Sunday, June 22, 2014

Minimum wage is complicated

According to a simple economic analysis, minimum wage should decrease employment.

At equilibrium, the wage level is set such that the supply of workers is equal to the demand for workers.  If we artificially set wages higher, then the supply of workers increases (as more people are willing to work) and the demand for workers decreases (as fewer employers are willing to hire).  The level of employment is set by the supply or demand, whichever is lower.  Thus a minimum wage should create a demand-limited market with fewer people employed.

Personally, I would support increasing the minimum wage whether or not it reduces employment.  In light of the gross wealth inequality in the US, I am in favor of transferring as much wealth to unskilled workers as possible.  Thus, I do not actually want to maximize employment, I want to maximize the product of wages and employment.  Even though a higher minimum wage might hurt some people by costing them their jobs, there is a net gain in wealth to the class of unskilled workers.

One thing that annoys me about (other) people who advocate increasing minimum wage is that they never seem to discuss the argument that it decreases employment. Do they believe that decreased employment is an acceptable cost, or do they believe that the simple economic argument is incorrect?  If the latter, why is it incorrect?  Silence is just about the least satisfying rebuttal.

But the other day I heard an interesting argument.  Minimum wage workers currently have their income supplemented by welfare.  This allows employers to skimp on wages, essentially benefiting from welfare.  A minimum wage should be implemented such that employers can no longer do this.

Intriguing, but does it actually work as an explanation?

I wanted to do some simple mathematical analysis, like I did with monopolies and monopsonies, but I immediately ran into problems.  For one thing, a simple analysis of welfare suggested that it should actually increase wages, not decrease them (perhaps I'll show this in a different post).  For another, a quick bit of research revealed that nobody understands how minimum wage affects employment.

Apparently, it's one of the hottest questions in economic research.  A few major meta-analyses show that there is no link between state-level minimum wage and unemployment, and that net positive results are due to publication bias.  However, there might be a link for federal minimum wage.  Economists have proposed all sorts of explanations but few of them I can understand, and none of them have consensus.  One thing's for sure, the simple economic analysis is inadequate.

Lesson learned: I was wrong.  I had a little bit of knowledge of economics, but this is a case where a little knowledge is actively harmful.  I believed that I could apply simple economic analysis when I couldn't.  People who argue that minimum wage does not increase unemployment, but fail to supply any reason for this are in fact taking the correct position.  So far as we can tell, minimum wage does not necessarily increase unemployment, and so far as we can tell, no one knows why.


miller said...

Card and Krueger's (1992, 2000) work is important.

Basically, labor is not like other goods. If you'll forgive me for oversimplifying, people spend their wages, and minimum wage workers have a very high propensity to consume, and they consume the products of minimum wage workers, so there's a multiplier effect.

Even without multipliers, we have to consider elasticity. If demand for minimum wage work is relatively inelastic, an increase in wages may reduce total hours worked, but still might increase total wages paid to minimum wage workers. Even mainstream economists believe that demand for minimum wage workers is relatively inelastic. (In contrast, Card and Krueger believe that demand is *negatively* elastic: increasing the minimum wage *increases* demand for minimum wage labor.)

miller said...

elasticity: % change in dependent variable = elasticity * % change in independent variable. ln(y) = elasticity * ln(x)

miller said...

Low or negative elasticity is one of the few explanations I actually understand, at least in the abstract.

In the concrete, it's hard for me to understand because it appears that the more workers you employ, the more each one is worth.

miller said...

Economists generally believe the opposite: the more workers you employ, the *less* each one is worth. Let me know if you want a more thorough explanation.

miller said...

But negative elasticity seems to imply that the more workers we have, the greater the marginal value of an additional worker. If it does not imply this than I do not understand negative elasticity.

miller said...

Ah, ok; I misunderstood your comment. I think you understand it well enough, but you can't think here just at the micro-level; the effect is at the macro level: the more minimum-wage workers *the economy as a whole* employs, the more each worker is worth. This is a macro concept because in micro we will always hold the demand curve constant, but raising the minimum wage increases the *aggregate* demand curve to the right when at less than full employment.

miller said...

I see. Thanks!

miller said...

Keep in mind that my explanation is just what I think. Your original post is correct: no one really *knows* what happens at the minimum wage.

miller said...

I would also like to point out that the simple economic analysis based on demand/supply curves is based on the assumption that everyone has equal bargaining power, and when it comes to minimum wage workers that is often not true. For example, if someone lives in a small town where the only employer hiring is Walmart, Walmart has a lot more bargaining power than the job-seeker - basically a monopsony.

Another example would be people on parole. Many employers refuse to hire people with a prison record, yet often finding employment is a condition of staying out of prison. Thus, many people on parole end up in jobs where they essentially make no money (sometimes they need to take expensive taxi rides to get to a public-transit-inaccessible job) just so they can stay out of prison. People in this situation also have very little bargaining power. And this is without getting to the issue that it is legal to pay prisoners less than minimum wage for their labor in prison...

In most parts of the USA, minimum wage is below living wage. People with adequate bargaining power do not accept jobs below living wage (unless they are getting some kind of subsidy).

miller said...

John Weeks On "The Unpredictable Outcome Of A General Wage Increase"