The Miracle of “Anchoring”

How raising the minimum wage will psychologically trick employers into raising other wages, too.

Protesters rally outside of a Wendy's in support of raising fast food wages from $7.25 per hour to $15.00 per hour on December 5, 2013 in the Brooklyn borough of New York City.
Protesters rally outside of a Wendy’s in support of raising fast-food wages from $7.25 per hour to $15 per hour on Dec. 5, 2013, in Brooklyn, N.Y.

Photo by Andrew Burton/Getty Images

Seemingly out of nowhere, a movement to raise the minimum wage has been gathering momentum. It’s about time. No one can live on $7.25 per hour. In real terms, the national minimum wage has dropped about 30 percent since its peak several decades ago. And yet there is a chorus of concern that raising the minimum wage, while it benefits some people, will be a disaster for others, because employers who rely on the minimum wage will find ways to eliminate jobs. The last thing you want to do in a time of high unemployment is threaten jobs. Research comparing adjacent states, one of which has raised its minimum wage, indicates that job loss from raised minimum wages is quite modest. Nonetheless, there is little doubt that if the minimum wage were raised enough, job loss would occur.

I don’t want to minimize the pain that lost jobs would produce, but I want to suggest, based on much research in the psychology of decision-making, that these immediate negative effects of minimum-wage increases would be temporary, and in the long term, raising the minimum wage would have benefits that dwarfed the costs. The research in question concerns the phenomenon of “anchoring.”

It has long been known that we evaluate virtually everything in comparison with something else. What makes a big car big is the existence of smaller cars. Same with a big house. Economist Robert Frank has pointed out that over the years the average size of an American house, in square feet, has doubled, even as family size has shrunk. But a big house isn’t very big if everyone else’s house is the same size. Our assessment of house size is anchored by the size of other people’s houses (though it could be anchored by the size of our previous house, at least temporarily).

To illustrate the power of anchoring, consider the example of a cooking-product retailer who introduced the first automatic bread maker to the market some years ago for a price of about $260. Is $260 a lot of money to pay for a gadget that takes flour, yeast, water, salt, and sugar and turns it into a loaf of bread at the push of a button? Who knows? What should we compare it to? What we do know is that when the company introduced a deluxe version of the bread maker about six months later for $400, sales of the regular model went through the roof. The deluxe model told consumers that indeed, $260 was not a lot of money to spend. With the $400 anchor, $260 seemed cheap.

Or consider how people pay their credit-card bills. Each bill comes with a required minimum payment, a tiny fraction of the outstanding balance. No doubt, this minimum is there in part to protect consumers from falling deeply into debt. But a recent study has shown that people who get bills that contain required minimum payment information pay down less of their balance than people who get identical bills but without the required minimum. The researchers estimated that the size of this effect was large enough to roughly double the lifetime costs of the debt for people whose bills contained the required minimum. Why does this happen? Well, suppose your bill comes and you’re feeling kind of flush this month, so you decide to pay more than you normally do. Well, how much more? With a required minimum of say $15 on a $1,500 balance as an anchor, you may decide that a generous payment would be $50. Without that anchor, you might think a generous payment was more than twice as large.

What does this have to do with the minimum wage? The minimum wage supplies an anchor, and when employers are setting wages, they can judge themselves to be paying generously and competitively by exceeding the minimum wage. When the minimum wage is $7.25, then a wage of $9 seems quite generous. But when the minimum wage is $9, the costs of being generous will go up. In other words, though the minimum wage only establishes a floor, we can reasonably expect that over time raising the anchor by raising the minimum wage will ramify over a wide swath of the wage scale. In the long run, everyone’s wages will go up. This will allow people earning wages near the bottom to manage to pay their bills, and it will allow those with higher wages to join the middle class.

You might be suspicious that raising the anchor set by the minimum wage will not have this general effect. After all, employers are pretty savvy. They know about what the labor market has to offer. They know how much they can raise their prices without suffering. Surely these factors will influence wage-setting rather than an externally imposed anchor. If you think this, you underestimate the power of anchors. They have effects even among extremely sophisticated people.

Consider two examples. In one, experienced real estate agents with thorough knowledge of the local area were given packets of material describing a house that was coming onto the market. They were asked to estimate what the house would sell for. Among the many bits of information they were given was a statement of what the seller’s asking price would be. Different real estate agents were given identical packets of information, except for the proposed asking price, which varied among packets. All the agents insisted that when they were valuing properties, the asking price had no influence on their judgment. Nonetheless, the higher the proposed asking price in the packet of information, the higher the real estate agent’s estimate of what it would sell for.

In the other example, groups of experienced jurists were given a description of a criminal case (a real case, with identifying details changed) and asked to estimate the sentence that would be handed down, which could be a maximum of one year. Some of the jurists were told that a newspaper article about the case had estimated a sentence of nine months; others were told that the newspaper article estimated a sentence of three months. The jurists given the first piece of information estimated significantly longer sentences than the jurists given the second piece. Indeed, the same effects occurred if, instead of a news report, the experimenters rolled a pair of rigged dice in front of the jurists that summed to either nine or three before asking them to estimate the sentence.

Experienced real estate agents said they ignored listing price in estimating selling price, but they were wrong. Experienced jurists (indeed anyone) would insist that they ignored the roll of a pair of dice in estimating a criminal sentence. But they would be wrong. If experienced jurists and real estate agents are powerfully affected by anchors, it would be naïve to imagine that employers won’t be.

Thus, aside from matters of justice and fairness, the purely instrumental argument for raising the minimum wage is that it will lead, over time, to a rise in the wage scale more generally. This will result in fewer people in poverty, fewer people just getting by, and less income inequality. It will give people more money to spend, thus stimulating the economy. Raising the minimum wage has the potential to affect everyone through the mechanism of anchoring, and not just those at the bottom. It seems that paying an extra quarter for a Big Mac is well worth it, given the potential massive benefits.