I’ve been planning to do a fairly lengthy post on my thoughts about the minimum wage for a while. So, here it is.
Q: Do you think a minimum wage is a good idea?
A: Yes. There are a number of good arguments in favor of a minimum wage in some form. I’m particularly fond of economic models that show that employers have some degree of price setting power (and some of the empirical evidence for these models, famously Card and Kruger). My overall opinions on it are thus
- It’s better to look at the minimum wage as a backstop to excessive market power in the hands of employers, than to treat it as mostly an anti-poverty measure. A minimum wage increase would be vaguely similar in effect in increased unionisation, or other ways to limit market power of employers.
- The overall seems to be little impact on the overall unemployment rate due to current minimum wage.
- However, effects on the employment of subgroups of the labor force (young and or, low skill workers) seem quite strong, even if the unemployment rate does not budge overall (due to increases in employment in other sectors). This is to some degree a direct prediction of the price setting power model of minimum wages.
- There is some room to increase the minimum wage (~$12/hr) but the $15/hr and $20/hr proposals are excessive.
- While a BIG or a similar anti-poverty program may be a good idea, there are strong arguments for having both a BIG and a minimum wage in effect simultaneously.
- The dynamic around discussion of the minimum wage is not good. There are actually good arguments for it, but those arguments are complex enough that few people understand them, so, most of the arguments you hear IRL are garbage.
Q: What do you think of the state level $12/hr minimum wage initiatives that passed in the recent election?
I voted yes on the one in my state (I live in Arizona) because it is in the fairly reasonable $12/hr (10 initially increased to 12 over time) range for the min wage,making it within the range of estimates for the optimal minimum wage, and because the paid sick leave policy that was also part of the initiative was very positive.
Part 1: Theoretical arguments
Q: What are the most common models of the impact of the minimum wage?
A: This article does a good job at explaining the textbook models of the minimum wage (supply/demand graphs shown below come from there). Really, I recommend you read that whole link, but I’ll summarize the core points here.
The simplest model imaginable might be a supply and demand equilibrium model — which reflects what can be predicted to happen to the market under ideal competition.
(Image from https://commons.wikimedia.org/wiki/File:Surplus_from_Price_Floor.svg )
Without a minimum wage the market will reach an equilibrium wage based on the level of demand for the labor of workers at every possible wage, and the willingness of workers to work at every given wage. Now, let’s redo history and imagine that Hillary won the election and was able to put a $12 minimum wage on this market. Notice that the number of workers willing to work in this model at the $12/hr wage now exceed the number of workers that employers are willing to hire. Thus, you can expect an increase in unemployment.
Most arguments against the minimum wage in the economics literature take roughly that form.
Now, lets imagine that really, the equilibrium wage was $10/hr, but employers have a lot of market power here (in the extreme case imagine a small town where a large part of the community works at a single factory, creating only one buyer for a certain type of labor) — and thus wages were depressed. If a $10 minimum wage is enacted you get a different effect.
In this case the number of workers who get hired actually increases. Employment goes up! The employer was increasing profit at the expense of overall output.
This right here is one of the most powerful arguments for the minimum wage.
Q: The whole thing seems arbitrary. Why can’t this be used to justify a $20 wage, a $30 wage, a $1000 wage? Where is the natural limit here?
A: There is actually a very simple way that the price setting power model can be used to predict an optimal minimum wage.
The minimum wage should be set at what the equilibrium wage would have been set at were there not the presence of the price setting power. If the government sets the minimum wage above that level, then there will be an increase in unemployment (because the situation pretty much degrades to the first model in that situation), but otherwise there will not be that disemployment effect.
Q: But labor isn’t an uniform commodity. The equilibrium wage for some workers is going to be lower than the equilibrium wage for other workers. Won’t you get some subgroups of the labor market unemployed?
A: Yes, very possibly. And this is one of the stronger arguments against the minimum wage, despite the possibility of price setting power. You can easily construct a situation where a minimum wage that causes little overall unemployment still unemployed a lot of young or low skill workers. There is a lot of empirical evidence for this . The unemployment of the worse off subgroups, would however, in this case be offset by higher employment in other subgroups of the labor market. And policy makers should (but don’t) take this into account when setting the structure of the minimum wages.
