Is maximizing "total wages" the right goal?
By Scott Sumner
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.