Raise the Minimum Wage

Believe it or not, somebody has requested that I discuss the minimum wage. Apparently a politician of note in the US has suggested that increasing it to $9/hour would be a good thing. It would certainly be better than nothing, but should be raised significantly beyond that. However, even the present proposal, which is so modest as to be offensive, has apparently sparked debate in the mainstream press. Considering that most economists have been taught from texts that double as bad joke books, this is entirely predictable. One tome, authored by the notorious Mankiw of Harvard, used to report (maybe it still does) that 90% or so of economists – from memory – agree that “the minimum wage causes unemployment”. Or maybe what they agreed was that “the minimum wage hurts those that it is intended to help” or some such disingenuous nonsense. Evading, as usual, the sewerage gushing out of the mainstream press, I remained blissfully unaware of the latest kerfuffle until the request for a post on the topic forced me, instead, to swim in it. Thanks, anonymous request person.

As always, the mainstream debate has been conducted within narrow bounds. We can cut to the chase by noting that Paul Krugman, as is so often the case, gives the right answer, which is to “Raise That Wage”, even if he cites somewhat different reasons than would be chosen by economists working somewhere in the Classical-Marx-Kalecki-Keynes tradition.

No doubt quite a few other economists would have put in their two cents, but here I will mainly confine discussion to an article by Christina Romer entitled “The Business of the Minimum Wage”, since it raises most of the textbook arguments sold to unsuspecting students. (Both Krugman and Romer’s articles are in the NYT.)

Before entering neoclassical terrain, however, it may be worth pointing out a basic theoretical point. A rise in wages (whether a rise in the minimum wage or wages in general) may well cause job losses in particular firms or industries, but economic theory provides no legitimate basis for asserting a general inverse relationship between real wages and aggregate employment.

The traditional neoclassical argument for an inverse relationship between real wages and aggregate employment – which failed – was based on the notion of ‘factor’ substitution in the face of alterations in income distribution. The idea was that if the price of one factor of production fell relative to the other, demand for the former would strengthen at the expense of the latter. So, for instance, if real wages rose with no change in rates of interest, demand for ‘capital’ would increase and demand for ‘labor’ would decrease as capitalists substituted capital for labor. The result would supposedly be a reduction in employment.

However, it is well known, though generally concealed from students until graduate level in mainstream economics departments, that this logic was found wanting in the Cambridge Capital Controversies (or capital debates). The main problem with the neoclassical argument related to the faulty notion of a ‘demand for capital’ function. Samuelson’s acknowledgment of the problem effectively put the idea to bed. (Newer readers may wish to consult Nobel-nomics and, especially, this highly informative introduction to the capital debates by Matias Vernengo).

When a general negative relationship between real wages and aggregate employment is presented to unsuspecting undergraduates as if it is a respectable theoretical claim, the argument is usually couched in terms of either partial-equilibrium (microeconomic) models, which are inapplicable, or macro models with an aggregate production function, which should be disallowed due to the capital debates.

The partial-equilibrium argument goes something like “If wages increase, firms won’t want to hire as many workers – the ‘marginal’ units of labor – because they’ve become more expensive.”

One flaw in this reasoning is that it ignores the interdependency between wages and demand, or between product markets and labor markets. Firms in aggregate will produce any level of output for which there is effective demand. So the question becomes, will a rise in wages reduce the overall level of effective demand?

Well, on theoretical grounds, there is no way of knowing the effect of an increase in wages on overall demand, and hence production and aggregate employment. Will a redistribution of income away from capitalists towards workers lead to higher overall demand or less? There is no obvious answer. It is likely that consumption demand will increase. Investment demand could go either way. It will be encouraged by the strength in consumption demand, but discouraged by the reduced profit margins implied by the wage increase. Overall, the effect on aggregate demand is ambiguous.

