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The minimum wage: theory before history
Greg Mankiw and Brad DeLong are having some back and forth over the minimum wage. I'm willing to admit, unabashedly, that I form my judgments on this matter by theory more than "raw evidence." When the evidence is unclear, or points in multiple directions, I favor the most plausible explanation.
Unlike like most market-oriented economists, however, I am not obsessed with the story of the downward-sloping demand curve for labor, to the exclusion of all other possible mechanisms. I am more likely to see markets as extremely flexible and to look to the quality of job as a critical variable. If minimum wages go up, I expect some mix of two scenarios:
1. The employer restores the previous net wage by worsening working conditions.
2. The employer upgrades the quality of job and thus marginal products, to meet the new level of minimum wage.
Now #1 is not much of an argument for boosting the minimum wage. But is #2?
It sounds good but the employer had decided in the first place not to create those higher productivity jobs. So those jobs must cost more and we should expect a negative effect on employment, albeit perhaps a slight one.
It is also the case that those jobs will go to the "most easily upgradable" workers among the low-wage working set. I suspect those are the low-wage workers with relatively high human capital and high levels of adaptability. Among the class of low-wage workers, the effects are probably anti-egalitarian. That again does not make the minimum wage sound so great, even though the employment effects could be small or perhaps even zero. I might add this also explains why the most articulate low-wage workers probably, for reasons of self-interest, favor increases in the minimum wage.
I don't buy into the Card-Krueger monopsony scenario, at least not outside of rural Nebraska. If you wish to defend it (does anybody? -- even Krugman scorned it), comments are open.
I invite all participants to the debate to indicate the relative weights they place on "theory" vs. "history." I'll invent an imaginary, meaningless scale and opt in at "0.7" in favor of theory. If the evidence were clearer, of course, my weights would change.
Posted by Tyler Cowen on June 26, 2006 at 01:33 AM in Economics | Permalink
Comments
I'm nearly 99% theory because the empirical data is so noisy. The simplest theory is that when the price goes up, the demand drops. Proponents counter with "Ahhhh, but the price/demand curve is vertical, so demand doesn't drop". Perhaps, but if demand didn't drop, then you wouldn't see capital investment substituting for labor. And yet you can see that everywhere and always whenever the price of labor goes up.
Even if the price/demand curve was vertical, the higher price for labor would attract discouraged low-wage laborers back into the job market. So in order to not create unemployment from these newly-added workers, the price/demand curve actually needs to slope backwards, so that as employers are forced to pay more, they voluntarily hire more workers.
So when you go looking in the marketplace for unemployment, you have trouble finding it. That's because minimum wage increases affect so few workers (currently only 3% in the US) and are small in magnitude. Plus you have methodology problems. An employer listens to the news as much as anyone, and they weigh the probability of a future minimum wage increase against their future need for employees. It's unlikely that unemployment will jump on the actual date of the change in the minimum wage.
And, the theory predicts that a discriminatory employer can discriminate at no cost to himself, so that the effect of a minimum wage law is to increase minority unemployment faster than majority group unemployment.
Posted by: Russell Nelson at Jun 26, 2006 3:02:45 AM
In ultra-expensive LA, fast food jobs at Jack-in-the-Box are being offered at $9/hr, so an increase in the federal minimum wage rate to, say, $7.25 would be mostly irrelevant.
So, one of the effects of a minimum wage increase is to keep jobs from shifting from expensive to cheap parts of the country. If you could cut pay from $9 to $5.25 by moving from LA to Podunksville, that might be worth the stress of moving, but not if the pay cut was only from $9 to $7.25. But it would be challenging to design a study that could detect that kind of effect.
Posted by: Steve Sailer at Jun 26, 2006 3:36:19 AM
Herr Cowen,
What good is theory without practical evidence?
Can you address the idea of the min. wage increase correcting for inflation or price increases in certain industries/products (i.e. gas, movie tickets, airfare)?
How much would a min. wage increase cost the private sector? Surely, there is a cushion at the very top of the pay scale that allows for discretionary adjustments to be made (i.e. smaller bonuses for the top 10%, a smaller corporate jet for the CFO or less alcohol at company events etc…). Can such cuts compensate for the increase in the min. wage? Would there still be a question regarding egalitarianism at the bottom quadrant and quality of jobs or products produced?
Posted by: Chairman Mao at Jun 26, 2006 3:54:17 AM
The argument being used against the minimum wage is that it harms
minimum wage employees. I seriously doubt that conclusion, but I for one have no trouble with
the idea that losing a few $5 jobs while business adjust so that the
minimum wage job can pay $7 and the worker is actually productive
enough to earn the $7 wage. That is the way we raise out standard of living.
