Basic economic theory has very clear predictions on what should happen to a labor market with a minimum wage. If we assume an upward sloping labor supply curve and a downward sloping labor demand curve, a minimum wage will cause demand for workers to fall while supply increases. The result: an excess supply of workers, also known as unemployment.
The real world is obviously much more complicated than the standard Econ 101 textbook story. Perhaps the most important difference is that there is not just one equilibrium wage. No two jobs are exactly the same. Workers with different skill levels will face different labor markets. Location matters. The list of reasons why the real world doesn’t conform to the simplifying assumptions of economic theory is potentially endless.
However, those caveats do not necessarily invalidate the intuition of basic economics. I don’t think it’s a controversial statement that firms will attempt to substitute away from an input when its cost increases. In this case, that input is low skilled workers. As minimum wage increases, so does the necessary productivity of a worker who wants to be hired. A worker who only produces $10/hr of value for an employer will never be paid $15/hr regardless of the level of the minimum wage. Their choice is not between 10 and 15, but between 10 and 0 (unemployment).
But can we be sure that workers are actually paid based on their productivity? Couldn’t it be that they are simply being exploited, with firms pocketing the additional profits they generate? Under this scenario, an increase in the minimum wage could increase wages without hurting employment.
Here we see the limits of theory. Under some assumptions a minimum wage is good and under others it is bad. The clear next step is to look at the facts. Do minimum wage laws hurt or help low wage workers in the real world? Luckily, due to recent experiments with a $15/hr minimum wage in some cities, we have plenty of data to work with.
Supporters of minimum wage laws will be happy to find out that cutting edge research shows we have nothing to worry about (here’s the link to the full study). The increase in Seattle minimum wage to $13 (15 is being phased in over time) hasn’t had severe disemployment effects. There was a minimal decrease in employment, but overall, “results show that wages in food services did increase — indicating the policy achieved its goal.” So take that Econ 101. Minimum wage is great. Case closed.
Well, not quite. Because this morning, just 6 days after the study above came out, we have a new study looking at the exact same natural experiment (although with a different data set). The results are not so nice. They find that “the minimum wage ordinance lowered low-wage employees’ earnings by an average of $125 per month in 2016.”
Now what? Theory gives us conflicting results and so does data. How can an unbiased observer make a decision about the truth? Well, to be sure of the results of the studies above, they would need to sift through around 100 pages of dense statistical analysis. But of course, anybody untrained in statistics would first have to take a few classes to have any idea what they were talking about. And even with that training, they’d need to take a close look at the datasets used, weigh the pros and cons of each methodology, decide whether the results can generalize to other places, etc. Maybe after about two years of hard work they’d be able to have a qualified opinion on the two studies (never mind the dozens of other studies that have been done on the topic).
What is actually more likely to happen? Everyone who supported the minimum wage will cite the first study and look for flaws in the second (I would bet anything that Arin Dube – one of the biggest minimum wage scholars to support an increase – is scouring it right now looking for something to criticize). Everyone against minimum wage will do the opposite. Both will pretend they are letting the facts decide.
32 thoughts on “Let the Facts Decide on Minimum Wage”
Attempting to create a ‘living wage’ or ‘affordable education’ by artificially increasing the supply has shown to have the opposite effect.
I think you need to do a study of babysitting wages – something that is governed more by the free market than any other system.
I think everyone agrees that there is a minimum wage that is too high, but that doesn’t guarantee that a nonzero minimum wage is optimal. There is a theoretical argument that if firms have monopsony power (like monopoly but instead of one seller it’s one buyer and many sellers) then they can set a below market wage and increase profits that will not be bid away by competition. If this is true then increasing the wage would actually move the market closer to the point it would be at in a perfectly competitive market. So then the question becomes empirical. What is the optimal wage? I agree with you that the government seems unlikely to find it, but others might be more optimistic and it is theoretically possible for a minimum wage to be beneficial.
As for the babysitting market, it might not be as simple as you think!
Unfortunately the babysitting article is hidden behind a paywall – so unable to receive insight on why somebody would pay my daughter $20/hr for watching TV. Although I have heard that the Economics tutoring wage scales are even more skewed.
I agree monopsony is probably not relevant in Seattle, but in some places there could be firms with some monopsony power.
The babysitting article isn’t about minimum wage in particular but it shows how even private interactions can sometimes lead to coordination problems. In this case it was a babysitting coop that tried to implement a coupon system where people who babysat for others got coupons to use when they needed babysitting. The result was that nobody ever went out because they wanted to hoard coupons. Of course that still doesn’t imply government could have helped the situation.
In my opinion, there are two overlooked things about minimum wages:
The first is that in labor markets where employers provide non-wage amenities, the relationship between wages and minimum wage laws is superficial. Rosen’s theory predicts that employers provide amenities when the perceived benefits exceed the cost. In response to minimum wage hikes, employers can simply eliminate amenities and pay more in wages. If the foregone amenities are roughly valued at cost, then supply and demand (hence employment) remain unchanged, earnings increase, but workers are no better off than before. Hence, our neglect to study non-wage amenities seems to create a tendency to find welfare benefits in cases where minimum wages have trivial effects. Perhaps amenities are uncommon, but I know that in retail and food services there appears to be a lot of variation in the amount of discounted goods offered to employees, time off, flexibility,
The second issue is that minimum wages are not just, if at all, a mechanism to curb exploitation or force employers to create “better” jobs. Minimum wages are a mechanism for achieving a more equitable distribution of wealth. In theory, although minimum wages create unemployment, they almost undoubtedly raise the aggregate earnings of low-wage workers, in a manner similar to the rise in profits and loss in output of firms colluding on prices. I think the key question should not be whether minimum wages create inefficiency, but whether they are worse than alternative transfer mechanisms.
