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MURRAY & BIER: A plan to chill employment

Raising minimum wage in recession makes it less likely employers will hire

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What are the best two ways to maintain unemployment? First, forbid people from working. Then pay them not to work. Maryland may soon get a perfect storm of both bad policies. Maryland lawmakers have proposed an increase in the state's minimum wage, which will eliminate many entry-level jobs. Meanwhile, President Obama's American Jobs Act would further extend unemployment insurance (UI) benefits, which pay people not to work.

The minimum wage causes unemployment because it establishes a regulatory barrier between an unemployed worker and jobs that create less value for employers than the proposed minimum-wage increases. Thus, many workers will end up unemployed.

The head of Mr. Obama's Council of Economic Advisers, Alan Krueger, doesn't believe this. Mr. Krueger studied the effect of a 1993 increase in New Jersey's minimum wage. He concluded that "stores that had to increase their wages increased their employment" - arguing essentially that if you increase the cost of something, you get more of it.

Other studies quickly refuted Mr. Krueger's findings. One study that used actual company payroll records, rather than Mr. Krueger's survey data, found that "the New Jersey minimum wage increase led to a 4.6 percent decrease in employment in New Jersey."

Maryland's timing would be particularly bad. The worst time to raise the minimum wage is during a recession, for that is exactly when wages must fall. This may sound like a radical claim, but it's one point where Keynesian and free-market economists agree.

Lower wages incentivize more production in two ways: First, workers must work more and, therefore, produce more in order to receive the same income. Second, lower wages mean the profitability of production increases and the cost of hiring employees goes down, so companies hire more workers and increase output. Economic growth follows, living standards improve, and recessions end.

Keynesian economists argue that unemployment insurance benefits enable the unemployed to spend and thereby stimulate the economy. Yet consumer spending has recovered already, even as unemployment remains high. Though there are many reasons for the high unemployment rate, UI benefits are a very important one.

Harvard economist Robert Barro has calculated that without repeated UI extensions in 2010, "the unemployment rate would have been 6.8 percent rather than 9.5 percent." This makes sense. If you subsidize something, you get more of it. The president seems to understand this principle perfectly when it applies to renewable energy but ignores it when it comes to unemployment. If you pay people not to work, a good proportion of them will prefer not to work.

To make matters worse, unemployment benefits rely on taxes and credit taken from elsewhere in the economy. Employers that have to pay for these benefits are less likely to hire as the cost for new workers rises. In Connecticut, for example, companies must pay as much as $1,020 per year in UI benefits for each new employee. The other shoe drops: If you tax something, you get less of it. Fewer employers hire workers as the costs for them increase. Furthermore, because fewer people are working, less is produced, which means the economy slows, living standards drop, and everyone is worse off.

The end result is that federal and state governments have helped create a new class of long-term unemployed that hasn't existed before. Six million Americans have been out of work for longer than six months. Many have given up and stopped looking for work. Mr. Obama's solution in his jobs bill is to make discrimination against the unemployed in hiring illegal, which probably will kill off for good what little hiring is going on at present.

Five states already have passed increases to their minimum wages, and Congress probably will extend unemployment benefits into next year, regardless of what happens to Mr. Obama's jobs plan. But the best way to end unemployment is just to leave workers and businesses alone to find what they need. The jobs everyone wants are out there. It's government that's stopping people from getting them.

Iain Murray is a vice president and David Bier is a research associate at the Competitive Enterprise Institute.

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