After my previous post, LK Beland left this interesting comment:
A minimum wage increase can lead to an increase in total wages–i.e. job loss smaller than wage gains–not only in the case of large monopsony power, but also because it effectively transforms the supply of low-skill work into a cartel.
This is certainly a respectable argument. More total wages and more leisure time—what’s not to like? But from another perspective this sort of argument is weaker than it looks. To see why, consider the following thought experiment from business cycle theory. When doing so, I’d like you to concentrate less on whether you think my numbers are plausible and more on whether this outcome would be desirable if the numbers were plausible.
Imagine an economy in a steady state. For simplicity, assume wages and prices both rise at 5%/year, and real wages are stable. A tight money policy causes inflation to suddenly fall from 5% to zero, but (sticky) nominal wages rise another 5% over 12 months, due to contracts already negotiated. This tight money policy raises real wage rates by 5%. Let’s also assume it slows the economy, and reduces employment by 4%. The unemployment rate jumps from 5% to 9%.
If this occurs, we are in a classic demand-side recession. Would this be a good thing? It depends on your perspective. Because real wages rise by 5% and employment falls by only 4%, in this case the total real wages received by all workers goes up by 1%. But most people would point to the hardship caused by a 4% jump in the unemployment rate. They would consider this recession to be a “problem”, an outcome that is less desirable than the preceding boom.
There have been a few recessions that are a bit like this hypothetical case, mostly in earlier periods such as 1921, and especially 1930 and 1938, when prices fell faster than nominal wages in the short run. The 1982 and 2009 recessions also saw inflation fall faster than wage growth, so real wages rose. In each case, employment fell as real wages rose.
In my view, the hardship caused by unemployment is severe enough that we’d like to avoid causing more of it, even if the total real wage bill were to rise. Especially when the unemployed are those at the bottom of society, as is generally the case with an excessively high minimum wage.
A better solution is wage subsidies for low-skilled workers, which makes it easier for those workers to get jobs. (Note that this is not a solution I favor for “right wing” reasons—it actually requires more government spending and taxes than with a minimum wage rate.)
PS. There are respectable studies that indicate a modest boost to the minimum wage will not increase unemployment. But many of the same studies find that higher minimum wages do boost retail prices, which undercuts the “labor market monopsony” model that minimum wage advocates tend to rely on. I also worry about the longer run effects of minimum wages, especially on working conditions. Minimum wage laws, rent controls, anti-gouging rules, etc., encourage people to act like jerks. I don’t know about you, but I think society already has enough jerks.
READER COMMENTS
SaveyourSelf
Oct 5 2018 at 12:30pm
Good post. Balanced. And it presents an really interesting ethical quandary.
If hurting a small minority could make the majority better off, should we do it?
The example above regarding the minimum wage proposes harming the poorest of the poor in exchange for making the marginally less poor better off. But what about the same argument applied to a different group? What about harming the “rich” to make the “middle class” better off? I am generally of the opinion that this is precisely what the Holocaust was all about. And I am also convinced that this is precisely what drives the “tax and spend to do good” equation socialists so desperately want to work. So it’s not just an academic question. It is the central question of our times.
nobody.really
Oct 5 2018 at 4:57pm
Indeed it is–although it’s probably a central question of many other times, too.
Evidence suggests that globalization over the past 40 years have produced world-wide income growth beyond our parents’ imaginations—AND that the top 1% have captured 27% of that growth. In short, globalization is the goose that lays golden eggs–and the populists who feel left behind want to kill it.
We need to let everyone feel as if they have a stake in the game–and that means we need to share the golden eggs. But then libertarians cry out, “Oh, no–that’s SOCIALISM!” So, instead, we get tariffs and protectionism. We’re killing the goose because we couldn’t agree to share the eggs.
The irony is that, as libertarians point to the history of economic growth in the US as evidence of how well free markets work, they ignore how much we have always regulated this “free” market to achieve a desired level of income redistribution. Consider public education; Homestead Act; progressive income tax, including home mortgage deductions and earned income tax credits; Sherman Antitrust Act and Clayton Antitrust Act; GI Bill and student loans; Morris Act (creating land-grant colleges); National Labor Relations Act; Social Security/SS Disability; Medicare/Obamacare; Fannie MEA/Freddie MAC; SNAP/food stamps, etc. We are CONSTANTLY tampering with our economy, often to shift income down the income scale (and, yes, often to shift income in other ways, too).
Thus, our goal should not be to optimize any ONE policy, but to optimize policy overall.
In short: Yes, we SHOULD adopt policies that increase overall wealth, even if it ends up hurting some segment of the population–provided we also have polices for sharing the overall wealth. It’s when we feel that we can’t share the wealth–that we need to lock in our advantages to the detriment of our neighbors–that we smother the system of creative destruction. That’s why populism is sweeping the developed world right now.
Scott Sumner
Oct 6 2018 at 2:33pm
Good questions, but I have to take issue with your comment on the Holocaust. In my view it did not make anyone better off, and was motivated by hatred, not utilitarian considerations.
Bill Wald
Oct 8 2018 at 9:07pm
Change the law which requires that all employees in a union shop must be covered by the union contract even if one is not a union member. Then wage problems should be settled with a union contract. Don’t want to join a union? Feel free to negotiate your own wage/benefit package with your employer.
LK Beland
Oct 5 2018 at 3:00pm
” many of the same studies find that higher minimum wages do boost retail prices”
I think that’s right. I would take that most minimum wage employers are in low-margin businesses. Costs are going to be passed on to the customers. I see them as intermediaries, that connect the low-skill supply to the low-skill demand–the consumers.
The analogy with the oil cartels is pretty good: OPEC sells oil to refineries and gas stations–i.e. low-margin businesses. However, when it sets oil production and prices, what really matters to OPEC is the demand curve set by retail costumers.
I tend to think of the minimum wage in a similar way. It’s OPEC for low-skill workers. Low-skill labor sells its work to low-margin businesses, but ultimately, what really matters is the retail customer demand.
LK Beland
Oct 5 2018 at 3:01pm
“customers”, not “costumers”…
Matthias Goergens
Oct 6 2018 at 10:32pm
If I remember right, Germany had the opposite a few years ago during the Great Recession in the US.
The German unemployment was falling but so were wages. The total situation was seen as a good thing and people were happy with the performance of the economy. (And how it was weathering the difficult times.)
Floccina
Oct 8 2018 at 12:28pm
There is another way that a higher total wage might be not as good.
Suppose you have a worker with a reserve wage of $6 and another with a reserve wage of $14. With the minimum wage at $7.25 the first employee is working and happy with surplus of $1.25/hour and the second worker is enjoying his free time waiting for a job to come along that pays at least $14. The you raise the minimum wage and the first worker loses his job to the second worker who gets $1 surplus. Total wages are higher but are they better off?
Hazel Meade
Oct 8 2018 at 5:49pm
As stated a modest increase in the minimum wage can only increase real wages under monopsony employment conditions. A state of affairs which definitely doesn’t exist at the national level, and hence actually undercuts the argument for a federal minimum wage. Nobody thinks monopsony labor markets exist anywhere but at a very local level. So it’s actually a better argument for allow minimum wages to be set by local governments.
andy weintraub
Oct 8 2018 at 9:36pm
But even if the higher real minimum wage raises total real wages received, while causing some direct reduction in employment, that increase in total wages has to come from somewhere, thus reducing demand somewhere else as well. The result is still less unskilled labor employed.
Comments are closed.