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Source link: http://archive.mises.org/10337/the-hidden-costs-of-a-minimum-wage/

The Hidden Costs of a Minimum Wage

July 23, 2009 by

Anyone who has taken an introductory economics course is familiar with the idea that a minimum wage leads to a reduction in the demand for labor and an increase in the supply of labor in the relevant market — usually, the market for low-skill workers. The minimum wage removes the ability of some workers to compete by accepting lower wages and shuts them out of the labor force. As a result, it reduces job opportunities for these workers. A minimum wage breaks the hinges on the door of opportunity.

However, there are additional, hidden costs of these interventions, which are more difficult to detect but perhaps more insidious. FULL ARTICLE

{ 32 comments }

Barry Loberfeld July 23, 2009 at 7:49 am
P.M.Lawrence July 23, 2009 at 8:47 am

“Anyone who has taken an introductory economics course is familiar with the idea that a minimum wage leads to a reduction in the demand for labor and an increase in the supply of labor in the relevant market…”

Well, no. That’s a crude generalisation, and anyone who has read Lippsey’s Positive Economics – an introductory text – is familiar with the idea that a minimum wage leads to precisely the reverse in certain cases.

In any event, the adverse effects only show up in the other cases when the minimum wage is implemented by a simple government fiat. However, I researched the area for a submission to the (Australian) Henry Tax Review, and it turns out that some economists, e.g. Professor Kim Swales of the University of Strathclyde and his colleagues, and Nobel winner Professor Edmund S. Phelps, McVickar Professor of Political Economy at Columbia University, have found another approach to implementing a minimum wage without those defects (see here and here).

Lowell Sherris July 23, 2009 at 9:02 am

According to Professor Swales:
… such subsidies improve productive efficiency by offsetting market failures in other parts of the economy. They restore, rather than distort, appropriate price signals. They do not rob the private sector of resources but reallocate resources within that sector.

Apparently Professor Swales believes he is smart enough to fine tune subsidies for millions of people so that he can restore rather than distort price signals. Those of us who have read Mises and Rothbard know that is impossible.

I will agree with you P.M. that students who have studied under Professor Swales make indeed still be ignorant of even the most rudimentary concepts of economics.

Jonathan Finegold Catalán July 23, 2009 at 9:52 am

For those who have not read the book linked from the article (Out of Work), it is a masterpiece and I’d suggest it to anybody.

Nick July 23, 2009 at 10:53 am

The problem with this analysis is that its a very careful crafted analysis where the boundary to the system is picked to exclude one major factor.

By making it the government legistlating, the employer, and the employee it has deliberately excluded part of the government activity, taxation and benefits.

Until that’s taken into account, its irrelevant.

In my view, setting a minimum wage can be a good thing so long as it is higher than the level of benefits.

The poor aren’t stupid, and in the UK they regularly make the calculation that working even for minimum wage isn’t worth it. People on minimum wage are taxed, and quite often end up on less money than sitting at home doing nothing.

Benefit levels should be less than minimum wage with a clear margin between the two.

Minimum wage earners should not be taxed. It should the start of taxation.

Otherwise the game will be played to the detriment of the majority

Nick

David Spellman July 23, 2009 at 11:12 am

To extend Neuman’s example of using two skilled workers versus three unskilled…

The net result is not one job lost, but the real comparison is two people employed versus three people unemployed. The skilled workers benefit from the minimum wage law because they will be employed. In the absence of a minimum wage, the skilled workers would be unemployed and would have to accept a lower wage.

In the example, the skilled workers could work for $7 per hour and be more cost effective than three unskilled workers at $5 per hour. Of course, the unskilled could work at $4 per hour and win back the business. Supporters of minimum wage laws would argue that this vicious cycle would reduce all workers to working for nothing.

But if that were true, then why is it that almost everyone is working for more than minimum wage? For some reason, nearly everyone has a choice of many jobs paying quite a bit more than minimum wage. It would appear that there is a counter-balancing brake on employers lowering wages because of competition for quality labor to make profits.

There is no such thing as a minimum living wage. If a person cannot earn enough to avoid starvation, raising the minimum wage will merely thrust starvation upon them through unemployment. It is a bitter reality when people are told they must be worth the minimum wage to be able to work and then discover they are not that valuable. How hard it must be for those people to live in a society that says “You are not good enough to participate in any capacity!”

