Minimum wages and predistribution: Extract from Economics in Two Lessons

I have all sorts of problems with this. But I’ll put most of them aside for this comment.

As I understand it, A. Dube (often with coauthors) has validated and extended Card and Krueger’s analysis of natural experiments. Can you mention this work?

I like the whole idea of meta-analysis. Card and Krueger had a paper on such. More recently, H. Doucouliagos and T. D. Stanley had another analysis. I appreciate describing the whole concept in a work intended for a popular audience is beyond my capabilities.

John Schmitt, of the CEPR – a think thank, put out a summary not too long ago.

5th para under your first heading ends rather abruptly.

Economists working in this approach expected to find a moderately elastic demand for labor, and they did so. Econometric analysis undertaken in the 1970s and 1980s typically yielded estimated elasticities above 0 (no response) but below 0.5. However, over the course of the 1980s, the estimates tended to decline.

My recollection of Lesson 1, or rather Economics 101, is that if an elasticity exceeds 1 in absolute magnitude, we term the response “elastic”. If it does not, we term the response “inelastic”. In what world (other than the MW – okay, you got me!) is an elasticity less than 0.5 in absolute magnitude “moderately elastic”?

Also, if we are going to plug work on the minimum wage, I will take this opportunity to plug my own survey (see listing for 2014 near the bottom). You can find the conclusion here.

C-K succeeded because it hit at a time when New Keynesians were fiercely tussling with the RBC folks. C-K built their model in terms of search frictions and matching problems, and invoked very envelope-theoremy reasoning in their argument (e.g., arguing that the stock market response to minimum wage legislation is ‘flat’, hence…). It is Burdett/Mortensen/Pissarides/etc. inventively applied. This is why the reactions were sharpest from macroeconomists rather than labour economists.

With that in mind, the C-K model is not a static monopsony. Most obviously, the welfare of the C-K firm increases under a binding minimum wage, as turnover is reduced and less is lost to the solving matching problem. The search externality is internalized between employers and between jobseekers. Any further costs are simply passed on customers via prices. You have to be careful about how you invoke its reasoning.

Another way to see this. A minimum wage aids workers in appropriating a larger share of the value added (v+s in Marx’s terms) and that higher minimum wages are likely to cut into that part of the value-added that capitalists had wanted to reserve for their own luxury consumption (that is, surplus value is divided up into additional constant capital expenditures, additional variable capital expenditures and capitalist consumption).

If markets are competitive, then capitalists will have to compensate for higher wages through reducing their own consumption funds (that is, higher wages will result in smaller yachts and shorter luxury vacations and fewer mistresses) since they are compelled to accumulate, i.e. spend on additional constant and variable capital ( this compulsion to accumulate Marx famously called the Moses and Prophets).

Since workers have a higher marginal propensity to consume than capitalists, it may well be that effective demand and therewith employment levels will rise with an increase in the minimum wage.

This is not to say that there is no point at which higher wages would not reduce expenditures on additional constant and variable capital and thereby reduce employment levels or at least the rate at which the absolute level of employment increases.

@10: Any comments on David Neumark’s WSJ article …?

Yes.

I am not sure the economists care, but a lot of people rightly or wrongly don’t think higher minimum wages will come at the expense of job growth. As I noted above, they think higher wages will mean that CEO’s, upper management and big shareholders will have to do with a bit smaller houses or even one fewer house, one less luxury car, a shorter luxury vacation, fewer Michelin dinners, maybe short-lived affairs rather than concubines; and they may now have as much excess to gamble on derivatives or buy up real estate and use zoning codes to keep rents and their ROI on real estate high.
A lot of the people who want higher wages also have a strong sense that workers deserve them due to the nature of the work they do, which really isn’t much described in an economics textbook as opposed to sociology books.
It does not seem that economists want to address popular understandings of the issue due to the technical apparatus they have, which I grant looks scientific due to the equations and jargon.

