## Thursday, June 10, 2010

### Minimum wage decision and the textbook response

Economists like to promote the idea that increasing the minimum wage results in fewer jobs. The law of demand states that when the price of a good goes up, demand goes down. But a welfare State has a role not just to encourage people to work, but to improve overall welfare.

The job loss textbook response is only fair if we cling to the unreasonable ceteris paribus assumption – that minimum wage increases and all else stays constant. But that is not reality.

For example, offsetting effects of an increase in the minimum wage include

- people choosing to study instead of work
- businesses investing in capital equipment to improve labour productivity

Both of these indirect effects of the minimum wage are good for society’s welfare in the long run via increased productivity.

Apart from being a good long run policy, I see the minimum wage as a tool to control possible market power of employers. Uninformed and low skilled workers are easily vulnerable to manipulation, and are unlikely to access legal guidance or negotiate their wage with vigour. Not all people are fully informed, perfect knowledge homo economicus. Asymmetric information and the resulting market power of employers of low skilled workers are justifiable reasons for government intervention.

One needs to exercise extreme caution when applying economic principles to reality. Most mainstream economic theories are based on completely unreasonable assumptions (an upward sloping supply curve and an ignorance of time for example).

1. I can understand why increasing the minimum wage might encourage businesses to invest in captial equipment to improve labour productivity, but surely that is usually with the aim of employing less people.

And why does increasing the minimum wage lead more people to study rather than work?

2. Maybe the subsitution of capital means that those with the skills to use the captial attract higher wages and thus there is incentive to train up on those skills.

Alternatively, if there is a short run decline in demand, it will make the minimum wgae jobs more competitive and provide incentives to develop skills that allow entry to a higher wage and less competitive part of the workforce.

There must be more changes to incentives and thus more flow on effects (good and bad) that I haven't discussed.

3. what about the whole efficiency wage argument?

4. ======
Cameron Murray:  Alternatively, if there is a short run decline in demand, it will make the minimum wage jobs more competitive and provide incentives to develop skills that allow entry to a higher wage and less competitive part of the workforce.
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It seems that you see many minimum wage workers as only lacking self esteem. They could be earning more already, but they are too lazy or shortsighted to quit their jobs, "develop skills" and join the higher paid, less competitive part of the workforce.

How do they get these skills, and how do they eat and pay rent while doing so? I thought their minimum wage job was already the mechanism for acquiring better skills.

Thus (supposedly), a good effect of raising the minimum wage is to put them out of work as the incentive to overcome their low self esteem. Meanwhile, businesses that were happy to employ them can experience greater costs and pass these along to their customers, or alternately, reduce their services and get along without that help.

This doesnt' create a better world, as I see it.

Where is the data that raising the minimum wage increases employment and raises production (GDP) overall? (I note that it is possible to raise labor "productivity" merely by firing all the least productive workers.)

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(1) Why would the decline in labor demand at minimum wage be "short run" rather than permanent?

(2) Would you welcome the Economists Better Employment Act? It would mandate that economists working for the government be fired to look for work in the private sector, with the requirement that they be paid 20% more than their government salary. This would give them the incentive to improve their skills and be more productive in society overall.

5. The minimum wage law is a touchy subject, and one that I don't discuss with others (like many of my political views, they are too progressive for most).

The main thing we know about the minimum wage is that is increases unemployment. I don't think this can be debated. When you set the minimum wage at $X/hour, you make anyone who is worth less than$X/hour unemployable, even if they would have accepted that wage otherwise.

From a personal perspective, if I agree to be paid an hourly rate to perform some task for someone, I fail to see how it is anyone else's business how much I get paid.

The exploitation argument is the only thing I can see as being a reason for minimum wage. Cameron's paragraph:

"Uninformed and low skilled workers are easily vulnerable to manipulation, and are unlikely to access legal guidance or negotiate their wage with vigour."

I agree that there are people out there who will manipulate others. However, even if someone is paid less than they are deemed to be worth (and there is a question of how we value their worth), they still agreed to that wage, and they agreed to it because they believe they will be better off than if they remain unemployed. Who are we to say that they should be forbidden from taking it?

Regards,
Tim

I would just highlight that my main point is that raising the minimum wage does not necessarily lead to the textbook economics response because there are flow-on changes to behaviour, investment, and business practice that are ignored.

Also, the 'real data' reveals mixed results - including findings that increasing minimum wages results in greater employment.

