Minimum Wage & Consumer Borrowing

Over at VoxEU, economists Daniel Aronson and Eric French have a discussion about the their research of the effects of a minimum wage hike. I found my way to this post through Yves Smith's discussion of the topic at Naked Capitalism, which also includes some informative tables showing that the proposed hike to $9/hour is still below a living wage in many areas of the country.

My purpose here is only to highlight one part of this discussion. Aronson and French find that spending rises about $700 per quarter for households with minimum wage workers and that most of this spending ($500 per quarter) is for new cars and trucks, the majority of which is debt financed. The research suggests an increase in the minimum wage leads to an increase in borrowing from minimum-wage households in an effect that persists for a little over two years after the minimum-wage hike. The discussions at VoxEU and Naked Capitalism understandably focused on the economic stimulus effects of a minimum wage increase,  but what caught my eye was the consumer credit side.

Smith was sure that because of the findings on borrowing "moralists somewhere will look at this result and tisk tisk over the irresponsibility of poor people." I don't think anyone would accuse me of being moralist, and in any event, my reaction was a complete lack of surprise that minimum wage increases would lead to more consumer borrowing. First, a minimum wage hike makes it more likely that some consumers are now eligible for credit for which they would not have qualified previously. Second, experience in the U.S. and elsewhere suggests that when consumers can borrow, they will. Think of the whole "democratization" of credit idea that was so prevalent here in the U.S. in the 1980s and 1990s.

The standard economic account treats consumer borrowing as consumption smoothing and predicts these effects. Consumers will borrow to smooth over income shocks, and consumers living on the minimum wage will have had plenty of shocks where credit can provide some relief. Indeed, the fact that most of the increased borrowing in the research went to finance the purchase of cars and trucks makes a lot of sense. As Smith explains at Naked Capitalism:

Most places in America require having a car. Depending on relatives or friends for transportation is a risky proposition, particularly for low wage workers, where one absence often leads to being fired. So getting a car, or trading in an old one (that might be at risk of needing costly repairs) may not be as dodgy as it looks from 50,000 feet.

Exactly right. We need less moralizing about individual cases and consideration of the big picure. Rational credit regulation will treat consumer debt as an expected and inevitable reaction to its availability.

Comments

[Denis Drew]

$15/hr minimum wage: who's it gonna hurt -- get ready to do your eighth-grade math.

If the federal minimum wage had not shrunk 30 percent (figures rounded) -- from $10.50/hr to $7.25/hr -- between 1968 and 2013, then, Wal-Mart prices would be only 1 1/2% higher today and Wal-Mart workers would be earning 17% more (wages 10% of costs), McDonald's prices would be about 15% higher but McDonald's employees would be earning 45% more (wages 33% of costs), and overall prices today would be 1 1/2% higher for the kind of folks who read this message (by the minimum wage alone -- and not counting rippling push-ups which might not amount to much). Who would be hurt; who would be helped if we had maintained a $10.50/hr minimum wage -- as per capita income happened to grow 100%?!

If the federal minimum wage had grown 43% instead -- from $10.50/hr to $$15/hr -- Wal-Mart prices would now be about 5% higher than if the minimum stayed stuck in 1968 (6.5% prices higher than today) but Wal-Mart employees would be earning 43% more (66% more than today), McDonald's prices would be about 15% higher than in 1968 (35% higher than today) but McDonald's workers would be earning 43% more than in 1968 (107% more than today). Overall prices up 2% (3 1/2% higher than today). Who would be hurt; who would be helped?
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The problem with progressive economists analyzing minimum wage effects -- or anything else in the labor market -- is that they have completely lost track of how much the market might happily pay workers (twice as much?!) for their current level of productivity -- they and seemingly everybody else (except this washed up taxi driver? ).

The old story of boiling a frog comes to mind: put a frog into boiling water and it jumps right out -- put it into cool water and gradually raise the temperature to boiling and the frog wont notice. Not sure if this is true for frogs but the eighth-grade math above proves something very much like this seems to have happened to Americans across the board.