California’s Minimum Wage Hike Debate…Or Debacle?

A few weeks ago Governor Jerry Brown suddenly, and seemingly without warning, reached a deal with union groups under which California’s minimum wage will be sharply raised to $15 per hour by 2022. The measure was quickly rubber-stamped by the state legislature and puts California firmly on a path to one of the highest wage floors in the nation.

The complete lack of public debate over this policy decision harkens back to the smoke-filled rooms of old-time power politics, where the public had little say over what actually happened in the halls of power. And in the rush to shove this measure forward without any deliberation, the state is now forced to bear a policy that will, in all likelihood, do more harm than good to the very people the state is trying to, in theory, help.

Supporters of the new law predict large benefits for the state’s low-income population. Detractors are convinced that California’s economy has just signed its own death warrant. The truth is somewhat more mundane: While the increase will cause a net decline in employment in the state, the drop will be small overall. It will put a damper on California’s economic growth but it probably won’t have any worse impact than the effects of the mounting housing shortage. The strong drivers of economic growth in the state will ensure that California remains on the forefront of national trends. Reasonable supporters might argue that we can accept a minor loss in growth momentum in order to gain an ostensibly more fair society.

But broad economic impacts aren’t the reason that this minimum wage hike is a bad idea. It’s a bad idea because the largest negative impacts will fall squarely on the shoulders of the very households that supporters of the wage hike are, rightfully, trying to help—the working poor and those in or close to poverty.

The issue boils down to what is known as labor for labor substitution. This a 35% jump over today’s minimum wage even when adjusting for inflation. Due to wage compression issues (having to maintain a wage hierarchy for senior and junior workers) the actual impact on labor costs ends up being considerably higher than the new base. Some sectors—retail, restaurants, assisted living, personal services, certain charity groups and non-profits—will see their labor costs rise 30% or more. To survive, firms will have to adapt by raising prices and changing labor policies.

One change is that hard hit firms will use fewer and, on average, more skilled workers to accomplish their goals. Companies pressed to cut the cost of rising staffing hours will typically cut the most hours and positions among the least productive staff. Empirical research shows that while overall job losses are small as a result of minimum wage hikes, they are significantly larger for workers who are likely to be among the working poor—namely those with the fewest skills and the young (particularly from poor regions). Companies that use a predominantly low skilled workforce may choose to move out of state altogether, if feasible.

Those most at risk of falling into poverty are those without a job at all—perhaps unemployed or living on some sort of fixed income. And higher minimum wages drive increases in the prices of many goods and services, which will have a more significant negative impact on lower skilled, lower income workers.

There is no doubt that some workers will be helped by a higher minimum wage. But others will lose hours or lose their job altogether. And those who are helped may end up losing critical government benefits. In the end, since those who need help the most are also most likely to be negatively impacted by higher prices and reduced access to employment, there may not be a net positive impact on poverty. Many empirical studies show just that—a higher minimum wage does not reduce poverty. It is a failed policy tool.

Sadly, the negative impacts of California’s measure could have been reduced with a few logical changes. Exempting young workers or those in training and using a lower rate for non-profits or certified small businesses would have made sense. Giving companies credit for providing benefits or exempting workers who earn secondary income (tips and/or commissions) would also have been rational and commonsense provisions. But the politically calculated rush to slam the measure into law before any formal opposition could be mounted precluded debate on any such considerations.

Another critical aspect of the wage increase that should have been deliberated is the serious regional disparity created. California is a large and diverse state with many different types of economies; what’s good for the goose is clearly not always good for the gander. The negative economic impacts will be far worse in inland areas of the state where the proportionate increase in labor costs will be much higher. Yet the power groups behind the wage increase, who are largely based in the expensive coastal economies, felt fine imposing this wage hike on all areas of the state, despite how clearly inappropriate it is for some regions.

The scale of the negative impact from wage floors is a function of the real relative to existing wages and the cost of doing business. For high income/high cost areas of the state (think San Francisco and Orange County), the higher minimum wage will not have much of an impact. Since median wages are already so much higher in these communities fewer businesses will be affected. Additionally, the increase in the price of goods and services will be proportionally less for local residents.

But the impact will be felt very sharply in lower wage/lower cost areas of the state such as the eastern portions of the Inland Empire, and Fresno and Bakersfield. For example, the current median hourly income for a full time private sector worker in Fresno is just under $16 per hour. The cost increases to businesses in Fresno are going to be much larger, much more painful, and will create far more substantial changes in employment policies. In fact, the scale of the implied wage increase in these regions is truly unprecedented relative to past episodes. Unemployment, already high in these areas, will likely rise significantly.

Moreover, the hikes in these inland regions are simply not as much of an economic imperative relative to coastal areas. The median rent paid for an apartment in Kern County is only $870 per month, less than half what it is in San Francisco or Santa Clara. Even those who support higher minimum wages acknowledge that the hikes should be scaled to the cost of living. Dr. Arindrajit Dube, Associate Professor of Economics at the University of Massachusetts, has suggested that the minimum wage should be set at half the median income for a full time worker. This would suggest a $17 per hour floor in San Francisco and a $7.50 floor in Tulare County—a huge difference.

Lower cost areas are, in general, home to a higher overall share of families that need to be helped rather than harmed—a development imperative that factors into many of California’s policies. Yet one of the biggest sources of economic development in these inland areas, the relatively low cost of doing business, is going to be largely erased by this one-size-fits–all policy, slowing overall growth in these regions much more sharply than in the state’s coastal economies.

The real shame is that California continues to play with a policy tool that has a proven track record of not working when there are plenty of policy options that do. Pre-kindergarten education is a pricey but proven winner. The Earned Income Tax Credit is another potential option with a proven track record. But these programs cost money and that means either asking for tax hikes or taking money from other uses—options no one in Sacramento seems to be able to stomach.

Instead lawmakers went for a cheap political win—one that on net primarily hurts lower income households and communities. The good news is that there is still time to adjust and amend the minimum wage measure in logical ways. It’s time for the Governor to take a step back and redo this deeply flawed and unfairly rushed policy so that it is better targeted, more efficient, and most importantly does not burden or harm the very residents it is intended to help.