It is why it is called creative destruction. Free trade, new technology, etc., all causes people to lose jobs and economist support those forces because
we believe their is a net gain. The only difference I see between these forces
and the minimum wage is that the minimum wage is a government shift in
the factors driving the economy while the other factors may or may not be
market driven forces . But the world is full of such government actions and one more or less will not make much difference.
All the economic research on the impact of the minimum wage is some simple analysis that it causes demand for labor to drop. But if economists now claim that we should use "dynamic scoring" on tax cuts why can't we also havea little more complex analysis of the minimum wage.
Posted by: spencer at Jun 26, 2006 8:32:39 AM
I'm on the evidence side, too. I read this a few years ago from Steven E. Landsburg:
"Here's how: Ordinarily, studies with large sample sizes should be more convincing than studies with small sample sizes. Following the fates of 10,000 workers should tell you more than following the fates of 1,000 workers. But with the minimum-wage studies, that wasn't happening. According to the standard tests of statistical significance, the results of the large-scale studies were, by and large, neither more nor less significant than the results of the small-scale studies. That's screwy. Screwy enough to suggest that the studies being published couldn't possibly be a representative sample of the studies being conducted.
Here's why that matters: Even if minimum wages don't affect employment at all, about five out of every 100 studies will, for unavoidable statistical reasons, appear to show a significant effect. If you could read all 100 studies, that wouldn't be a problem—95 conclude the minimum wage is pretty harmless as far as employment goes, five conclude it's a big job-killer, you realize the latter five are spurious, and you draw the appropriate conclusion. But if the 95 studies that found no effect were deemed uninteresting and never got published, then all you'd see were the spurious five. And then the next year, another five, and the next year another five. "
In other words, the evidence must be pretty darn strong that there is no effect, but those studies just aren't being published, probably because people want to believe in "teh Theery". Its like something that can't die because people refuse to believe its dead.
Now, I am relying on SL to tell the truth in this case, I don't know if he is. He seems respectable.
Posted by: mickslam at Jun 26, 2006 8:50:22 AM
I do think the minimum wage needs to somehow be indexed to some regional standard of income. It doesn't make sense to enforce the same wages in Chicago as in Nebraska.
As I read that quote from Steven L again, it really hits me that this information isn't going to change anyones mind, which is sad, or even spur research. You would think this would be a career making area to do research - as it appears to be a place where standard economic theory doens't work so well, and some intelligent insight could be applied to many situations where some theoretically above market minimum price is established or enforced.
Posted by: mickslam at Jun 26, 2006 9:03:04 AM
Ill ask the same question that I have been asking on all the GMU blogs recently. If there exists superior interventions that the government could employ to assist the working poor, then why advocate for a policy tool whose effects are highly uncertain?
Posted by: John Pertz at Jun 26, 2006 9:10:24 AM
For some interesting ideas see:
Author(s): McKenzie, Richard B.
Title: The Labor Market Effects of Minimum Wage Laws: A New Perspective
Source: Journal of Labor Research v1, n2 (Fall 1980): 255-64
Posted by: jim at Jun 26, 2006 9:44:17 AM
You make an excellent point (which I don't recall seeing elsewhere) when you note that within the set of low-wage earners, minimum wage increases are effectively regressive. The most able might gain, but those who are at the low margin are the big losers. This inversion is one of the reasons I don't care for the minimum wage, and would prefer a more sensibly constructed intervention.
On the theory/evidence front: in principle, I'd prefer evidence, because I know that theory can and will fail to capture important details and effects. But right now the quality of available theory seems to exceed the quality of empirical data, so I'll say 5/10.
Posted by: bbartlog at Jun 26, 2006 9:49:54 AM
So what if raising the minimum wage eliminates some number of jobs? The United States can simply admit fewer unskilled immigrants or deport those illegally here. What's the problem? From the standpoint of our own poor people, it's all gain, no pain. Of course, housing would be more affordable and schools less crowded. No problems there as well. For poor American workers, a higher minimum wage looks rather good.
Posted by: Peter Schaeffer at Jun 26, 2006 10:34:48 AM
Peter,
Milton Friedman's argument comes to mind in response to your opinion that the minimum wage looks "rather good."
Milton argued that if a $ 5.15 min. wg. looks "good", what about a $10 minimum, why not a $30 minimum?
Posted by: jim at Jun 26, 2006 10:44:43 AM
If a minimum wage makes sense, why not a minimum price for all productive inputs used by firms?