Bellow is one of the papers that David Neumark references, in case people want to dig deeper:

http://www.nber.org/papers/w18681.pdf

As you may know, the city of Seattle has raised its minimum wage substantially and is scheduled to do raise it further in the coming years. Here is a site following the data, which are skimpy since the law was fairly recent:
http://evans.uw.edu/centers-and-projects/minimum-wage-study

No matter what any particular study may show, though, demand curves do slope downward, even for labor. Readers who are employed and who don’t believe me can try this little experiment: refuse to work at less than double your current salary, creating a self-imposed minimum wage. Do it for a year and report the results here.

Finally, it is not accurate to say that “The most direct way for government to influence the distribution of market income is to set minimum wages.” Minimum wages only affect workers with low wages. There is a way to affect higher-wage workers: comprehensive wage controls, such as the United States had in World War II and under Nixon. In the absence of a global war, one should expect the same results that Nixon got.

@17: High marginal tax rates for very high incomes discourage corporations from funneling very high salaries to their executives, as the latter see less utility from them. And, yes, once the salaries of executives hit the tens to hundreds of millions of dollars a year range, then they really do start to impact the salaries of ordinary employees. The government can set minimum standards for benefits.

The government has plenty of tools to nudge wages in the direction that it wants.

John @19

Neumark/Wascher are the main people doing “surveys” that don’t support the minimum wage. However, I would say that there are some areas where the jury is still out, particularly long-term (ie “lagged”) effects and hiring of entry-level workers. In addition, there has been surprisingly little conclusive evidence showing positive effects from raising the minimum wage. And certainly little evidence that increases lead to higher productivity or spending. In general, US studies tend to run up against shortcomings in the data.

Speaking to Jake @22’s point, this point is called “spillovers” in the literature.

In my opinion, the evidence is pretty clear that small minimum wage increases don’t have a big negative effect more broadly. But, most research looks specifically at the restaurant industry because it is (presumably) the most heavily affected. At businesses with fewer minimum wage employees. However, I have seen (non-academic) indications that there may be effects in government/non-profit industries (healthcare, childcare, retirement, social work, etc) because prices cannot be adjusted upward.

eric titus In addition, there has been surprisingly little conclusive evidence showing positive effects from raising the minimum wage.

I am having difficulty understanding what that sentence is supposed to mean.

The positive effect of raising the minimum wage is that it increases the incomes of the lowest-paid workers. Once you’ve established that the negative effects of reduced employment, etc are sufficiently modest, that positive effect follows as necessity from the arithmetic. Even in Neumark/Wascher, where employment is reduced by an increase in the wage, the numbers are such that the increase in income is substantial: the arithmetical implication is that a minimum-wage worker has a larger income and shorter workweek. Earning more and working less are both positive effects from the standpoint of a minimum-wage worker.

What’s going unargued here, but maybe should be confronted directly, is whether the perspective of the minimum-wage worker is sufficient proxy for the public interest.

Trader Joe @ 12: The problem I always have with these economic studies is that they think like utility optimizing machines and not like an actual business owner. . . . if the question is ‘What’s the impact of a higher minimum wage’ – I’m not sure the answer involves whether there is a net plus or net minus in employment – I think in the aggregate there’s not likely to be a lot of shift either way. But its also clear that corporate earnings don’t go down dollar for dollar to absorb the added cost, so the question is what constituencies absorb the net difference – suppliers, customers, employer and employee all seem to absorb some small share.

Peter T: . . . there’s an implicit assumption that employees can be added or subtracted one by one. But most (not all) production is done by teams, where the additional unit is the size of the required team – and no work at all takes place below the minimum number. It takes 5 employees to staff a single-person slot over 24 hours, it takes some minimum number greater than one to run even a small fast-food joint, it takes hundreds to run a factory or steel mill. The unit of employment is variously 5, 2-3 or 300+. Minimum wages can be expected to affect sectors differently according to the minimum size of the production unit. Larger production units will absorb the cost and seek ways to raise productivity.

The points that Trader Joe and Peter T raise go directly to some of the core issues in contrasting Lesson 1 with Lesson 2.

The economics of Lesson 1 — also the economics of conventional textbook economics, aka Econ 101 — are basically the economics of practical certainty and complete knowledge or perfect information. The economics of Lesson 2 are, or ought to be, the economics of uncertainty, incomplete and imperfect knowledge.