For example, here is a book by economists Card and Krueger that summarises a decade of research on natural experiment on the effects of the minimum wage on employment.

In the face of mounting evidence we began to question the applicability of the conventional models that are routinely taught in introductory economics textbooks. What does it mean if an increase in the minimum wage has no effect - or even a positive effect - on employment?

While the textbooks continue to promote theories relying on keeping all else constant, reality is much more complex.

We can explore the ideas here further. What if the minimum wage was increased by 500%? Clearly this would lead to significant inflationary impacts. So much so that in time there may be no real change in the minimum wage. Maybe the employment effects from government involvement in minimum wages is lost to inflation.

In that case, maybe it is like a cat chasing its tail - minimum wage causes inflation which results in government increasing the minimum wage.

I wonder, if there was no minimum wage law, how low a wage would someone accept? Without benchmark wages would employers offer more money? What would be the net welfare effect?

I don't know whether we'll ever have a certainty about the impacts of minimum wage laws, but maybe economists could acknowledge how grey reality is.

7. CKMurray: "The main point is that raising the minimum wage does not necessarily lead to the textbook economics response because there are flow-on changes to behaviour, investment, and business practice that are ignored."

The crux is "not necessarily". Does that mean the textbook response is observed 90%, 50%, or possibly only 10% of the time?

It seems to me that the textbook explanation results from an observed mechanism. Employers recalculate the cost of employing someone and either raise the wage or fire the employee. Has any employer said "less productive employees are going to cost me more, so I am going to hire more of them"?

I like irony. Maybe some statistics discover a situation where employment increases after increasing the minimum wage. That seems ripe for further investigation. Statistics alone are only a disovery device. What is the mechanism that causes the ironic result? Statistics without a mechanism is a form of story telling.

On one hand there is an observed, rational mechanism that explains why a higher minimum wage decreases employment, to the detriment of individuals with low productivity. On the other hand, there are statistics in a complicated world that suggest sometimes it may not quite work that way. That doesn't at all confront the textbook analysis.

CKMurray: "I wonder, if there was no minimum wage law, how low a wage would someone accept?"

A wage is only an easily observable transfer during employment, among other transfers and unstated benefits. So, measuring wages is inexact and possibly misleading.

Colleges place students in unpaid internships as part of work-study programs. The companies pay nothing, and students even pay the school for the opportunity. Clearly they are receiving more than nothing in this process. Part of their compensation is the experience they get at the company.

Absent a minimum wage, people might work for "nothing" directly for an employer. Of course, they are receiving training of value greater than or equal to the wage they could receive at some other company. They would be implicitly paying the company for that training, without a college as the middleman.

So, life is complex, dependent on individual preferences and situations, and very hard to measure. What supports the arrogance of stepping into the business relations between people (absent force or fraud) and telling them that they can't make the arrangement they want, but that parts of the arrangement have to suit some ideological requirement?

In other words, I can measure your cash wage, so I am going to place restrictions on that wage, so that I can assure myself that your are either getting a "fair" deal (to me, in the abstract) or no deal at all? That is unreasonable.

8. While it's very true that many people get a lot more out a job than just a wage. I personally know several people who have spent time in jobs which, after transport costs etc, left them worse off than if they'd stayed home on the dole. They stuck with it because of the experience it gave them towards better jobs in their chosen careers later down the track, the self esteem bonus from doing something productive with their days, as well as feelings of making a difference in their communities.

However, the question of welfare is tied into this. By taking these jobs, many were essentially disqualifying themselves from welfare. I can certainly see an argument that a government might make that if someone no longer qualifies for welfare, we'd want to be sure that they'll still going to have enough money to get by and not have their quality of life drop below what we as a society have deemed to be acceptable minimum standards.

9. Agreed Penny. Good point. Minimum wages need to rise along with welfare payments to ensure an incentive to participate in the workforce.

10. "The law of demand states that when the price of a good goes up, demand goes down". Well I've been around long enough to know that that simply is not correct. Increasing price can actually increase demand and often it does. Economists sometimes just don't get it otherwise they'd be out making money selling things (other than costly books) and increasing the price of things to increase interest. Many businesses go broke by trying to sell more things cheaper. Discounts are often illusionary and if ever I see a business selling product cheap, I tell them increase your price and create the illusion of quality. The fact is that many business owners would like to sit on their fat bums counting money while they employ managers and workers. The most successful businesses have a owner at the helm I believe.