The Minimum Wage
The minimum wage has been a big part of this year's election cycle, mainly due to Bernie Sander's campaign and his idea of a national minimum wage. There has been lots of discussion of this, but most of it is just, well, bad. There are really two things that one can point to as to why wages above the market wage can be good.
The minimum wage has been a big part of this year’s election cycle, mainly due to Bernie Sander’s campaign and his idea of a national minimum wage. There has been lots of discussion of this, but most of it is just, well, bad. There are really two things that one can point to as to why wages above the market wage can be good. The efficiency wage argument and monopsony.
The efficiency wage argument goes like this, firms paying a wage above the market clearing wage has two possible benefits to the firm. The first is that with wages higher than the market clearing wage the firm can reduce the costs of employee turnover. This part of the story goes something like this, a worker builds human capital that is specific to that employer. He knows “how things work there” and as he learns these things he becomes more valuable to the employer. For example, if he understands how the data systems work and can get data that is accurate and quickly he’ll be seen as more valuable than say a new employee that has yet to learn these things. If this employee leaves that human capital goes with him and the firm loses and will have higher costs until a new employee can acquire that human capital. The second line of this theory is that by paying workers more these workers will be more productive, thus the higher wages “pay for themselves”.
But, there are a number of problems with this story as a justification of the minimum wage and unemployment. The other part of the narrative of the efficiency wage is that it causes unemployment. The advocates of this view argue that one way to check the validity of this hypothesis is that jobs where the efficiency wage hypothesis holds will have more applicants than there are jobs–i.e. there is an excess supply of labor….which is pretty much the definition of unemployment. Second, the efficiency wage does not say that all wages should be the same or even have the same differential between the market clearing wage and the efficiency wage. That is, one market where the market clearing wage is $10 the efficiency wage could be $12 whereas in another market the market clearing wage is $12 and the efficiency wage is $13. Setting the wage in both markets to $15 would result in an inefficient wage. The whole idea of the efficiency wage is that it is efficient for a firm to determine that wage and implement that wage, not have some diktat issued by a guy in a funny shaped room. The last problem is that, even if it turned out that the efficiency wage for every market was $15/hour, if legislation is passed dictating that is the minimum wage everywhere, then the story about greater productivity goes out the window. As a worker I would not have to be more productive to keep that job because that is the minimum wage I am going to get at that job no matter how productive I am. Aaand the story of reducing employee turnover takes a hit too. If the wage is the same everywhere, then as a worker I’ll have less incentive to not switch jobs. The idea behind reducing employee turnover is that unless the other job is also offering a efficiency wage I’ll not want to quit. But if every job has the same wage by government diktat….
And, to be clear, I think there is likely something to the efficiency wage story. After all, what happens at the market clearing price? Markets clear. So for example if you walk into the grocery store where all prices are exactly at the market clearing price what would you see on the shelves? Nothing. Markets have cleared–i.e. there is nothing left to sit on the shelves. So prices have to be such to ensure there is stuff on the shelves when we walk into the grocery store. Why would this not hold for labor as well and wages. Of course, at the same time a permanent full time job could be argued has a lower wage. After all, we could all go out each day to the market and sell our labor services. But, most of us prefer the sure thing vs. the uncertain thing, so we take a full time job at a lower wage rate knowing that we’ll have a steady stream of income. This goes against the efficiency wage hypothesis. They could both be true though. I might be willing to take a permanent position for $12/hour and my employer might be willing to pay me an efficiency wage for $15/hour. In this case, I’m better off and my employer is better off. And that is the beauty of markets they are not zero sum, but positive sum (at least ex ante).
The other story is monopsony which kinda sounds like monopoly and it is kinda the same thing, but a monopsonist is a single buyer of a good. In this case the monopsonist will set the price too low whereas a monopolist would set the price too high. In the case of monopsony a minimum wage or setting the wage higher than what the monopsonist is paying can result in both an increase in employment, no increase in unemployment, and an improvement in the income for those workers affected by the minimum wage. This is the view of David Card (as in Card and Krueger).
