The Minimum Wage and Employment: The Case of Two Terrible, Horrible, No Good, Very Bad Assumptions

In any debate about the minimum wage, inevitably someone will dig out their knowledge of economics 101 and argue that raising the minimum wage is self-defeating because increasing the price of labor will decrease the demand of labor, and so unemployment will rise. Like most econ 101 arguments, this rest on some terrible, horrible, no good, very bad assumptions.(1) For the sake of space, let’s just talk about two of them.

  1. The labor market works like other markets.
  2. Raising the minimum wage will not affect anything else in the economy. (Economists call this ceteris paribus, Latin for “other things equal.” Because we all know that if you say it in Latin it must be true.)

Let’s think about the labor market compared to other markets. If I were to ask you the ideal price of any normal good or service, like a new computer or a haircut, you would probably say free. After all, in our ideal world, all of our material needs are satisfied at zero or at least very little costs. But what about the price of labor? Almost certainly you would not want labor to be free, because labor, on a fundamental level, is not the same as a commodity. (Thank you to blogger Squarely Rooted for this general idea).

The labor market is also characterized by large information asymmetries and differences in bargaining power. Potential employees have less information than their employers, and tend to have fewer options. This inequality of bargaining power only gets worse when there is high unemployment. You don’t have to be a radical to think this is a problem, you can find an analysis of uneven bargaining power between workers and employers in capitalism’s foundational text, Adam Smith’s Wealth of Nations. This inequality is a driving force behind unions, labor market regulations and yes, the minimum wage. Any time one party to a contract has significantly more power than the other there is always the opportunity for exploitation. (Fun Fact: Urban Sinclair’s The Jungle was not primarily about unsanitary food, the focus was actually on the terrible working conditions of the people preparing the food. As one example, he wrote about someone falling in a meat grinder thinking that people might care that unsafe factories were killing people, but instead the audience just freaked out about the possibility of there being human in their food). If you do not believe that power differentials lead to exploitation, please spend some time reviewing the history of the industrial revolution. Labor market laws were a direct response to historical abuses of power.

Second, raising the minimum wage will inevitably impact other parts of the economy. The Economic Policy Institute has argued that by increasing the earnings of people who are likely to spend all their extra money we can boost aggregate demand and therefore help stimulate employment. John Schmitt at the Center for Economic and Policy Research suggests 11 theoretical reasons a minimum wage increase might not increase unemployment. 

Fortunately, we don’t have to restrain ourselves to competing theories. The minimum wage has been empirically studied. A lot. So much that there are now many studies of studies (meta-studies) that try to see if there is a consensus about the minimum wage.  John Schmitt has a review of those, but the most compelling way to see the results of the meta-studies is this graphic on teenage employment and the minimum wage.

min wage funnel graph

 

The results are weighted by the accuracy of the estimate, with higher points being considered more accurate. So of the 1,492 estimates available, we see a clear convergence around zero. Now this is just teenage unemployment, but there’s widespread agreement that if the minimum wage has a dis-employment affect it will be strongest among teenagers. So if we can’t see it in looking at the data on teenagers, we won’t be able to see it with adults either. So at some point we may be justified in concluding that there just isn’t a strong effect of the minimum wage on employment.

Of course, if minimum wage doesn’t increase unemployment and does increase wages, we have a clear win for low-wage workers. One final note, although I criticized ‘econ 101’ logic at the beginning of this post, I’m not saying anything here that hasn’t been said by a lot of economists. In fact, a survey of leading economists found them ambivalent on the question of unemployment effects, but fairly decisively in favor of raising the minimum wage. Even among those economists who think there may be a small impact on employment, there’s largely agreement that the benefits of higher wages outweigh the modest effect on employment. Here are their responses asked if the benefits of raising the minimum wage to $9 an hour outweigh the costs:

minimum wage survey

 

So why do all these economists disagree with econ 101? Econ 101 makes assumptions in order to make things easier to understand as a starting point for learning about economics. Good economists understand that these are assumptions, look at empirical evidence, and then adjust by making increasingly realistic theoretical models. So next time someone says “It’s basic Econ 101” remember that’s not the end of the story. Economics only gets more complicated from there, so making policy decisions based on “simple supply and demand” is never a good idea.

 

(1) I realize this is redundant, but I want to (a) make a point about just how bad these assumptions are, and (b) make a reference to one of my favorite children’s books, “Alexander and the Terrible, Horrible, No Good, Very Bad Day”

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