If goal is redistribution, why not just redistribute directly? If they do generate inefficiency, there is a pareto superior outcome generated by allowing flexible wages and redistributing.
Also, the new Seattle study does show an aggregate decrease in low wage workers so it might not even be working in the right direction.
Probably not, but minimum wage seems like an especially crude method for redistribution. It pretty much ensures at least some redistribution from the lowest skilled workers (who lose their jobs) to slightly less low skilled workers (who are lucky enough to keep them). I don’t see how minimum wage effectively redistributes from rich to poor, which I assume is the goal, but I might be missing something. At least if we redistribute through the tax code it is more clear who we are taking from and who gets the benefits.
If one wanted to move beyond what is crude, one might observe that there exists a thin layer of (people and institutions) we might refer to as THE WEALTHY.
The wealthy deploy capital in ways to preserve or increase their wealth, and most of those ways result in zero productive activity. For example, if I buy $2BN worth of stock, evenly distributed, of all the companies on the Russell 2000, I have deployed $2BN worth of capital and not created a single job. If I buy $1BN worth of Treasury bonds I do not create a single job. If I buy a tract of land I do not create a single job.
So there is an “endemic dampening” related to the structure of the system that keeps the number of jobs available chronically low.
This could be remedied in a variety of ways — one might be to create a global (say) $25TR not-for-profit that funded (say) 8 million not-for-profits around the world.
If one wanted to move beyond what is crude, one might observe that there exists a BROAD layer of (people and institutions) we might refer to as THE POOR.
The POOR deploy LABOUR in ways to preserve or increase their wealth, and most of those ways result in zero productive activity. For example, if I was a dishwasher at McDonalds, I do not create a single job. If I were a worker in a sweatshop, I would not create a single job.
So there is an “endemic dampening” related to the structure of the system that keeps the number of jobs available chronically low.
If you’re a fan of Daniel Bernoulli, if we plot level of wealth on the x-axis and utility on the y-axis and posit that this is a log curve, it’s intuitively satisfying. If you have $400k and you lose $399k, you move left along the curve (where it’s steep) and have a massive decrease in utility If you are a person or institution worth $80BN and you lose $399k, you have an epsilon decrease in utility.
BUT, in the second case, if you move RIGHT by $5MM you have epsilon INCREASE in utility.
So there exists a “contradiction” if you buy into the curve / love Bernoulli that institutions or individuals who live on the far right of the curve have THE LEAST increase in utility if deploying capital toward some job-creating, entrepreneurial endeavor works out for them.
If you “helped them” by say giving them a tax break, you would move them farther to the right on the curve where deploying capital toward some job-creating, entrepreneurial endeavor would have even less of an epsilon increase in their utility if the enterprise was a success.
Killing them all doesn’t work either. So it requires some very original thinking as to how to address these problems (not that economists expend any mental effort whatsoever thinking about this sort of thing).
2. How do you know utility function looks like a log? Why does it have only labour as input? Rich work much longer hours and much more intensely with years of investment before the can reap the returns. There are huge risks of not making it or losing everything if you start a firm, which are not present in working a minimum wage job. How is all that factored in?
3. Why is your utilitarian approach correct?
My boss cuts my wage to $6/hr.
Wouldn’t I have to go get a 2nd job? In other words, supply would INCREASE at lower wages levels (past some “subsistence frontier”).
And then they pass a minimum wage of $8 per hour and your boss fires you because he only wants to pay you 6. Now you have 0 jobs
My goverment increases minimum wage to 8$ an hour. As a owner of the firm, I am not making any money because of the increased labour expenses.
Wouldn’t I have to go open a 2nd firm? In other words, demand would INCREASE at HIGHER wage levels (up to some “subsistence frontier”).
So does higher wages increase demand for labour, and decrease supply of labour.
At any rate, I don’t believe most businesses that go under go under because they have to pay wages that are too high. One HBS professor wrote a book analyzing something like 10,000 start-ups, and the main reason for business failures (by FAR) was fallings-out among the business partners.
Anecdotally I have a friend on FB who complained that he couldn’t keep his restaurant afloat paying sub-minimum wages to illegal immigrants who lived ten-to-a-room in the least expensive housing within a commute distance to his “business.”
Firms going under because of falling out between partners is like most divorces happen because there was a conflict between spouses – it gives zero insight into the cause. But even if it did, it seems like I would fall out less if wages were lower – if firms generates a lot fo money, I am less likely to fall out with my partner (same as couples who value marriage more divorce less). So, to help with falling out we should decrease labour costs.
If you can’t earn enough to feed yourself, you shouldn’t exist (same as if you can’t earn enough profits your business shouldn’t exist).
Well that is exactly the current approach, although it’s implemented in a manner more elegant than your description — namely by flooding the world with weapons so the “extra people” can murder one another with wild abandon.
The military is actually the largest and most expensive social welfare program.
Also, if I remember correctly, there wasn’t a single Economics doctor in attendece, though there were several doctors in jurisprudence, history and philosophy.
Hey! “Dismal science”!
Dismal science relates to a specific model in economics, and this model does not govern modern US economy.
But the only reason economics is a dismal science is because economists make it a dismal science.