Tuesday, November 02, 2010

The minimum wage and economic intuition

I am, of course, a communist, and I consider the economic and social status of workers, especially in relation to capitalists, to be of primary importance. I'm all for anything that improves the economic status of workers. The minimum wage in a capitalist society, however, fails to do so; even within a capitalist society, the minimum wage is one of the least effective tools for even temporarily and partially improving workers' standard of living.

The minimum wage is good for one and only one purpose: to exclude certain kinds of industry, industry that can be profitable only by paying individuals less than that required for what a society considers a minimally civilized life, i.e. to prevent de facto slavery. A minimum wage, like all direct government price interventions, produces a deadweight loss; a minimum wage fails to offer any additional additional compensation, such as tax revenue. Since a minimum wage can only exclude economic activity, its only proper use is to exclude economic activity we intentionally want to exclude: i.e. that activity insufficiently valuable to support its workers' civilized life.

Furthermore, the benefit of a minimum wage is not that it actually excludes insufficiently valuable activities, but that it conveniently does so. We must implement other macroeconomic policies to ensure that a fraction of the population does not have to choose between slavery and starvation. A minimum wage is not so much an economic policy as it is a political policy: to bring the issue of inefficient production to light, to transform the plight of those workers invisibly and silently employed in inefficient industries into a socially urgent and visible problem of unemployment.

As a political policy, I support a minimum wage. But as an economic policy, a minimum wage — indeed any law that affects only nominal wages — cannot transfer economic demand from the owners of capital to workers, even those workers paid the minimum wage: it is simply ineffective. If a minimum wage were set substantially above the current price levels necessary to support a minimally civilized life, the increased wages would merely cause price inflation necessary to bring the minimum wage down to the minimum standard of civilized life... or even below that standard: a minimum wage in a capitalist society requires continuous adjustment.

While I don't think the minimum wage is a particularly effective tool, many criticisms of the minimum wage reveal a deep misunderstanding of macroeconomics, especially when people attempt to apply their naive* microeconomic intuition to what is essentially a macroeconomic issue. Remember: microeconomics is about relationships between elements within an economy; macroeconomics is about emergent properties of the economy as a whole; an economy as a whole does not (setting aside international economics) have any relationship to anything else. Also, you'll often see economists use the phrase ceteris paribus (literally "with other things the same") especially when they're talking about microeconomics. But when we're** talking about macroeconomics, we usually want to talk about how everything adjusts around various changes; in macro, ceteris is often not paribus.

*I don't mean to disparage naive intuition; by definition everyone has only naive intuition about a field in which they are not experts. But the only way to learn is to be criticized.

**Hey, I'm at least a
junior economist... very junior, to be sure.

We can see these naive intuitions and mistaken analysis in Alonzo Fyfe's post, Minimum Wage.
First, in any economy there are some businesses that are succeeding, some that will fail, and some that sit near the border barely hanging on. Today, they are making enough to keep the doors open. Tomorrow, with the added burden of a higher minimum wage, they slip below the line and close their doors. Rather than making an extra dollar per hour, these employees lose their livelihood. They have not been made better off as well.
First of all, it is only those business that are both minimally profitable and are paying below the proposed minimum wage that would be affected by a change in the minimum wage. Many businesses are barely profitable regardless of (or sometimes because of) their workers' wages above the minimum. So Fyfe overstates whatever case he might initially have. As noted above, an industry that requires its workers to live below what our society considers a minimally civilized existence are precisely those industries we ought to have a moral objection to supporting.

Furthermore, in any economy, we are constantly reallocating labor from less productive to more productive uses. By definition, those businesses that are minimally profitable are precisely those that are ripe for failure, so the labor they're presently using can be allocated to other more productive uses. Even if we set the minimum wage higher than the minimal standard of civilized life, the only businesses that would be affected in the short run would be precisely those businesses least worth preserving.