Q: I still don’t get how a minimum wage increase can increase employment in some sectors of the economy. WTF?
A: Here is an analogy.
Consider a power company that is a monopolist. Let’s say that in this market, were it competitive, would come close to the nationwide average power rates of 12 cents per kilowatt-hour. But this isn’t a competitive market. The power company is effectively a monopoly. Its out of the question for someone else to easily set up their own power company. Off grid solar is prohibitively expensive, and thus not a serious competitor.
The power company can charge well above 12 cents per kilowatt-hour. If the power company charges too much demand will sink (ie. due to consumers conserving energy) sufficiently that the company loses money. But it will almost certainly be able to charge a bit extra.
Fleecing incoming! Let’s say that the company finds that its profit optimising price is 20 cents per kilowatt-hour. If a state utility commission puts a price control on the power company (and this type of issue is why utility commissions exist and impose price controls) forcing them to charge no more than 12 cents per kilowatt-hour the impacts will be positive. Prices will fall for consumers, and the amount of electricity sold will actually increase (consumers will back off from the energy conservation efforts forced by the high price for electricity).
Now, if the commission goes too far and, lets say, forces the price down to 9 cents per kilowatt-hour, then the power company will find that it cannot really produce enough electricity at that price to meet consumer demand, and there will be a shortage (more demand than supply).
The labor markets under a price setting power model work in a fundamentally similar way. A powerful employer can optimise its profit by underpaying workers, at the expense of reducing output. A minimum wage that is not excessive reverses this. But an excessive minimum wage will cause unemployment (technically a labor surplus, but equivalent to shortage in the power company example).
Q: The whole mainstream supply and demand model is crap. There isn’t really an “equilibrium price” that exists outside of the action of individuals trading under market conditions. Go read mises.org.
A: The above linked post from the Mises Institute shows a generic version of an argument that I’ve seen a few times in the minimum wage context (usually from conservatives and libertarians). The author writes “The price is just given. In brief, both consumers and producers react to a given price. But who has given the price? Where has the price come from?”
The price is not just given. It derives from the demand/supply curves. The demand/supply in turn come from consumer preferences. The willingness to buy/produce at a given price is where consumers get their say. The shape of the curves is a model that reflects this willingness. The aggregate decisions of all the consumers/producers in the market result in the demand/supply functions and the resulting equilibrium price.
You can think of this in terms of an idealised auction, or a situation where a large number of firms set their prices, and consumers/workers (who in the idealized world have perfect information and no transaction costs) respond.
Q: Why wont, even in the ideal competition case, demand stimulus neutralize the effects that a minimum wage can have on employment?
During a depressed economy the increased consumer demand due to the wage increase can reduce unemployment. The problem here is that this applies only in very particular conditions.
- The economy is not at full employment
- The central bank is at the zero lower bound (otherwise it could lower interest rates, thus stimulating the economy, and bring willingness to borrow money in balance with the savings rate)
Part 2: Just wage arguments
Q: Why should an ambulance driver, who helps a large number of people, will post-minimum wage earn the same as a grocery bagger. It seems unfair.
There isn’t an extrinsic “just” or intrinsically optimal wage. The optimal wage (in terms of producing the best consequences if the wage is set at that level) for a sector of the economy is set by 1) the number of people who are willing to work in a sector at a given wage, and 2) the demand for workers in that sector at the given wage. The point of variation in a wage rate is to efficiently allocate labor and other scarce resources between sectors.
Q: No one should work and still be poor. We need a living wage!
All throughout the political discourse, you will see the opinion that wages and labor are separate from the pressures that affect all other things in the economy. In a normal market prices are subject to the usual situation of supply and demand. And the prices fluctuate according to how many people want to supply a good, and how many people want to buy the good.
The optimal value for the minimum wage is set, not by the overall costs of living, but instead by the same market factors mentioned above. If the value of the “living wage” is above the optimal value of the minimum wage, then effects on employment will be sufficiently severe as to create more poverty than before. If additional efforts to reduce poverty are needed then they should be done through other programs.
