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Poor Economics at The Economist

Here’s a letter to The Economist:

Your attempt to justify minimum wages fails (“The logical floor,” Dec. 12).

First, after announcing that “Scepticism about the merits of minimum wages remains this newspaper’s starting-point,” you abandon that scepticism on the grounds that income inequality is growing and workers’ share of national income is shrinking.  But however regrettable such trends might be, they are irrelevant to the case against minimum wages – a case that emphasizes employers’ incentives to employ fewer low-skilled workers as the cost of employing these workers rises.  Neither greater income inequality nor a lower share of national income going to workers in any way weakens those incentives.

Second, it is untrue that the classic case against minimum-wage legislation assumes that labor markets are perfectly competitive.  Again, this case rests upon the recognition that all employers – even ones with monopsonistic power – will further economize on their use of labor as the cost of labor rises.

The truly unrealistic theory is the theory of monopsony that you use to justify the minimum wage.  Even if, as you heroically assume, employers possess monopsony power over low-skilled workers, those employers also enjoy a variety of options for dealing with higher labor costs – options that include, most relevantly, the ability to replace workers with machines.  Contrary to all-too typical sloppy interpretations of the monopsonistic theory of labor markets (in which employers are simply assumed not to increase their capital-labor ratios in response to higher wages), because incentives to economize on the use of labor intensify with rising costs of labor even for the most monopsonistic of employers, there’s every reason to believe that higher minimum wages diminish the employment options of low-skilled workers regardless of how competitive or monopsonistic labor markets might be in reality.

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

Other flaws – logical, theoretical, empirical – mar The Economist‘s case here for the minimum wage.  But the above letter is already too long.