3 Comments

Arminius
February 26th, 2010 | 12:30 pm

Joe,

At least these kids are learning their economics! Remember, classical economic theory DOES teach that raising the minimum wage (just as artificially raising the market price of any good or service) will tend to reduce employment by forcing employers to hire folks at an artificially high price — a price that is not set by supply and demand.

James Durand
February 26th, 2010 | 1:15 pm

I was struck by this also. I have never come accross (in college or elsewere) any one arguing that raising a minimum wage would increase employment. However, it occured to me some time ago that an argument could be made that an increase in minimum wage would make employment more desireable and in the long run might incentivize individuals to raise there own productive capacity to get that higher wage. A kind of Laffer curve for employment vs. min wage.
Has anyone explored this?

Frank McLaughlin
February 26th, 2010 | 9:18 pm

The proposition that an effective minimum wage (one higher than the market clearing wage in a competitive market) will reduce the quantity of labor demanded in the market is as firm a theoretical statement as you can find in neoclassical economic theory. It follows from the theory that the demand curve for labor of the representative firm in the market is negatively sloped and thus the market demand curve, which is the sum of al the firm demand curves is also negatively sloped. But this statement depends, as Alfred Marshall emphasized in his famous Principles text (1890) on the ceteris paribus assumption. It also should be recognized that the theory indicates that an effective minimum wage will (normally) increase the amount of labor offered for hire in the relevant market (ceteris paribus). So the resulting unemployment caused by the mandated wage increase is the sum of a decline in demand and an increase in supply.

There are many other propositions relevant to the minimum wage question in the tool box of economic theory. For example, it can be shown theoretically that if labor markets are characterized by monopsony ( a single buyer of labor in a market) or if employers have monopsony like power ( they face upward sloping labor supply curves), then employers will have some control over the wage they offer ( they are not simply passive adjusters to a wage over which they have no control, as is assumed under conditions of perfect competition). In such markets employers will, in pursuit of profit maximization, pay wages below the market clearing level, and if a higher minimum wage is mandated it is possible, according to standard theory, that both employment and wages will be increased One can question the empirical relevance of monopsony theory, especially in the long run. I mention as an example simply to suggest that the minimum wage question in practice may be more complex than common simple statements indicate.

There are hundreds of careful empirical studies testing the proposition that a legally mandated minimum wage increase will reduce employment. The expected relationship does, on average, show up in the data, but the effect is often quite small. For example, the Minimum Wage Study Commission some years ago reviewed 300 empirical studies and concluded that (as a general statement of the findings) the expected effect showed up in a firmly only for teenagers, and for younger teens more than older teens. The summary statistic was that a 10 percent increase in the minimum wage was related to a 1 to 3 percent decrease in teen employment with the better results closer to one than three. Big negative employment effects have shown up only in cases where the minimum wage increases are large, say 30 to 50 percent. When the U.S. continental minimum wage was fully extended to low wage Puerto Rican industries some years ago big negative employment effects were observed.

And there are other effects of increases in the minimum wage to be considered. They cause some poor families to have an increase in income and the income share of those at the bottom of the income distribution is probably increased. Some years ago I heard the economist Ray Marshall, Jimmy Carter’s Labor Secretary, tell how he convinced Carter to sign a minimum wage increase bill when many of his other economist advisors were opposing it. He said to Carter. “Mr President if you don’t sign this 5 million poor people won’t get a raise.” Marshall said he carried the day with Carter because he spoke Baptist to the president rather than economics.

My view is that in the world as it is, the parts of the economy are much more loosely linked than is assumed in perfectly competitive neoclassical theory, and that small change in one place may simply get absorbed in the play of the links and not have the effect that would result in the rigidly linked economy of competitive theory. Back in the 1940s the economist Arthur Ross opined in his book Trade Union Wage Policy that normally the volume of employment associated with a given wage increase is “unpredictable before the fact and undecipherable after the fact.” His point was that there is just too much play in the links connecting a wage increase to a labor cost change, and then to a total product cost change, and then to a product price change, and then to a change in sales volume. and finally to employment to be able to say with any firmness what will be the employment effect of a modest wage increase.

Finally: Personally I avoid the use of the word artificial when describing an administratively determined price. Artificial carries a negative connotation, and why should a mandated price be called artificial (bad?) and a market price natural (good?). It’s better to avoid the words natural and artificial in this context. One can read Aristotle’s Ethics to say that he favored a set of administrative rules to set prices in a way that would achieve justice in the affairs of the polis.