This means that the question of the effect of wage changes on employment becomes an empirical one. Here, as both Krugman and Romer point out, the evidence is overwhelmingly against the story told to students in introductory economics courses. Both cite a recent paper entitled, “Why Does the Minimum Wage Have No Discernible Effect on Employment?”, which pretty much gives the game away.

From the conclusion:

Economists have conducted hundreds of studies of the employment impact of the minimum wage. Summarizing those studies is a daunting task, but two recent meta-studies analyzing the research conducted since the early 1990s concludes that the minimum wage has little or no discernible effect on the employment prospects of low-wage workers.

This summary of the empirical evidence is consistent with the theoretical implications of the capital debates. But mainstream economists are loathe to acknowledge this. To do so would be to require a major re-write of the textbooks, which currently play a significant propaganda role in the dissemination of neoliberal ideology.

So mainstream economists who wish to take issue with the textbook story but also wish to stay mainstream must keep silent on the more fundamental implications of the capital debates and instead identify various ad hoc stories that could contradict the textbook without challenging the basic neoclassical framework. This turns out to be a great career move, not least because there is almost an infinity of ad hoc factors that could serve that end. Krugman mentions some of them, including the observations that employers, being human, may be reluctant to fire employees, and workers, who are also human, may respond positively to a wage rise by exerting more effort.

The objection to this exercise is not that the ad hoc factors highlighted are necessarily irrelevant to the effects of a change in the minimum wage but rather that they are not what prevent the textbook story from coming true. The textbook story would fail even in the absence of these factors. Despite frequent claims to the contrary, the textbook does not provide even a useful benchmark against which reality can be compared.

Some economists don’t even bother to identify ad hoc explanations for the textbook’s failure. They take a different tack. Since it can’t be shown that a higher minimum wage causes unemployment, it is instead claimed that an increase in the minimum wage is either unnecessary or not the best way to help low-wage workers.

Consider the opening to Romer’s article:

Raising the minimum wage, as President Obama proposed in his State of the Union address, tends to be more popular with the general public than with economists.

I don’t believe that’s because economists care less about the plight of the poor — many economists are perfectly nice people who care deeply about poverty and income inequality. Rather, economic analysis raises questions about whether a higher minimum wage will achieve better outcomes for the economy and reduce poverty.

In reality, the first paragraph of that passage is the most significant. I’ll return to it later.

As for the second paragraph, anyone who has worked or studied in an economics department could confirm that there are plenty of “perfectly nice people”. Apologists for the status quo are capable of niceness, perhaps even perfect niceness, especially toward those who butter their bread, as well as to others. But nice or not, economists who push neoliberal economic policies may as well be assholes. The effect is the same.

But to the substance, Romer continues:

Many of my students assume that government protection is the only thing ensuring decent wages for most American workers. But basic economics shows that competition between employers for workers can be very effective at preventing businesses from misbehaving. … [P]erhaps not when unemployment is high, but certainly in normal times. Robust competition is a powerful force helping to ensure that workers are paid what they contribute to their employers’ bottom lines.

The final sentence in that paragraph is staggering, particularly the claim that workers are paid in accordance with how they help the employers’ bottom line. The neoclassical claim that the ‘factors’ of production are remunerated in accordance with productive contribution (the ‘marginal productivity theory of distribution’) was the biggest casualty of the capital debates. Romer would be well aware of this. Her readers, less so. This result lent credence to the classical and Marxian view that wages are culturally determined and not determined by productive contribution.

The students who believe that wages are prevented from falling by government protections are correct. In the absence of unions and government regulations the tendency under capitalism would be for the lowest wages ultimately to fall to the subsistence level.

Romer hedges by conceding that competition between employers may be insufficient to maintain wages when unemployment is high, while denying the relevance of this concern in normal times. But this, also, is nonsense that no mainstream economist is entitled to present as respectable theory in light of the capital debates. It is implied that “normal times” is a situation of full employment. But how often is there full employment? “Normally” is the mainstream answer, but only after redefining “full employment” to mean a NAIRU of 6%?, 7%?, 9%?, and counting. The NAIRU is typically redefined as necessary to be whatever it takes to claim full employment either prevails or is not far off.

