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Comparing Wins and Losses from Free Trade and Minimum Wages

A common refrain is the following (the wording is my own):

Minimum-wage legislation creates benefits for some people and causes harm to others. Likewise, free trade creates benefits for some people and causes harm to others. So someone who opposes all minimum-wage legislation while supporting all efforts to make trade freer is inconsistent. Why should the benefits of minimum-wage legislation always be smaller than the costs of minimum-wage legislation while the benefits of free trade are always greater than the costs.

Thomas Hutcheson, among others, offers this – or a very similar – refrain frequently in the comments section of Cafe Hayek (and, I think, also in the comments section at EconLog). And several people over the past couple of months have e-mailed me, or written to me on Facebook, making this same point.

So am I – and the many other economists who take the same position on these issues that I take – inconsistent? Do I and like-minded others allow our priors to cause us to reject scientific cost-benefit analysis in favor of conclusions driven by our ideology?

No and no.

If you’re interested in the explanation, it appears below the fold.

A preface: all statements about the effects of real-world policies are – or should be – statements about plausible or, better, probable effects rather than statements about effects that are merely possible. Nearly everything that is possible in reality will never occur. Therefore, obsessing over the merely possible – or treating the merely possible, either explicitly or implicitly, as if its relevance is on par with what is plausible and probable – is, at best, a waste of time and, more commonly, a source of confusion.

Of course it’s possible, under just the ‘right’ set of circumstances, that freer trade in country X will over time generate net harm to the denizens of country X; of course it’s possible, under just the right set of circumstances, that a minimum wage imposed in country X will over time lead to no job losses and only to higher incomes for low-skilled workers in country X; of course it’s possible, under just the right set of circumstances, that someone who is pushed from the observation deck at the top of the Empire State Building will suffer no harm as a result of the fall and then whistle “Dixie” while skipping down 34th St. away from his point of impact. But no one should regard the possibility that protectionism and minimum-wage legislation will generate net benefits for society as being any more probable than is the possibility that a free fall from 1,000+ feet above the surface of Manhattan will generate a happy falling victim immediately afterward skipping merrily down 34th St. under his own power.

In the discussion that follows I focus only on plausible or probable consequences.

The losses created by minimum-wage legislation differ fundamentally from the losses created by free trade.

First, over time free trade creates net gains while minimum wages create net losses.

Both minimum wages and tariffs – by blocking some mutually advantageous exchanges – make society as a whole less wealthy, even though each policy makes a handful of specific individuals wealthier. In econ-speak, both minimum wages and tariffs create deadweight losses – Harberger triangles. (And the size of these losses, of these Harberger triangles, is greater the higher are the minimum wages and the higher are the tariffs.) Therefore, a policy of free trade makes society as a whole wealthier (that is, it creates net wealth) while minimum wages make society as a whole poorer (that is, they destroy net wealth).

Second, those who are harmed by a policy of free trade (that is, those who lose jobs or income as a consequence of the resulting shift in trade patterns) are harmed by a particular manifestation of economic competition – competition that is at work no less domestically than internationally.  In stark contrast, those who are harmed by minimum-wage legislation are harmed by a restriction on economic competition.

The harms created by free trade are inextricably part of the competitive market process that over time improves living standards for everyone (and especially for the poor). The only way to protect people from these harms is to successfully attempt to freeze in place the current pattern of economic activity, international and domestic. But not only would such ‘success’ prevent further economic growth (no one would get richer, and today’s rich and poor would be tomorrow’s rich and poor), such success is impossible. Any serious attempt to freeze in place the current pattern of economic activity would violently rip the heart out of the market economy. The actual result of any such attempt would be, not only serfdom, but also widespread and deep impoverishment.

But protecting people from being harmed by minimum wages is simply a matter of removing the restrictions. Those who were harmed by the restrictions are, when the restrictions are removed, no longer harmed and, again, society’s net wealth over time will, as result, increase.

Put differently, minimum-wage legislation is a restriction on people’s freedom to find mutually agreeable terms of exchange while free trade is a policy of refusing to so restrict people’s freedom.  Free trade, unlike minimum-wage legislation, is a policy of refusing to interfere with mutually agreed-to terms of trade. Therefore, to protect individuals from being harmed by free trade requires granting those individuals special protection from competition – protection that, as mentioned above, if given to everyone would destroy the economy. In contrast, to protect individuals from being harmed by minimum wages is to remove protection from competition; it is to subject to competition those workers who were protected by the minimum wage from the competition posed by lower-skilled (or otherwise less ‘desirable’) workers.