Posted by: jim at Jun 26, 2006 10:52:49 AM
Milton Friedman's argument comes to mind in response to your opinion that the minimum wage looks "rather good."
Milton argued that if a $ 5.15 min. wg. looks "good", what about a $10 minimum, why not a $30 minimum?
Would someone please put this argument out of its misery? Degree matters. If a 10mg dose of some medicine helps you does that mean taking 100mg must be better?
On the history/theory question surely we must begin with a very strong bias in favor of history, which is sometimes called "data." The burden must be on the theoretician to explain why the data conflicts with the theory. And the explanation better be good.
Posted by: Bernard Yomtov at Jun 26, 2006 11:07:46 AM
Whenever I hear this debate, I think of a statement one of my professors made about the welfare theorems: "If you want to redistribute income, redistribute income; don't manipulate prices." IMO, the biggest reason that the min. wage is so popular among Democrats and others is that it allows them to give the image of helping the poor without bearing the cost. The EIC, and other relatively good programs, actually make the cost explicit.
Posted by: Alex at Jun 26, 2006 11:12:48 AM
The paper is:
Card, David and Alan B. Krueger (1995). "Time-Series Minimum-Wage Studies: A Meta-Analysis
I haven't read the paper yet.
Posted by: mickslam at Jun 26, 2006 11:29:32 AM
Jim,
The minimum wage was over $9 back in the 1960s, adjusted for inflation. See http://oregonstate.edu/instruct/anth484/minwage.html. The US could support at least at $10-12 minimum wage now. Of course, back then we had immigration enforcement. Now we don't. See any connection?
Posted by: Peter Schaeffer at Jun 26, 2006 12:42:03 PM
Bernard,
You wrote:
"Would someone please put this argument out of its misery? Degree matters. If a 10mg dose of some medicine helps you does that mean taking 100mg must be better?"
Of course degree matters. Does anyone seriously think that THE GOVERNMENT will produce better social results fine tuning the labor market than the market would produce via spontaneous order resulting from free contracting? The record of governments' fine tunings does not inspire confidence.
And if we think human freedom in contract, what a minimum wage does is to reduce this freedom. In this dimension, the greater the increase in minimum wage, the greater the reduction in this freedom.
Posted by: jim at Jun 26, 2006 12:55:18 PM
Peter,
You wrote:
"The minimum wage was over $9 back in the 1960s, adjusted for inflation. The US could support at least at $10-12 minimum wage now."
The question of what the US "could support" is distinct from the question of what would be most efficient. In the 1960s people didn't have cell phones. The US "could support" a lower usage of cell phones than present levels, but who would think it sensible to try to replicate 60s style telecommunications? As John Stossle would say "Give me a BREAK"
Posted by: jim at Jun 26, 2006 1:04:24 PM
Peter, your argument about tying minimum wage increases to immigration "reform" is both selfish and ill-considered. Why should we be concerned about the poor in America but throw others, just as human as those in America, to the dogs?
More importantly, though, you ignore that the idea of an "American Economy" is a fiction that exists only for political purposes. The econcomy is a worldwide thing, and the more productive that the world AS A WHOLE can be, then the higher a standard of living will be enjoyed across the globe. The bottom line is that by preventing immigrants to come mow my lawn, you're making me do it. And when I'm doing that rather than, say, building a new software system, the effects are rippling out to the entire community. Everyone *loses*.
And, to provide a fig leaf of on-topicness: in the absence of compelling evidence I have no choice but to be biased towards theory, say 0.8. When something is clearly shown empirically, then I may shift the other way -- but not until then.
Posted by: CWuestefeld at Jun 26, 2006 1:30:12 PM
spencer wrote: "It is why it is called creative destruction. Free trade, new technology, etc., all causes people to lose jobs and economist support those forces because we believe their is a net gain. The only difference I see between these forces and the minimum wage is that the minimum wage is a government shift in
the factors driving the economy while the other factors may or may not be market driven forces. But the world is full of such government actions and one more or less will not make much difference."
1) To suggest that there is no difference between the economic consequences of a technological advance and an increase in the minimum wage makes no sense to me. For one thing, when a technological advance occurs, there are immediate observable changes that are positive; namely the share prices of the corporation(s) that created the advance rise. I know of no evidence indicating that increases in the minimum wage have driven up corporate share prices.
2) To argue that because there are already lots of government interferences one should not worry about one more misunderstands the importance of marginal analysis. The fact that there are lots of other government regs seems to me to be absolutely no basis for ignoring the impact(s) of the minimum wage.