The imagined world of Lesson 1 is a world on a knife-edge — a metaphor I used in earlier comments on JQ’s drafts to describe Hazlitt’s village with a broken window. Belman and Wolfson used that or a similar metaphor in general reference to business operations in the conclusion Wolfson linked to, upthread .

In the world of practical certainty imagined for the purposes of Lesson 1 reasoning, labor (services) are a quantity metered out at the wage rate to be a quantitative input to a production process. You need more labor to produce more restaurant services, and both are added to the point of diminishing returns.

In a world of practical uncertainty, things are a bit different. Labor isn’t a quantity so much as it is a behavior. The quantity is still there — so many labor hours and muscular effort and so on, but the critical elements become behavior and control of the production process. The wage isn’t a simple meter placed on the quantity of labor used as an input; the wage is part of a contingent contract designed to elicit effort to follow rules.

You don’t need rules in a world of practical certainty. Local knowledge is enough to make the right decision and the right decision is known to be optimal and all that. Hayek and Friedman and Hazlitt have exploited this aspect of a simplified economics of distributed decision-making in constructing their ideology.

In the real world, you need rules. You need rules and learning to achieve technical efficiency in the production process. And, the rules may be embodied as technology in very useful machines and systems of operating procedures. Peter T mentions that people are organized in teams. But, it is more than that. The organization of production, with its teams and machines and rules, results in a cost structure of a completely different character from the one envisioned in Lesson 1 economics, a cost structure where costs at the margin of production are low (relative to average unit cost) and often declining.

In short, firms in a Lesson 2 world are pre-occupied with the problems of technical efficiency and waste. They want to sell more stuff at the current price, because their costs for the last meal served are lower than the average. The restaurant wants the servers to upsell the customer on another drink, another dessert, but also to deliver the check and get the customer out the door in order to seat the next customer, when that’s possible. There’s slack and unused capacity; food left over at the end of the night.

In a world of certainty, the marginal product of labor determines the wage. But, a world of uncertainty, the wage determines the marginal product. Causality, if you like, reverses. Because in a world of uncertainty, someone is managing production and the production process. Management will take the wage as given and manage in such a way as to make marginal product equal the wage. If the wage is low enough, managers may well hire people to supply slack in the system, a use of labor with a particularly low marginal product, even if inframarginal uses of the same labor is quite productive.

If the wage is low enough, managers will hire people and waste their time. And, though economists are remarkably reluctant to do the obvious and model managers slacking, I will tell you that managers do slack. So, when wages rise to some modest degree, part of what disappears from the system is waste. Managers will tighten schedules, retain workers longer and train less often.

“The economics of Lesson 1 — also the economics of conventional textbook economics, aka Econ 101 — are basically the economics of practical certainty and complete knowledge or perfect information. The economics of Lesson 2 are, or ought to be, the economics of uncertainty, incomplete and imperfect knowledge.”

I would say that dividing the arguments for different policy options in this way is a straw man argument.

Although it is true that silly introductory models have a “knife edge” aspect to them, you’re not arguing against the best case for laisse-faire when you assume that the only defense of such policies are the silly little Econ 101 models, GE models and the like.

I would say that the opposite is the case: the decentralized nature of markets, the selection process of the markets, is what enables such a system to function in the sea of uncertainty and intractable economic problems, what gives the market system robustness to the general lack of knowledge present in most economic actors.

Letting a large number of actors come up with solutions to different economic problems and then having the market selection process triage those solutions is an insanely general problem solving mechanism. Such a mechanism is robust to the lack of knowledge even of the majority of the participants, and is robust to a large spectrum of intractable uncertainty — you don’t need assumptions about god-like knowledge and instant adaptation to advocate for such a problem-solving system.

By contrast, expert driven, top-down solutions are extremely fragile to the lack of knowledge of the supposed “experts” — and in the real world, we have mostly experts on economic literature, rather than experts on the actual, concrete, economy.