Unemployment has been a permanent feature of capitalism. When it temporarily reaches low levels and the so-called labor market tightens, capitalists have a strong interest in technical innovation that temporarily expels workers from employment until they are required elsewhere in the economy. In the so-called developing countries, another key strategy is to expel people from the land so as to open up new sources of labor.

These processes are the real normal, and are functional for capitalists. By creating unemployment, technical innovation or enclosure put downward pressure on wages. As a result, an excess supply of labor is the normal situation. This is the main reason wages would tend to cultural subsistence levels in the absence of the countervailing power of unions and government protections.

When unions are weakened and governments deregulate employment relations (or, rather, regulate against the interests of workers), real wages stagnate. This, of course, is the aim of those pushing for the neoliberal policy agenda. The result, as we have seen over the past forty years is, unsurprisingly, stagnating real wages and a more unequal distribution of income and wealth.

Romer also appeals to the notion that a minimum wage, to be justified, should be a targeted form of income redistribution:

An important issue is who benefits. When the minimum wage rises, is income redistributed primarily to poor families, or do many families higher up the income ladder benefit as well?

The “perfectly nice” economists are “deeply disturbed that some hard-working families still have very little”, but worry also that “some minimum-wage workers are middle-class teenagers or secondary earners in fairly well-off families” who would also benefit from an increase in the minimum wage.

The view here seems to be that it’s okay to pay individuals outrageously low wages as long as some of them have a parent, husband or wife who earns a decent wage. On this logic it’s reasonable to pay teachers and nurses less on the grounds that some of them have partners who are lawyers or doctors.

The fact that only about half of minimum-wage workers are from low-income households is not an argument against a minimum wage. It is an argument for other redistributive policies benefiting the poor in addition to the minimum wage, a point which is made by Krugman. The minimum wage is not solely about redistribution. Its chief function, as the name suggests, is to set a minimum standard on what is a socially acceptable wage.

Also, what Romer holds up as “better targeted” – a tax credit – is only better targeted if the target is the employer. As anyone familiar with Kalecki’s profit equation knows, both wages and unsaved tax credits end up in the hands of capitalists. At least in the case of wages, capitalists have to pay them out before getting them back. This is not true of the tax credit.

For many mainstream economists, though, the employer evidently is the preferred beneficiary of redistributive policy. The “concern” for the poor is just for show.

The real motive surfaces in this passage:

By raising the reward for working, this tax credit also tends to increase the supply of labor. And that puts downward pressure on wages.

Brilliant. So the idea is not only to oppose an increase in the minimum wage but to bring about a decline in wages! The apologists outdo themselves.

But there is some good news. It seems that the economists are out on a limb when it comes to the minimum-wage issue. I suggested earlier that the most significant paragraph in Romer’s article was the first one:

Raising the minimum wage, as President Obama proposed in his State of the Union address, tends to be more popular with the general public than with economists.

Despite the unrelenting onslaught of neoliberal propaganda of the past forty years, the economists have failed to dissuade the public from the benefits of the minimum wage.

Krugman links to a report that in fact suggests very strong public support for the minimum wage. The first key finding will suffice to make the point:

A proposal to raise the federal minimum wage garners striking support, in terms of both breadth and intensity. Nearly three-quarters of likely voters support increasing the minimum wage to $10 and indexing it to inflation (73% support, 20% oppose) in 2014, including a solid 58% majority who feels that way strongly.

So almost three-quarters of Americans support an increase in the minimum wage beyond that proposed by Obama, whereas 90% of the economists oppose the minimum wage. For once, the textbook writers have failed abysmally in their propaganda mission.