Supply and demand isn’t the only market force that also applies to labor. A business will only hire someone if it sees a profit from that action. But at some point there is only a certain amount of income that a worker can generate for a business. If the wages required to hire a worker exceed the level where it is profitable to hire then the worker won’t be hired. Oh. And there are substitutes to hiring workers. A lot of low-wage workers in retail can be substituted by computer kiosks — if it becomes profitable to make the substitution. Labor markets cannot avoid being exposed to the forces that other markets are, but a lot of arguments for the minimum wage of the living wage form require suspending disbelief on this matter.
Part 3: Empirics
Q: What do economists think about the empirical evidence for the price setting power model of minimum wages?
The economics community is clearly divided on this issue.
A literature review by Hristos Doucouliagos and T. D. Stanley, Publication Selection Bias in Minimum-Wage Research? A Meta-Regression Analysis, found that, after taking publication bias into account, the empirical studies were roughly evenly divided on both sides, such that the adjusted average effect is on the net zero. When the data from the various studies are put together, no net disemployment effects is seen. Although a number of individual studies and authors do find a disemployment effect. http://onlinelibrary.wiley.com/doi/10.1111/j.1467-8543.2009.00723.x/full
Card and Krueger’s meta-analysis of the employment effects of minimum wages challenged existing theory. Unfortunately, their meta-analysis confused publication selection with the absence of a genuine empirical effect. We apply recently developed meta-analysis methods to 64 US minimum-wage studies and corroborate that Card and Krueger’s findings were nevertheless correct. The minimum-wage effects literature is contaminated by publication selection bias, which we estimate to be slightly larger than the average reported minimum-wage effect. Once this publication selection is corrected, little or no evidence of a negative association between minimum wages and employment remains.
This points towards a largely neutral effect of current minimum wages on employment.
A literature review by Neumark, and Wascher (authors that are skeptical of the minimum wage but well within the mainstream of the economics world), Minimum wages and employment: A review of evidence from the new minimum wage research, is more skeptical of the overall employment effects of minimum wages, and found substantial subgroup effects on unemployment.
We review the burgeoning literature on the employment effects of minimum wages – in the United States and other countries – that was spurred by the new minimum wage research beginning in the early 1990s. Our review indicates that there is a wide range of existing estimates and, accordingly, a lack of consensus about the overall effects on low-wage employment of an increase in the minimum wage. However, the oft-stated assertion that recent research fails to support the traditional view that the minimum wage reduces the employment of low-wage workers is clearly incorrect. A sizable majority of the studies surveyed in this monograph give a relatively consistent (although not always statistically significant) indication of negative employment effects of minimum wages. In addition, among the papers we view as providing the most credible evidence, almost all point to negative employment effects, both for the United States as well as for many other countries. Two other important conclusions emerge from our review. First, we see very few – if any – studies that provide convincing evidence of positive employment effects of minimum wages, especially from those studies that focus on the broader groups (rather than a narrow industry) for which the competitive model predicts disemployment effects. Second, the studies that focus on the least-skilled groups provide relatively overwhelming evidence of stronger disemployment effects for these groups.
And literature reviews involving subgroup effects have otherwise produced strong results.
A literature review by Brown, Gilroy, and Kohen,The effect of the minimum wage on employment and unemployment: a survey, looked at the effect of minimum wage changes on youth unemployment. They give an overview of the theoretical models of the issue and then they look at studies of the empirical evidence. They found that most studies suggest small increases in unemployment in response to an increase in the minimum wage, and substantial numbers of youth will drop out of the labor force altogether. The data is ambiguous on the issue of whether whites or minorities will be affected more.
Q: What do you think this means for policy?
This indicates that the evidence for the ability for the price setting power effect to offset a lot of the negative impact of minimum wages. However, the data available also tends to confirm the possibility that minimum wages will be net negative for substantial subgroups of the labor market. However, there are some methodological limitations on the subgroup studies.
Q: Those studies are about minimum wages increases that are near the current level. What about fight for 15?
Most economists are negative about the $15/hr minimum wage idea, as one survey shows.
Key Findings: Nearly three-quarters of these US-based economists oppose a federal minimum wage of $15.00 per hour. The majority of surveyed economists believe a $15.00 per hour minimum wage will have negative effects on youth employment levels (83%), adult employment levels (52%), and the number of jobs available (76%).When economists were asked what effect a $15.00 per hour minimum wage will have on the skill level of entry-level positions, 8 out of 10 economists (80%) believe employers will hire entry-level positions with greater skills.When economists were asked what effect a $15.00 per hour minimum wage will have on small businesses with fewer than 50 employees, nearly 7 out of 10 economists (67%) believe it would make it harder for them to stay in business.