Of course, insanely general is not yet universal, but I will not elaborate, on Crooked Timber, on the possible systemic failures of market systems. But I will say that the remedies to such systemic failures would better be similarly robust to the lack of knowledge of the “experts” about the concrete economy, otherwise the solutions may be worse than the cure.

(This is just a general point, triggered by BW’s comments above, only vaguely related to the minimum wage issue)

Alex K @ 29: I would say that dividing the arguments for different policy options in this way is a straw man argument.

It would be, I suppose, if I had had to stuff “Lesson 1” economics myself, but I didn’t. It is an already existing and extensive set of texts. You can find many examples, from Hazlitt to Hayek, Friedman to Mankiw. (I looked at Mankiw’s textbook discussion of minimum wage policies once, but I couldn’t recount it now; I recall it as mildly misleading and ideological.)

For whatever it is worth, I agree with you that it is possible to make sensible arguments for conservative and even propertarian laissez faire views, while adopting a realistic appreciation of the concrete economy. It is absolutely not my view that a full appreciation of uncertainty would lead to advocacy for fully centralized direction of the economy; quite the opposite. Top-down solutions, as you label them, designed by mandarins steeped in the fantasies of the economics literature, would be as much a nightmare scenario for me as it would be for you.

When you write, “the decentralized nature of markets”, I suspect you have not quite left Lesson 1 behind. We have an economy in which decision-making is extensively distributed and somewhat loosely coupled, coordinated in important respects (but by no means exclusively) by money and finance. Hierarchies, public and private, are extensive and salient. Actual markets are very few. None of that necessarily obviates what you wrote about the importance of a kind of trial-and-error and evolutionary selection in the way institutions develop and are modified in this system of distributed decision-making that we label the political economy.

It does suggest that when economists tie themselves into intellectual knots pattering on about “labor market monopsony” — just to take one example from the present topic of discussion — they are practicing a kind of doctrinal idiocy, substituting ritualized manipulation of the conventions of the economics literature for investigation of the concrete economy. I don’t think that informs the policy debate, even if I am sympathetic to the policy point of view.

I would only add two points to this excellent chapter:
Firstly, Karl Marx would have been as critical of monopsony power as the laissez-faire capitalist writers were of monopoly power. Classical, or even modern day orthodox economists, implicitly assume that local domestic based employers are somehow ethical in labour negotiations but foreign multinationals are unethical in labour negotiations. The “take it or leave it era” (my way or the highway approach) under the old liberal government’s Workchoices legislation suggests otherwise. As for value added theories justifying higher minimum wages, Marxian
economists would suggest that marginal physical product should determine wage rates.
The idea that only productivity increases can justify any wage rise is so debased when you look at the cross elasticities of labour supply and demand theory. Income elasticity of supply considerations are relevant here. The efficiency first argument that states only technical optimum is acceptable for production will always predicate the lowest possible minimum wage.

Secondly, if the labour supply curve behaves like all other supply curves then it can be seen to be a backward bending supply curve. The current penalty rates debate in Australian politics seems to ignore this theoretical constraint. If a work unit has already worked a forty hour week (still the statutory maximum for normal rates) and is asked to do overtime on a Sunday, they should get penalty rates. There is now some valid arguments for overtime rates for Saturday work when it is less than eight hours a day. But after that penalty rates should also apply on Saturday. The backward bending supply curve can support this argument in theory as labour elasticity changes over the curve. As for the elasticity of 0.5, the whole idea is that it is a relative elasticity calculation. Simply put, perfect elasticity of supply almost never exists and this goes for perfect inelasticity of supply.

“It would be [strawman], I suppose, if I had had to stuff “Lesson 1” economics myself, but I didn’t. It is an already existing and extensive set of texts. You can find many examples, from Hazlitt to Hayek, Friedman to Mankiw.”

There’s supposed to be an “as if” justification behind the unrealistic models, although the justification is rarely provided. Ideally models would have robustness analysis, where you would find that say, arbitrage models, while highly dependent on liquidity assumptions, are very robust to relaxing rationality assumptions: a handful of actors with limited and partial rationality are enough for obtaining roughly the model’s results. On the other end of the spectrum, some General Equilibrium models are robust to virtually nothing, and the slightest wind breeze would completely throw off their predictions.
But such robustness analysis of models does not seem to be very popular.