Third, those who lose today from free trade have already been greatly benefitted by free trade, for not only are the jobs that they lose likely themselves to have been earlier created or made more lucrative by trade, but the wealth of the economy of which these ‘losers’ are a part – and from which they will continue to draw sustenance – will grow because of free trade. In short, over time, free trade has no losers; every individual, even each of today’s ‘losers,’ is richer than he or she would otherwise be because of free trade.

In contrast, those who lose today from minimum wages are unlikely to have already been benefitted by minimum wages. Not only do minimum wages reduce society’s net wealth – that is, unlike free trade, they ‘shrink the pie’ – but the jobs lost to minimum wages are in no way ones that in the past were created by minimum wages. Unlike free trade, minimum wages do not overall and over time improve the welfare (relative to what that welfare would have been without minimum wages) of those who lose today from minimum wages. For those individuals who lose from minimum wages, minimum wages are all loss with no offsetting benefits from the past or in the future. (Indeed, because those who lose jobs because of minimum wages lose not only current income but also opportunities to gain on-the-job skills and job experience, minimum wages make these workers unambiguously worse off in the future.)

Fourth, the losers from minimum wages are not as randomly selected as are the ‘losers’ from from free trade. Those who lose today from free trade are not singled out in any way. They are simply those suppliers, regardless of skill level or of work experience, who consumers choose to patronize less than in the past. The losers from minimum wages are very different. They are the lowest-skilled and least ‘desirable’ workers in society.

Because the minimum wage creates a surplus of workers competing for jobs, employers – when choosing whom to hire (and whom not), as well as whom to retain (and whom to fire) – must use criteria other than wages. Those criteria will typically select for acceptable traits such as workers’ skills, experience, and reliability. Those criteria will also, in some cases, select for traits that civilized people understand ought not be among the criteria for employment, such as workers’ skin color, workers’ sex, workers’ sexual preferences, or workers’ physical attractiveness.

If you’re a teenager with your own car but with no parental responsibilities, and raised by a middle-class family in a leafy suburb with good schools, you will likely be among the beneficiaries of minimum wages. If you’re a teenager or single-mom, raised in the inner city with unusually bad schools and dependent upon public transportation, you will likely be among those who are rendered indefinitely unemployed by minimum wages.

Fifth, in principle, no one must remain permanently or indefinitely unemployed because of free trade. In principle – and in practice over time – free trade does not reduce the net number of jobs. Not so with minimum wages: in principle, minimum wages destroy some jobs; minimum wages, in principle, permanently reduce the net number of jobs (from what this number would be absent minimum wages). Put differently, unlike with free trade, even in principle – and, of course, also in practice – some number of workers must remain unemployed (or work fewer hours) in the long run as a result of minimum wages.

Put yet another way, while in practice any changes in trade patterns – including, but by no means limited to, those changes made possible by a freeing of trade – always destroy some particular jobs and often result in a short-run net decrease in jobs, the net decrease in jobs is not a long-run phenomenon. Minimum wages, in contrast, not only destroy some particular jobs, but the net decrease in jobs caused by minimum wages is permanent (or, rather, lasts for as long as the minimum wages remain in effect at their current levels). Any net decrease in jobs caused by free trade is a short-tun phenomenon. In the long run free trade has no effect on the number of jobs. In contrast, minimum wages reduce the number of jobs even in the long run.

Put yet another way, one of the chief ways that free trade creates benefits is by shifting employment, often with a short-run decrease in the net number of jobs in the domestic economy. But minimum wages create what benefits they create only by reducing employment, always with both a short-run and a long-run decrease in the number of jobs in the economy (or a worsening of many jobs for the lowest-skilled workers).

UPDATE (February 13, 2021): To be more precise about the effect of minimum-wage legislation on the number of jobs, I add that in principle minimum-wage legislation destroys some number of the precise kinds of jobs that low-skilled workers hold before any unexpected increase in the minimum wage.

As argued by many (and by Jeffrey Clemens most recently), among the negative consequences of minimum wages is that they cause the nature of low-wage jobs to change. Fringe benefits, such as employee discounts, are reduced; the number of hours worked falls; jobs become more onerous. Technically, these changes are not captured in the standard supply-and-demand analysis used to show the consequences of minimum wages, for among the assumptions of that analysis is that the only feature of the job that changes is the monetary wage.

Also, the reason I used “unexpected” two paragraphs up is this: If an increase in the minimum wage is expected, employers and employees start adjusting to that expected higher wage before the actual increase kicks in. Any post-increase adjustments, therefore, do not reflect the full impact of the increase in the minimum wage.