Compare that to polling on smaller minimum wage increases.
Q: Could there be effects on long term employment growth, instead of a short term disemployment effect?
Yes. Some research has shown this. Although, this is much less well studied.
Q: What is the optimum value for the minimum wage?
A number of studies have estimated the optimum value of the minimum wage to be at around 40% – 50% of the median wage — roughly $12/hr . See, for instance, this paper http://www.hamiltonproject.org/assets/legacy/files/downloads_and_links/state_local_minimum_wage_policy_dube.pdf
Q: Is there a good example of a case where the minimum wage was set excessively high in a way that created a noticeable disemployment effect?
Yes. About a decade ago Congress imposed the national minimum wage on Puerto Rico (which has a much lower percapita GDP than the mainland U.S. This created a minimum wage that was 77% of the median wage — relative to labor market forces the highest minimum wage in the world. See, this paper
This paper seeks to answer these questions using diverse bodies of data on employment and earnings in Puerto Rico and on the employment and earnings of Puerto Rican migrants in the United States. It reports the following findings. (1) The U.S.-level minimum altered the distribution of earnings in Puerto Rico to an extraordinary extent, creating marked spikes that dominate the earnings distribution. (2) Imposing the U.S.-level minimum reduced total island employment by 8-10 percent compared to the level that would have prevailed had the minimum been the same proportion of average wages as in the United States. In addition, it reallocated labor across industries, greatly reducing jobs in low-wage sectors that had to raise minima substantially to reach federal levels.
And this paper
The single most telling statistic in Puerto Rico is that only 40% of the adult population – versus 63% on the US mainland – is employed or looking for work; the rest are economically idle or working in the grey economy. In an economy with an abundance of unskilled labor, the reasons boil down to two. Employers are disinclined to hire workers because (a) the US federal minimum wage is very high relative to the local average (full-time employment at the minimum wage is equivalent to 77% of per capita income, versus 28% on the mainland) and a more binding constraint on employment (28% of hourly workers in Puerto Rico earn $8.50 or less versus only 3% on the mainland); and (b) local regulations pertaining to overtime, paid vacation, and dismissal are costly and more onerous than on the US mainland.
Part 4: Alternate policy options
Q: What other mechanisms than minimum wage do policy makers have to help poor people?
- Transfer payments (in the extreme case a Basic Income)
- Target employment programs.
We don’t need minimum wages to alleviate poverty, and they have arguably been quite ineffective at it. Even though they are very good at offsetting some of the effects that market power in the hands of employers have created.
A basic income policy that would give all adult citizens an unconditional payment that would be sufficient to take them out of poverty.
Or you could make the MMTers proud and enact a nation wide jobs program — possibly one similar to the Great Depression era Works Progress Administration, but also possibly one created by subsidising private employers — could be created with the task of guaranteeing a job at a reasonable wage to all willing and able to work. This type of jobs program would serve a similar role to a minimum wage, but it would not increase unemployment because the workers that would wind up unemployed under a higher minimum wage would instead wind up on the government payroll. It could be one possible mechanism to alleviate subgroup employment effects.
The combination of the two programs would serve to eliminate poverty, and would give all individuals a chance to earn a good income.
Q: Would a BIG alter the optimum minimum wage, or even make it unneeded?
Probably not. When you look at the minimum wage from the perspective of being a way to offset price setting power held by employers, you can see that the minimum wage really serves a different purpose than a BIG. A BIG is a highly effective way of eliminating poverty. But it doesn’t really do much to take care of labor market power held by employers.
A BIG may make potential employees less willing to work for low wages. But note, this is an effect on the supply of labor. Not an attenuation of the power of employers in a way that is germane to setting the minimum wage. Go back to the supply and demand curves that I inserted in part 1. If the supply curve shifts, the equilibrium wage will go up, along with the actual wages that employers pay (even under the imperfect competition model).
But the employer with price setting power still has the ability to force wages below the market equilibrium wage. And indeed, if the existence of a BIG increases the equilibrium wage for low wage labor, then the optimal minimum wage may actually increase.