One common macroeconomic misconceptions is that jobs are externally limited. They are not. There are internal limitations to employment, but a job is not itself a resource that needs to be protected or conserved. Depending on what sort of economist you ask, unemployment is due to either workers themselves choosing not to work or because economic demand, not supply, is somehow poorly allocated. Either way, protecting a job in and of itself is not something we want to worry about... for precisely the same reasons we don't want to put too much economic burden on the minimum wage.
Second, the employer could try to get the money it needs to pay its minimum-wage employees by raising prices. Of course, if it raises its prices, then it will probably have fewer customers. If the business has fewer customers, then it does not need as many employees. Therefore, it lays some of the employees off, effectively redistributing their paycheck among those employees who get to keep their jobs.

Again, Fyfe is again employing "micro" thinking to a macro issue. In aggregate terms, if companies in general raise their prices to match an increase in factor prices (increased wages and the increased profit on the new wages), the increase in aggregate demand will in the long run exactly offset the increase in prices. This is why a minimum wage is typically ineffective (except to conveniently prohibit insufficiently valuable activities), but it is not actually harmful. Even in the short run (because only those companies presently paying under the minimum wage that could raise their prices), because of the increase in aggregate demand, a change in the minimum wage will cause a reallocation of labor, not a reduction in total employment.
Third, it becomes more profitable for the company to invest in automation. Minimum-wage jobs are typically just the types of jobs that are easy to automate. There are certainly going to be companies for whom automation just is not cost effective at the moment. However, an increase in the minimum wage will tilt the balance in favor of automation. With past increases in the minimum wage, we saw the rise in self-service gas stations. The next increase in the minimum wage will see a boom in self-service (automated) checkout stations in supermarkets.

This objection is probably the most serious error that Fyfe makes. All increases to real Gross Domestic Product — the best (but hardly perfect) measure of specifically economic well-being — is a result of labor becoming more efficient, producing more use-value with fewer number of labor hours. In general automation is a Good Thing. One substantial problem with capitalism is that the benefits of automation and labor productivity in general are often poorly distributed (and one argument for socialism and communism is that these systems would more equitably distribute the benefits of increased productivity), but the misallocation of a benefit is not an argument against creating that benefit.
Fourth, a higher minimum wage draws people into the labor market that would otherwise have stayed out. This means that those with jobs will have to compete against a larger labor pool to keep those jobs. One of the biggest sources of new labor are high-school students. There are always some high-school students who consider working and dropping out of school a better option. The more profitable it becomes to drop out of school, the larger the number of high-school students who will pursue this option. Many of these new workers will force existing minimum-wage employees out of the market. The result of fighting for this increase then is to put high school students in minimum wage jobs, and put the people who already have those jobs on the unemployment line.

Fyfe is just wrong here, making three different mistakes. First, drawing more people into the labor market is generally a Good Thing: more people means more productivity per capita. Additionally, you cannot simultaneously draw more people into the labor pool and (per his earlier mistaken point) simultaneously reduce the total number of jobs. (Fyfe at least puts his contradiction in separate paragraphs, avoiding a common error of theologians and religious apologists.) Also, drawing specifically high-school students into the labor force is usually caused by a reduction in the minimum wage (or specific exemptions from the minimum wage), since a high-school students have a lower opportunity cost for working (as they do not typically have to support themselves). Third, at any given wage, new workers do not "force out" existing workers at the same wage; new workers are less experienced and less well-trained than existing workers; they represent a poorer value at any specific wage. New workers force out existing workers only when those new workers can or must accept a lower wage.

A high minimum wage — over and above what is necessary to signal a minimally civilized standard of living — isn't a particularly good idea, but objecting to it for reasons that make absolutely no economic sense is as counterproductive and damaging to our "intellectual health" as justifying humanistic principles on an irrational religious basis. Economic illiteracy is a serious enough problem among the general population. Economic illiteracy in a supposedly educated, thoughtful writer is inexcusable.

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