Friday, July 8, 2011

Minimum Wage 101

. Friday, July 8, 2011

Kevin Drum and Karl Smith are having a go-around about the effect of minimum wages on employment. There is the famous Card/Krueger study (and others) showing that increases in the minimum wage do not adversely affect employment rates, and a bunch of other studies plus basic economic reasoning suggesting that they do. Drum weights the former more heavily, Smith weights the latter more heavily, but they can both be right. The effect of a price floor of any kind depends on where the floor is set relative to the competitive equilibrium. In the graph above (originally used to depict a basic relationship between capital ratio regulations and bank behavior, but the same principle works here), a floor below the equilibrium has no effect on behavior. Think of this as a minimum wage below the market wage, or (perhaps) the Card/Krueger finding. In the graph below, the floor is above the market equilibrium, so behavior is altered.

The point is that the effect of a minimum wage change will depend on many factors besides the minimum wage itself. In a depressed labor market, with many potential low (or zero) marginal product workers, the demand curve for labor shifts left, the equilibrium price falls, and a minimum wage increase is more likely to retard employment rates than it would in a robust labor market where the demand curve shifts right and equilibrium price rises.

Many people argue that a relaxation of payroll taxes would help boost employment. If that is true, then a minimum wage increase would decrease employment, at least for workers at the margin where any of this is relevant. That may not be many workers (as Drum claims), but given the depressed labor market today it is probably a lot more than it would have been in 2005.

Also keep this in mind: if a minimum wage is successful it must set a floor above the competitive equilibrium, and therefore must reduce employment. Maybe that shows up in hours worked or price increases rather than crude employment rates but it has to be there somewhere. A wage floor below the equilibrium doesn't change anything, and is therefore unsuccessful.


Latinamericanist said...

this is all a bit too 101ish for me. I don't think it's that unreasonable to claim that labor demand in many sectors with MW jobs is de-facto monopsonistic - which of course provides a theoretical explanation of how a minimum wage can both lift wages and not affect employment. (I believe there is a study that shows that empirically shows MW increases eat mainly into corporate profits, which would fit with the monopsony claim - something from Texas, but I can't find it atm.)

It would also be fair to argue that with slightly higher wage jobs with higher skills, demand is less monopsonistic, so that the same logic needn't apply and a payroll holiday could help. That said, the payroll holiday as I understand it was supposedly designed more as a demand stimulus measure - giving money to consumers likely to spend it soon - than as a labor supply measure.

Kindred Winecoff said...

Right, my point was that the effect of a minimum wage increase will depend on many other factors. It's not pre-determined. In a monopsony situation, it's like setting a floor below a competitive equilibrium -- since a monopsony market isn't competitive -- and wages can go up while employment rates are unaffected.

So the discussion needs to be about what those other factors look like. I doubt monopsony describes the situation very well, since many of the jobs we're talking about are in retail or other low-end services, and those markets are pretty competitive. Monopsony is a pretty special, and relatively rare, case. But maybe it does... high corporate profits may provide some evidence that there is monopsony-lite going on. Of course if the markets are uncompetitive we should do things to make them more competitive rather than entrench the uncompetitiveness by hiking the minimum wage.

I think the payroll tax holiday was intended to stimulate both the demand and supply side, but there were definitely a lot of people making the case that a tax holiday would boost employment, and they were using the same logic that operates here.

Minimum Wage 101
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