However, this story is also not without its problems. Monopsony only works when there is no competition. If there is competition then the story falls apart. If I try and pay a monopsony wage the people I want to hire will go to my competitors. My employees will also see employment elsewhere. And if having a high turnover rate for employees is costly, then I’ll be incurring higher costs. So competition will lead me to increasing the wages I pay whether I want to or not.
Further, note that a minimum wage can result in increasing employment, but that is not the position of those who argue increasing the minimum wage won’t raise unemployment. They do not argue raising the minimum wage will decrease unemployment. Further, they argue their results only hold for small changes in the wage rate, not large ones. But the monopsony argument rests very much on the notion that the demand for labor is inversely related to the wage rate. Or to explain it differently, the monopsony argument not only accepts that was wages go up the demand for labor goes down, it won’t work without it. Whereas a monopolist restricts supply to artificially raise the price and capture economic rents, the monopsonist restricts the number of employees to drive down wages and capture economic rents. One solution for the monopolist is to set a price ceiling, maximum price the monopolist can charge. If this price ceiling is below the price the monopolist would charge absent the price ceiling output will increase as per the law of demand. Similarly with the monopsonist, a minimum price (wage) will result in the monopsonist hiring more workers–i.e. employment goes up and unemployment goes down.
But like monopoly monopsony is probably not the typical situation. When there are many potential employers of low skilled labor it is hard to argue that any one firm has monopsony power at least everywhere and at all times. It might be true in some locations and for some time periods. So again, if a national minimum wage is set at $15/hour while it might increase employment in those labor markets where there is monopsony power, in those markets where there is competition it would reduce employment. If this is the case, which I find more likely than either competition everywhere all the time and also more likely than monopsony everywhere and all the time, then a one-size-fits-all policy of setting the minimum wage nationally to $X/hour is likely not going to be a good one.
Finally, I’ll address what I consider a non-argument for the minimum wage. This position relies on some variant of the story, “If we pay low skilled workers more money, they’ll spend it, meaning more economic activity and thus the increase in the minimum wage pays for itself.” This is just stupid. Especially stupid because if we replaced minimum wage with “tax reduction” these same people putting forward this story would scoff. But the minimum wage is, in many ways like a tax. Like a tax the minimum wage comes with a deadweight loss. You could get to the minimum wage by also placing a per unit tax on the employer and transferring the money to the worker. So if a tax reduction is unlikely to pay for itself on the tax revenue side, the same is almost surely true for the minimum wage. Further, people making this argument need to go back to Frederic Bastiat’s essay on the cobbler, the glazier and the young lad who likes to throw stones through windows. In that story the young lad breaks the cobbler’s window. The cobbler hires the glazier to replace it and people wrongly conclude, no worries that resulted in increased economic activity. What those people making this argument fail to grasp is that the cobbler could have spent that money buying bread from the baker, meat from the butcher, or any number of other goods or service, but now he cannot so there is no new economic activity–i.e. they failed to take into account opportunity cost. Further, the stock of wealth wealth has been reduced so in the end, society is no better off. Same thing applies here. That money for the minimum wage has to come from somewhere and it is strains credulity to think that that money would not have somehow entered the economy save for an increase in the minimum wage. Sure, maybe it wouldn’t have. Maybe the people with that money would have stuck it in a mayonnaise jar and buried it in the backyard, but absent that it would have somehow gotten into the economy and resulted in economic activity. Further, that part about deadweight loss…yeah, taking the money from whomever had it before and giving it to the workers…you can’t give it all to them due to the deadweight loss. So you also end up with less economic activity. If you make this argument you are basically saying, “I know nothing about economics at all.”
Lastly, I am not opposed to using price floors, ceilings or even price controls when there is sufficient reason to use them. A good case of this was the California electricity meltdown. In that case the market was clearly broken. The solution was quite obvious, set a “soft” price ceiling which was based on the cost of the least efficient generator to clear the market. It took months, but when the FERC finally intervened and did that…the market settled down, rolling blackouts and brown outs stopped being a Thing™ and people got to work figuring out how to fix that market. I am just not convinced that the low skilled labor market is “broken” as the California electric market was.