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Econ 101 and the Minimum Wage

Posted By Russ Roberts On April 8, 2013 @ 11:34 am In Work | Comments Disabled

Those who argue that the minimum wage has little or no effect on employment sometimes describe those of us on the other side as using Econ 101 or perfect competition or the marginal product theory of the demand for labor or an equilibrium concept of the labor market to argue that the minimum wage reduces employment.

But none of those theories or models are necessary for making the case against the minimum wage. It’s even simpler than that. It’s Econ 1 or maybe Econ 0.

The minimum wage makes some workers, those with the lowest skills, more expensive than they otherwise would be. When things get more expensive, people look for ways to avoid that increased expense. In the case of the minimum wage, employers try to substitute machines and technology for workers, or use higher-skilled workers who are already paid above the minimum instead of lower-skilled workers. It doesn’t require any extreme assumptions about the labor market being in equilibrium or that the demand curve is derived from the marginal product of labor. It’s just that there is some demand for labor and that it slopes downward. All that means is that when workers get more expensive, you try to avoid paying those costs. This is a not neoclassical or neoliberal or Chicago view of the world. It’s everyone’s view of the world.

Yes, it is an empirical question as to how big these effects are. But the size of those effects depend on the size of the minimum wage. The minimum wage in America right now is $7.25 at the federal level. Almost all (97%) of full-time hourly workers earn more than $7.25. (Some do so because they are in states with an even higher minimum wage, but even the most “generous” minimum wage state is Washington state with a state minimum of $9.19 and hour. When the minimum wage is relatively low as it is now, the amount that employers substitute machines for workers is going to be relatively small and the harder it will be to distinguish those effects from other changes going on in the economy. So it is not that surprising that some of the newest studies find little effect of the minimum wage on employment. But I believe there are still hundreds of thousands of workers, those with the lowest skills, who are priced out of the labor market by the minimum wage. I am not a utilitarian. Giving some workers a raise while other workers lose their jobs, is to me, a repugnant policy.

But the new studies find zero effect! (Let us ignore the studies on the other side that find that the minimum wage reduces employment.) So you then have to ask if the precision of these studies outweighs everything else you know about how employers respond to changes in wages.

As I argued in the Intelligence Squared debate [1], we know employers respond to changes in wages–that is why manufacturing employment is falling in absolute terms at the same time that manufacturing output is rising. It is not because the workers in manufacturing employment have learned new skills and become more productive. It is because employers have added automation, robots, and computers to the manufacturing process as well as moved factories overseas. Employers have not done this because they like shiny metal robots or the thrill of exotic foreign travel. They have done it because it is profitable–the costs of producing with a different mix of machines to workers or a different mix of foreign workers to domestic workers is lower. And those costs and profits are driven by the relative cost of domestic workers to machines and foreign workers. The minimum wage changes those tradeoffs to make ¬†American workers less attractive than they would otherwise be. Why would you want to make the lowest-skilled workers less attractive relative to the alternatives?

Yes, some poor workers get a raise. But that raise comes at the expense of even poorer workers who see their wage reduced to zero.

If you really believe that the minimum wage is a force for social justice and that it has minimal effects on employment, you should support a much higher minimum wage. I’m not talking about a reductio ad absurdum level, but something like $18 an hour, an amount that at full-time work would give workers an income of $36,000 in a year. Does anyone really believe that there would be negligible employment effects from such a change just because some current attempts to measure the impact of the minimum wage find little or no effect?

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