites,” Sidney Webb (1912, p. 992) opined in the Journal of Political Economy, “the most ruinous to the community is to allow them to unrestrainedly compete as wage earners.” A minimum wage was seen to operate eugenically through two channels: by deterring prospective immigrants (Henderson, 1900) and also by removing from employment the “unemployable,” who, thus identified, could be, for example, segregated in rural communities or sterilized.


     Columbia’s Henry Rogers Seager, a leading progressive economist who served as president of the AEA in 1922, provides an example. Worthy wage-earners, Seager (1913a, p. 12) argued, need protection from the “wearing competition of the casual worker and the drifter” and from the other “unemployable” who unfairly drag down the wages of more deserving workers (1913b, pp. 82–83).

I encourage you to read the whole article. It is an informative read.

It would be wise of the modern progressives to remember the roots of the minimum wage. It is not a tool to lift people out of poverty; rather it is a tool to keep people in it. The effects of a minimum wage are the same today as they were back then: It makes the least educated, lowest skilled people unemployable by raising the cost of their labor above the value it produces. If you want to ensure that those types of people remain in poverty, a high minimum wage is a good place to start.

Wednesday, May 27, 2015

A higher minimum wage in one area may harm low-skill workers in other areas

The Los Angeles' city council recently passed a anti low-skill worker bill minimum wage increase that will increase the city's minimum wage from $9/hour to $15/hour. This ill-advised, and I would argue cruel, increase in the minimum wage will banish the least productive workers of LA - teens, the undereducated, the elderly - from the labor market. For LA teenagers in particular it will now be more difficult to find their first job. In light of LA's actions, Don Boudreaux at Cafe Hayek asks all minimum wage supporters a very appropriate question: if the minimum wage was enforced by fining and arresting employees who voluntarily work for less than the government mandated wage rather than the employers who pay them, would you still support it? He states that:

"If a minimum-wage policy is both economically justified and morally acceptable, you should have no problem with this manner of enforcement."

I agree with him. And when the question is phrased in the way he poses it a minimum wage sounds even worse.

And if punishing LA's low-skill workers by preventing them from negotiating their own wage with employers isn't bad enough, there is reason to believe that a higher minimum wage in places like LA, Seattle, and San Francisco will also eventually affect the employment opportunities of low-skill workers in other areas of the country.

Profit maximizing firms are always on the lookout for ways to reduce costs holding quality constant (or in the best case scenario to reduce costs and increase quality). Since there are many different ways to produce the same good, if one of the factors of production, say labor, increases, firms will have an incentive to use less of that factor and more of something else in their production process. For example, if the price of low-skill workers increases relative to the cost of a machine that can do the same job firms will have an incentive to switch to the machine. It is easier to demonstrate this using some simple math.

To set the stage for this post, lets think about a real life example; touch screen ordering. McDonald's is currently installing some touch screens for patrons to order their meals and at Clemson University one of the food courts also has a touch screen ordering system for the grill portion of the restaurant. The choice facing a restaurant is touch screen or cashier. If a restaurant is currently using a cashier and paying them a wage, they will only switch to the touch screen if the cost of switching and the future discounted costs of operating and maintaining the touch screen device are less than the future discounted costs of using workers and paying them a wage. We can write this as

D + K + I + RK  < WL

Where D represents the development costs of creating and perfecting the device, K represents the costs of working out the kinks/the trial run/adjustment costs, I represents the installation costs, and RK represents the net present value of the operating and maintenance costs. On the other side of the inequality WL represents the net present value of the labor costs. (In math terms RK and WL are: RK = [ (rk) / (1+i)^n from n=0 to N ] where r is the rental rare of a unit of capital, k is the number of units of capital, and i is the interest rate and WL = [ (wl) / (1+i)^n from n=0 to N ] where w is the wage and l is the amount of labor hours. But if this looks messy and confusing to you don't worry about it as it's not crucial for the example.)

The owner of a restaurant will only switch to a touch screen device rather than a cashier if the left side of the above inequality is less than the right side, since in that case the owner's costs will be lower and they will earn a larger profit.

If the cashier is earning the minimum wage or something close to it and the minimum wage is increased, say from $9 to $15, the right side of the above inequality will increase while the left side will stay the same (the w part of WL is going up).  If the increase in the wage is enough to make the right side larger than the left side the firm will switch from a cashier to a touch screen. Suppose that an increase from $9 to $15 does induce a switch to touch screen devices in LA McDonald's restaurants. Can this impact McDonald's restaurants in areas where the minimum wage doesn't increase? In theory yes.