Posted by: jim at Jun 26, 2006 2:31:48 PM
...and Tyler nails the problem with Economists. They believe their threory over evidence. In most professions this would be considered a problem.
The economic conventional wisdom that took over in the late seventies fetishized incredibly simple models (people often talk of two freaking curves!), and it has been a horrible period for American workers, and at a time when there should have been an enormous peace dividend.
We should index Mankiw's wage from what he was making in 1975 to the real increase in the lower quintile since the same period.
Posted by: theCoach at Jun 26, 2006 3:10:49 PM
mickslam,
RE Steven E. Landsburg's argument (article here):
If your null hypothesis is that the there is no difference in unemployment, it'd be pretty hard to create a concensus around a type I error via publication bias at 95% confidence, since in order to force an even split between favoring the type I error and correctly accepting the null, you'd need to throw out 18/19 of the studies that don't reject the hypothesis - it's going to be pretty obvious to anybody who works in the field if that's happening. And it's not like there is no interest in studies showing no difference - the Card and Kruger paper is probably the most talked about economics paper out there.
You'll see the same rate of the null being rejected at the same confidence level independent of the sample size, since the confidence level is an expression of how often you will expect to experience a type I error. The advantage of a larger study is that it makes it less likely to experience a type II error, where the null is accepted despite it being incorrect.
So, if the null is correct (change in minimum wage has no impact), then you'd expect type I errors (incorrectly saying that it does have an impact) just as frequently at 95% confidence in large and small studies.
And, if the null is incorrect (change in minimum wage does have an impact), then you'd expect type II errors (incorrectly saying that it does have an impact) more frequently in small studies than in large studies.
I wish Lansburg supplied a little more technical detail in the column on the differences between the large and small studies (although it really isn't the venue for such), but here's an alternate hypothesis to chew on - larger studies tend to be better regarded because of their lower probability of type II errors, so they're the standard against which smallers studies will be judged, so smaller studies are more likely to be ignored if they contract the larger ones. Larger studes also can detect smaller differences (lower type II error). If the large studies were qualitatively right in that minimum wages have an impact, but it's a fairly small one (as Landsburg in the column and Russell Nelson above point out), but more small studies with type II errors were rejected than is representative of the overall pool of them because the editors recognize them as having type II errors because of random variation and the studies that don't contradict the larger studies get disproportionately accepted despite the fact that while they are nominally correct in rejecting the null, they don't have large enough sample sizes to reliably observe the effect in question, so it skews the overall incidence of results the body of literature.
Aside from Lansburg's point:
If you're saying the published studies don't reflect reality, unless you have your own secret cache of data, you're rejecting the empirical data and substituting your own theory - it's just one that has to do with econ journal selection bias rather than the elasticity of labor demand at the minimum wage.
Posted by: MattXIV at Jun 26, 2006 3:35:41 PM
jim,
Without getting into your broader arguments, let me just clarify.
What is under discussion is an increase in the minimum wage of a certain size. Your argument, which you attribute to Friedman, is that this can't possibly be a good idea because a very much larger increase is obviously a bad idea. This makes no more sense than claiming that two aspirin won't help a headache because taking 20 aspirin would be a bad idea.
You clearly oppose any minimum wage whatsoever. But not everyone agrees with you. Some people think a small increase would be a good thing. That an exorbitantly large increase, to $30/hr, would be a bad idea does nothing to refute their points. Nothing.
Posted by: Bernard Yomtov at Jun 26, 2006 3:36:49 PM
Well, there's also the obvious question of "how do we know where to set the minimum wage?", and the related question "why do we expect the minimum wage to be set there?" I thought that was what jim was getting at.
The cost of living is wildly different in different parts of the country, which means that the minimum wage pretty much can't be set at an optimal level everywhere. If we set it high enough to raise wages in the big cities, we'll set it way too high for everywhere else. This makes a pretty strong argument to me that minimum wages should either be local cost-of-living indexed or enacted at the state or local level, if you're going to have them at all. I'm pretty sure that in Montgomery County, MD, even the illegal immigrants don't work for anything close to minimum wage. But again, we have to ask: Even assuming that the minimum wage can be set to a value that makes things better, how will the people setting the minimum wage know that level, and why should we expect them to set it there?
Posted by: albatross at Jun 26, 2006 4:32:47 PM
"I might add this also explains why the most articulate low-wage workers probably, for reasons of self-interest, favor increases in the minimum wage."
Call me too literal-minded, but I'm having a hard time picturing any low-wage worker speaking out against raising the minimum wage, articulate or not.
Posted by: PJ on WI at Jun 26, 2006 4:40:46 PM