What that says to me is that, in the case of the minimum wage, it should be all systems go. The president wants to increase it. The vast majority of the public agrees with him. We’re supposedly living in democracies. So who gives a damn what the economists say?


9 thoughts on “Raise the Minimum Wage

  1. Peter,

    “One tome, authored by the notorious Mankiw of Harvard, used to report (maybe it still does) that 90% or so of economists – from memory – agree that ‘the minimum wage causes unemployment’.”

    That expression reminds me of a graffito I once saw. It said something like “X [a really really large number, made up of all digits] flies around the world cannot all be mistaken at the same time: eat shit”.

  2. “At least in the case of wages, capitalists have to pay them out before getting them back.”

    Probably off topic, but this opened my eyes to something they should have already been open to. I’ve been concerned that with wages stagnant, the various credit bubbles: mortgages, student loans, credit cards, etc. have been a major means of getting any money into consumers’ hands. Now that I’m reminded how the loop closes, I can state: in the case of credit, capitalists have to pay it out before getting it back, and then getting it back again.

  3. What is the key to all of this peterc (anyone)?

    From one angle it seems to me to be a unified realisation that it’s all about real limitations and distribution of resources; a real consciousness limited human value system; and the almost unlimited and vaporous expanse of money which in the end is nothing but a scoreboard and can disappear overnight? Am thinking of how nebulous and distant, out-of-focus is the concept of a triple balance sheet here.

    I don’t live in a city, but one thing I notice when I go there: walk down any city block and there are thousands of outright lies and modifications staring you in the face on every block (advertising)!

    What have people allowed themselves to become?

    What key will unlock all of this?

    The other thing is the frenetic activity of the place and the calm on boot hill (probably should be jogger hill in the computer age)!

    So from the other angle an interior refurb seems way overdue.

  4. Mel: Good point. Interest on private lending is the gift that keeps on giving for the rentiers, especially for those who are “too big to fail” when things go haywire.

  5. What is the key to all of this peterc (anyone)?

    Can you tell I’ve been hoping “anyone” would have the answer, jr? 🙂

    I wish I knew the answer.

    I don’t live in a city, but one thing I notice when I go there: walk down any city block and there are thousands of outright lies and modifications staring you in the face on every block (advertising)!

    Neoliberalism on steroids. The feds starve the states, creating an artificial need for billboards on buses, light rail and the insides of trains, and other spaces for hire.

    The other thing is the frenetic activity of the place and the calm on boot hill (probably should be jogger hill in the computer age)!

    I love cities but also enjoy being completely away from cities.

    A friend used to say he loved all the frenetic activity around us as we lazily sipped coffee in city cafes or on the steps of the Town Hall, Reserve Bank or Stock Exchange. Then he got a hectic office job in the city and didn’t find the frenetic pace quite so enjoyable.

    I like the anonymity with proximity in the city, the energy and connectedness, the international representation and multiculturalism, and relative open mindedness and tolerance. But it is nice to get out of the place once in a while, for sure.

  6. Concerning the theoretical aspect, some remarks can be made. First of all, production precedes demand. For example, a person would not have dreamt of buying a TV set before the first TV set was produced. When a company decides to produce something, it can only take a guess that demand for its product will be sufficient to cover its costs.

    Meanwhile, the costs of a company are known exactly in advance; they include wage costs. Due to the fact that demand is uncertain while costs are certain, it follows that companies decide whether or not to hire someone depending on the cost and not depending on a pie-in-the-sky expectation of an increase in demand that would follow an increase in wages for some lucky people.

    It thus follows that the traditional analysis of demand as a declining function of price remains valid. Should wages be increased artificially, it is logical for companies to react by cutting jobs or, at the very least, by cutting future hiring plans. Whether they cut jobs immediately, or they just cut hiring plans, depends on the cost of firing people and on the magnitude of the wage increase.