Hayek does have a lot of work which fits the ecological view of the economy, with trial and error and market selection processes playing important roles. He also had periods when he exposed a more simplistic view of equilibrium. He had a long and productive life and it is unrealistic to expect 100% coherence in his thought across decades.

I guess my objection is that focusing criticism on unrealistic and unjustifiable models is in fact breaking the norm of arguing against the best case of your ideological counter-party.

“When you write, “the decentralized nature of markets”, I suspect you have not quite left Lesson 1 behind. We have an economy in which decision-making is extensively distributed and somewhat loosely coupled, coordinated in important respects (but by no means exclusively) by money and finance. Hierarchies, public and private, are extensive and salient. Actual markets are very few. ”

I’m never sure what you mean by markets being few. The space for human action left over by the market discipline is not a measure zero set, on which economic actors have to do an elaborate tightrope walking exercise. There is plenty of space remaining for human agency — including space for organizing a firm’s behavior in different ways, hierarchically or not. But I don’t see the value in claiming that market discipline essentially does not exist.

To put it concretely, the behavior of a plumber in pricing, getting and executing his work is not well described by perfect markets. But the plumber’s behavior –and the deal you can make– will be quite different when you can call ten other plumbers (the market) as opposed to when he knows that he is the only one available.
A large organization will also operate quite differently in an environment without competitors as opposed to an environment with free entry and with free exit as a “reward” for bad decisions.

I’m sure all of the trivialities above are known to you, so what you mean by there being very few markets is still a mystery.

Looks like the comment I attempted to post before the preceding one got lost. It was about privatization, a bit off-topic, but something to John Quiggin has written about in the past and I shared because it illustrates one of his central arguments. The quote I meant to post from the previous link is:

“The Housing and Planning Bill, which returns to the Commons this week, will make it even more difficult for anyone either to get a council home or to keep it once they do. Councils will be forced to sell off higher-value properties that could have been let to people on their waiting lists. Most of the money will go to the Treasury. It’s nominally aimed at funding the new right to buy for housing association tenants, but it now looks likely that the ‘higher value’ threshold will be set so low that the sales will create enough money to fund other policies, too, such as the programme to build ‘starter homes’ for first-time buyers. According to Shelter, ‘the only group it appears to help on a significant scale will be those already earning high salaries who should be able to afford on the open market without government assistance.’

The problem I have with the term market discipline is the implication that some self discipline is exerted due to ethical standards. So for minimum wage setting, the inference here is that the employer (who demands the labour hours worked and choose the working conditions they like) somehow limits their behavior to accommodate the needs of the workers (who supply the labour). In free enterprise market theory, the usual market model is the monopolistic competition model. This implies a degree of competition from rival bidders for labour units but suggests that each bidder regards their operation as uniquely desirable to those who “win” employment contracts. This sense of entitlement seems to somehow negate ethical considerations. The monopolistic competitor sees themselves as the exception to any ethical rule. In Australia we have the franchise industry that seems reluctant to negotiate minimum wages on ethical grounds. The Seven Eleven cases that have made news in Australia are just one case in point. There is also the last collective bargaining deal for the McDonald’s franchise workforce.
Also there are cases of below minimum wages paid to seasonal workers in fruit picking. These workers can be backpackers who have little knowledge of Australian labour laws and even less bargaining power.
The elasticity of demand for low paid workers can be illustrated by many diagrams but understood only through bitter experience. Try taking a small elastic band and see how much this can expanded, the physical limitations encountered can represent the futility encountered by workers on minimum wages who try to get a substantial wage rise. The term “working poor” was first used in the USA to describe the lowly paid workers who had little choice but to accept a wage rate that was so low that they had no ability to save any income.

Most of them. They tend not to be ideal markets but are close enough that modelling them as an ideal market s a non misleading simplifying assumption. The number of competing products is limited. However provided that collusion between producers is prevented you still get a fairly well functioning market even with a surprisingly small number of competitors. The actual markets that Smith was discussing were imperfect they still function as markets.