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Minimum Wages and Labor-Market Frictions

Here’s a letter to a lawyer friend who, because he refuses to use Facebook, can only read comments at Café Hayek; he cannot make comments at Café Hayek.  So he writes to me frequently.  Ken is very smart and kind, but quite suspicious of free markets.

Mr. Ken S ___


You ask why I oppose minimum wages despite the undoubted reality of what Café Hayek commenter Daniel Kuehn calls “search and matching frictions.”  (“Search and matching frictions,” of course, are in this context frictions that prevent low-skilled workers from instantaneously switching from their current jobs to better jobs that are available.  These frictions are said to give firms monopsony power over low-skilled workers – power that allows firms to underpay these workers and, thus, opens up in theory the possibility for minimum wages to raise workers’ wages without destroying a single job.)

Your question is good.  I have, though, addressed this issue often at Café Hayek; see the first link* below my signature.  But let me here summarize three main reasons for my rejecting the reality of search and matching frictions as a sound justification for minimum wages.

First, monopsony power is merely a necessary condition for minimum wages not to destroy jobs; it’s not sufficient.  If minimum wages are not to destroy any jobs, employers – needing excess profits out of which to pay the higher labor costs – must also have permanent monopoly power in the markets in which they sell their outputs.**  It is plain, however, that monopoly power does not exist in reality in those industries that employ lots of low-skilled workers.

Second, another name for “search and matching frictions” is “profit opportunities.”  Central to market processes are entrepreneurs who search for pure (that is, above-normal) profit in the only places that pure profit can be found, namely, in arrangements that can be, but haven’t yet been, improved to better satisfy human wants.  If search and matching frictions do indeed loom large in labor markets, we can depend upon entrepreneurs to discover ways to make it easier for underpaid workers’ to find and seize these entrepreneurs’ better job offerings.  Or more precisely: private entrepreneurs, spending their own money, are far more likely to accurately identify such profit opportunities than are academics with no skin in the game.  Because entry into most of the industries that employ large numbers of low-skilled workers is quite easy, it is simply unbelievable that search and matching frictions loom so large in those labor markets as to make minimum wages economically justified.

Third, minimum wages themselves create search and matching difficulties for workers.***  By reducing the attractiveness to employers of using business plans calling for lots of low-skilled workers, minimum wages themselves increase workers’ risks of quitting their current jobs.  The reason is simple: minimum wages artificially reduce the number of jobs available for low-skilled workers.  Therefore, workers fortunate enough to find jobs at the minimum wage are less likely than otherwise to risk quitting those jobs in order to search for better ones.

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


** And here.

*** I do not call the search and matching difficulties created by minimum wages “frictions.”  The reason is that minimum wages are not frictions; they are permanent (save to the extent that they are reduced by inflation).  Unlike frictions that are the result of ‘imperfect’ markets, minimum wages are enforced with threats of violence.  The job-search difficulties created by minimum wages are far more lasting and binding than are those of ‘imperfect’-market frictions.


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