    As an aside, let’s take as an example a company with two employees. Let’s imagine that wages are increased artificially and the business is forced to dismiss one of the two employees because it cannot afford paying the higher wage to two people. What is the total effect on demand? You now have one employee with a higher wage, one idle employee without a wage, and one employer who is forced to pay an artificially-high amount of money for a lower quantity of work.

    And if the business absolutely required two people for production to happen, then you now have two idle people without wages plus one idle would-be entrepreneur without income, who is not allowed to continue his activity because it is deemed not to be socially beneficial to society. In all these cases, it’s hard to believe that the net effect on demand would be positive.

    Claiming that a business may actually benefit from an artificial increase in wages is like claiming that businessmen are stupid; that they don’t know their business and that a politician would be much better at managing businesses. Because the businessmen would not need to be coerced into raising their wages, if they thought that doing so would benefit them.

    Businesses do not hesitate to raise wages when doing so is necessary or beneficial to them. As an example, Switzerland has no minimum wage, while France has a minimum wage of 9.53 euros per hour. Yet, the median monthly gross wage in Switzerland was 5,085 euros in 2012, while the median monthly gross wage in France was 1,717 euros. (Source: http://en.wikipedia.org/wiki/List_of_European_countries_by_median_wage) You can see that the Swiss wage was *three* times the French wage.

    How do you reconcile the difference between French and Swiss wages with your assertion that ‘the tendency under capitalism would be for the lowest wages ultimately to fall to the subsistence level’? On the contrary, my observation is that the more the state intervenes in the economy, the lower the wages for everyone and the more the unemployment.

    Again, making the argument that artificially-high wages can stimulate demand is like saying that a business could benefit from extortion. You’re saying: let’s take money away from that business, and give it to someone, so that this person can then return the money to that same business in exchange for its goods. A business is not made any better off by having someone steal its cash, even if that cash is then spent buying the goods of the company.

    One thing is for certain when a minimum wage exists: there can be no jobs that pay less than that wage. Regardless of effects on demand, having a minimum wage completely removes the layer of paid jobs comprised between zero and the minimum wage. These jobs cannot exist, or they have to be undeclared. It is this dim, reluctant intuition that prevents welfarists from adopting a very high minimum wage.

    When the layer of low-paid jobs is removed two very significant effects are created in the economy. Firstly, it becomes much more difficult for unskilled and inexperienced people to find employment. Secondly, it becomes much more difficult for a small business to hire employees. There are always winners and losers with all government policies. The two categories above are the clear losers.

    Who are the winners? Again, there are two groups. Firstly, the government can gloat about its own philanthropy. Secondly, big businesses benefit from a reduced level of competition, because higher wages are equal to a new barrier against the entrance of competitors.

    Ironically, people who stand to receive a higher wage are unlikely to receive any benefit. This is because their purchasing power would be reduced by the general price increase resulting from the increase in company costs and reduction in competition. In addition, their future employment opportunities are reduced.

    You mentioned empirical studies. But empirical studies seeking to prove the absence of effect on unemployment usually take advantage of the fact that the response of businesses depends on the cost of firing people and on the magnitude of the wage increase. Therefore, they offer little value when it comes to drawing conclusions.

    It is sufficient for me simply to look at countries without a minimum wage. Singapore has no minimum wage. Its current unemployment rate is 2%. How many countries are there with a high minimum wage and an unemployment rate consistently below 3%? I don’t think there are many, and for good reason. Likewise, Switzerland has no minimum wage and its unemployment rate is just 3.2%.

    Meanwhile, let’s look at unemployment in some minimum-wage countries: 10.4% in France, 8.6% in Belgium, 8% in the Netherlands, 6% in the UK and 23.67% in Spain.

    Also look at the extremely-high youth unemployment levels in Europe. They are usually two times or three times the unemployment rate. This observation perfectly matches the expectation that inexperienced workers would be affected the most.

    Why should we need any more evidence than that? This charade has been going on for decades and I have never seen unemployment below 3% in the EU.

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