Previously published on April 14, 2016 on Newgeography.com
Most commentary on California’s decision to increase the state minimum wage to $15 over time is either along the lines of it being a boon to minimum-wage workers and their families or a disaster for California’s economy. Neither is accurate. Different regions sill see different outcomes. Central California, the great valley that runs from Bakersfield to Redding, once again, will bear a disproportionate burden.
Some workers’ income will increase, but hardly enough to afford a standard of living that most readers would find acceptable. At 40 hours a week and working 52 weeks a year, the minimum-wage worker will earn $31,200 a year before taxes. Try living on that in San Francisco or Santa Barbara.
Then, there are the workers who will lose their job, or never get one in the first place.
A $15 an hour wage would devastate some economies, but California is different. Individuals and families may be devastated. Regions may be devastated. Coastal California, with the possible exception of Los Angeles and the far northern counties, will do just fine. You will probably not be able to see an effect in their data.
Central California is another story.
California is in transition from a tradable goods and services producing economy to a consumption and non-tradable services producing economy. Tradable goods and services are goods and services that can be consumed far from where they are produced. Manufacturing is the classic example of tradable products, but thanks to the internet, services are also increasingly tradable.
These days, many services that were once non-tradable are tradable. Tax preparation, legal research, accounting, and term-paper writing are examples of tradable services that were once non-tradable. As a friend of mine says, anything done at a computer can be done anywhere in the world.
Non-tradable services are those that must be consumed where they are produced. Lawn care, haircuts, and home maintenance are some examples.
The distinction is important because a minimum wage increase affects each differently.
The initial impact of a minimum wage increase is to increase the cost of the goods or services, tradable or non-tradable. It’s what happens after the increase in cost that makes the difference.
Consider a minimum wage increase on one side of a street and not the other side. You might consider walking across the street for a burrito, cup of coffee, or haircut, if the price is cheaper there. This is the substitution effect. It will be almost non-existent for non-tradable services with a statewide minimum wage increase. No one will drive to Arizona for a haircut or cup of coffee.
Non-tradable services are left with only a price effect, to be discussed in a bit.
Tradable producers, though, face a formidable substitution effect. They are competing with producers worldwide. If they raise their prices, it is likely that enough customers will switch to other producers that tradable producers will be forced to relocate for lower-wage workers of go out of business. If they lack monopoly power, they are unlikely to be able to absorb the cost increase.
One impact of California’s minimum-wage increase, then, will be an acceleration of California’s transformation to non-tradable services production and the permanent loss of tradable sector jobs, outside of fields like software.
It is fundamental to economics that the higher the cost of any good or service, the less that will be consumed. This is the price effect, and it affects tradable producers differently than non-tradable producers.
Unless they have monopoly power, tradable producers will not see a price effect. The world price will remain the same. Total world consumption will stay the same. The distribution of sellers, however, will change. Agriculture is an excellent example of competitive world markets. California will likely provide a smaller share of the world’s agricultural output.
If the tradable producer has monopoly power, the price effect may be large or small. If it is small, they will see a small decline in sales. If it is large, they may have to absorb the increase, sacrificing some of their monopoly profits.
Non-tradable producers will face a price effect. How big that price effect is depends on the wealth of their customers and how essential the service is to the consumer. A wealthy person will probably not change their behavior because of, say, a ten percent increase in the cost of haircuts. A poor person may reduce the frequency of haircuts.
Tradable sector and non-tradable sector businesses will attempt to minimize the cost increase of a minimum wage hike. This is most easily achieved by replacing some labor with capital. This is the production function effect. Assembly line workers may be replaced with robots. Waiters may be replaced with tablets at the table, as we’ve already seen in some restaurants.
Some would argue that there is another effect, an income effect. The idea is that the increased income, and spending of minimum-wage workers will more than offset the price and substitution effects. This violates another fundamental economic principle, the one that asserts that there are no free lunches. The minimum wage earner’s new income is not new wealth miraculously provided by the minimum-wage fairy. For every new dollar the minimum-wage worker has to spend, someone else has one less dollar to spend. In fact, due to inefficiencies (distortions in product mix and markets resulting from non-market prices) created by the transfer, someone else must forego more than one dollar in order to create the dollar provided by wage increase.
Analysis of price and substitution effects implies that different California regions will be affected differently by the minimum wage increase.
Because wages are generally lower in Central California than in Coastal California, the minimum wage increase will be more impactful in Central California, amplifying both price and substitution effects relative to Coastal California. Central California’s economy is also more dependent on tradable-goods production than is Coastal California, it will, therefore, be hurt more by the decline in tradable-goods producers. Similarly, because Central California’s income is less than Coastal California’s, it will also see a greater price effect on its non-tradable producers.
Central California is seemingly in perpetual recession. Even in good times, many Central California counties see double-digit unemployment. Colusa County’s unemployment rate was over 20 percent in the most recent data release. The region also sees disparate impacts from California’s high energy costs, water policies, and regulatory infrastructure, all of which hit them much harder.
Coastal Californians underestimate the economic differences between California’s regions. They are huge. California simultaneously has some of America’s wealthiest communities and some of its poorest. It’s important that we remember that California, with about 12 percent of America’s population, has 35 percent of the nation’s welfare recipients.
Most of California’s wealthy coastal citizens never see California’s poor inland communities. Yet, wealthy Coastal Californians — particularly from San Francisco — dominate state policy. They implement policy as if the entire state were as wealthy as the communities they live in. The minimum wage increase is just the latest example.
Decency would seem to require that California find ways to accommodate the circumstances and needs of our least advantaged citizens and regions. We don’t though. Instead we create policy that hurts our least advantaged and makes their challenging lives even more so.