Once some McDonald's restaurants make the switch, the costs for other McDonald's to switch will be lower. The reason for this is that the McDonald's who switch later will not have to pay the D or K costs: the development or kinks/trial run/adjustment costs. Once the technology is developed and perfected the late-adopting McDonald's can just copy what has already been done. So after the McDonald's restaurants in high wage areas install and perfect touch screen devices for ordering, the other McDonald's face the decision of

I + RK < WL

This means that it may make sense to adopt the technology once it has been developed and perfected even if the wage in the lower wage areas does not change. In this scenario the left side decreases as D and K go to 0 while the right side stays the same. In fact, one could argue that the RK will decline for late-adopting restaurants as well as the maintenance costs decline over time as more technicians are trained and the reliability and performance of the software and hardware increase over time.

What this means is that higher minimum wages in areas like Seattle, LA, and San Francisco can lead to a decline in low-skill employment opportunities in places like Greenville, SC and Dayton, OH as the technology employed to offset the higher labor costs in the former cities spread to the latter.

Also, firm owners and operators live in the real world. They see other cities and local governments raising their minimum wage and they start to think that it could happen in their area too. This also gives them an incentive to switch since in expectation labor costs are going up. If more cities make the same bad policy choice as LA and Seattle firm owners around the country may start to think that resistance is futile and that it is best just to adapt in advance of a minimum wage increase by preemptively switching to more capital.

And if you think that touch screen ordering machines aren't a good example, here is a link to an article about an automated burger-making machine. The company that created it plans on starting a chain of restaurants that use the machine. Once all of the bugs are worked out how high does the minimum wage need to be before other companies license the technology or create their own by copying what has already been done?

This is just one more way that a higher minimum wage negatively impacts low-skill workers, even if the workers don't live in an area that has a relatively high minimum wage.

Wednesday, May 20, 2015

60 years of urban change

The Institute for Quality Communities at the University of Oklahoma has a neat collection of maps that allow you to view cities from all over the country both before and after highways were constructed. It is troubling to see how many people were displaced by eminent domain and the highway system. Atlanta in particular was heavily impacted by I-85.

Tuesday, May 19, 2015

Federalism and economic growth

In a recent paper by J.W. Hatfield ("Federalism, taxation, and economic growth." Journal of Urban Economics, 2015. A draft version can be found here.) the author shows that federalism and the resulting competition for capital leads to a tax policy that maximizes economic growth. From the conclusion:

"Our work shows that federalism, and the attendant competition for capital, will drive tax policy to the growth maximizing level, while a centralized government will choose tax policy that does not maximize growth....When many districts exist, competition will drive the districts to choose tax policies that maximize the private rate of return and hence the growth rate of the economy. A centralized government, by contrast, will choose to maximize its own objective function, the welfare of the median voter..."

Their model does make some important assumptions that do not exactly match reality, namely that labor is completely immobile and that all capital is mobile. Neither assumption is true, since labor i.e. workers are able to move to new locations and some capital, such as buildings and roads, are immobile once they are built. But a lot of capital is relatively more mobile than labor, which is the primary reason countries often tax capital gains at lower rates than labor income. Because there are international capital markets capitalists are able to invest their capital where it will get the highest rate of return.

What this paper does show is that municipal and state competition is an important condition for generating economic growth. Just like in the business world, competition encourages governments to produce the stuff that people want. When people are able to vote with their feet government officials must be attentive to the needs of their constituents. If people are unable to exit the jurisdiction of a bad government there is less of an incentive for the government to change course. The federal government can afford to be less attentive than the state governments, and the states less than the cities, towns, and villages, because it is harder to leave the US than it is to leave South Carolina or the city of Clemson.

Competition is also important because it fosters innovation. Economist and Nobel Prize winner F.A. Hayek noted that competition is a discovery process. He explained that we need competition to help us discover what are the best ways of doing things. Because firms have to compete with each other for customers they are continuously looking for new and better ways to provide a good or service that already exists or create a new good or service that satisfies a consumer want. Firms need to provide consumers with value, and that means giving them what they want at the lowest possible cost. Competition ensures that firms are always on the lookout for new ways to create more with less, which keeps prices low and conserves resources that can then be used on other things. Competition between governments fosters similar outcomes.

In the business world it is well known that monopolies stifle innovation, reduce output, and charge high prices. But it is less understood by the general public that a government monopoly leads to these same bad outcomes. Federalism is important and needs to protected. It helps create the conditions necessary for innovation and economic growth, both of which make us all better off.

Tuesday, May 12, 2015

The Rise of American Big Government

Here is a paper by Michael Dahlen that provides a brief history of how the US government became so large and intrusive. It is a good paper that anyone can understand and everyone should read.