DavidH July 23, 2009 at 11:21 am

@Nick – I fail to understand your argument that the minimum wage could be a good thing. You seem to be saying that if somebody chooses to work for a low wage rather than become a parasite on the taxpayers then it should be made illegal for them to work?

waywardwayfarer July 23, 2009 at 12:12 pm

Would not minimum wage also be a contributing factor to the over-valuing of college degrees? Since minimum wage effectively eliminates the option to learn a trade “on the job” people are forced to learn skills elsewhere before entering the work force. Demand for higher education goes up, prices of higher education go up, a “right” to higher education is conceived, and ever-increasing governmental subsidies for higher education become an institution. We go from people actually being productive in some measure while learning a trade, to people consuming tens of thousands of dollars in wealth, either out of their own pockets or fleeced from taxpayers, and spending years in school before they actually start making a net contribution to the economy.

billwald July 23, 2009 at 12:54 pm

In the Seattle area it is not possible to live on the minimum wage without being subsidized by someone, by charity, by tax money. The only question is subsidized by whom?

Around here the scam is to con the working middle class into subsidizing the working and nonworking poor. This is done by building subsidized housing with property tax money. The fast food franchise owners don’t need to raise the pay of their employees if they can get their customers to pay the employees rent through real estate taxes.

Walt D. July 23, 2009 at 1:27 pm

The minimum wage is just an easy back door way for the Federal Government to raise taxes.
The minimum wage is the benchmark wage that drives all other wages. So increasing the minimum wage has the effect over time of raising all wages. The Feds collect more income tax and FICA and extra FICA from the employer.

Daniel C July 23, 2009 at 2:03 pm

PM Lawrence,

The author says that anyone who has taken economics is familiar with the logic that it leads to more unemployment, etc. He doesn’t say that anyone who has taken economics agrees with it, or that they were taught to do so.

Russ July 23, 2009 at 3:50 pm

Nick wrote:

“Benefit levels should be less than minimum wage with a clear margin between the two.”

That is one solution. Another solution is to have the margin between two be zero. As in, 0 – 0 = 0! (That’s an exclamation point, not a factorial sign. *grin* )

Sally C. July 23, 2009 at 4:11 pm

Ireland has a very high minimum wage Euro 8.65 per hour or over $12 an hour. This article appeared in the Irish Times today :
‘FINE GAEL enterprise spokesman Leo Varadkar yesterday questioned the benefit of cutting the minimum wage from its current rate of €8.65 an hour.

Mr Varadkar said he did not believe that cuts in the minimum wage would benefit job creation and said he agreed with the trade unions in this respect.

He was responding to comments made by Minister for Finance Brian Lenihan at the MacGill summer school in Co Donegal where he said cuts in the minimum wage would be justified if it was shown that the current rate was an obstacle to job creation and job retention.

“I don’t honestly believe that reducing the minimum wage would achieve anything in relation to job creation,” Mr Varadkar said.

He said a 50 cent decrease in the rate would yield savings of only €16 per week to the employer. He said that even with six employees, this would be minimal savings.

Speaking on RTÉ’s Morning Ireland , Mr Varadkar said it would be hard to imagine a company going “to the wall” on the basis of those figures.

He pointed out that the minimum wage had been frozen since 2007.

He said the solution was to change social welfare to make it more advantageous to be in work.

He denied that this policy would involve cuts in social welfare rates. He also denied that Fine Gael was trying to play the issue both ways.

The Labour spokesman on enterprise Willie Penrose described the call for a cut in minimum wage as “misdirected” and said that other ways should be looked at to cut the costs of small employers.

“The Minister for Finance and the economic consultant, Dr Peter Bacon have now joined the predictable chorus of calls from organisations like Isme for a cut in the minimum wage,” Mr Penrose said yesterday.

“Those on the national minimum wage did not create our current economic difficulties and should not now be asked to bear the brunt of corrective action,” he said.

“It is easy for somebody with the massive earning potential of Dr Peter Bacon to call for a cut in minimum wage.”

Aengus Ó Snodaigh of Sinn Féin said that any such move was simply not an option.

“The minimum wage has played an important role in keeping Ireland’s lowest-paid workers out of the poverty trap.’

In the meantime, unemployment in Ireland continues to rise.

Christopher George July 23, 2009 at 5:11 pm

What about the fact that the minimum wage, through causing unemployment, causes factors of production to be underutilized, reducing supply and, over time, raising prices over what they would have been otherwise?

Christopher George July 23, 2009 at 5:12 pm

What about the fact that the minimum wage, through causing unemployment, causes factors of production to be underutilized, reducing supply and, over time, raising prices over what they would have been otherwise?

Christopher George July 23, 2009 at 5:12 pm

What about the fact that the minimum wage, through causing unemployment, causes factors of production to be underutilized, reducing supply and, over time, raising prices over what they would have been otherwise?

Chris George July 23, 2009 at 5:13 pm

What about the fact that the minimum wage, through causing unemployment, causes factors of production to be underutilized, reducing supply and, over time, raising prices over what they would have been otherwise?

Gerry Flaychy July 23, 2009 at 7:03 pm
“Suppose that a job can be done by either three unskilled workers or two skilled workers. If the unskilled wage is $5 per hour and the skilled wage is $8 per hour, the firm will use unskilled labor and produce the output at a cost of $15. However, if we impose a minimum wage to $6 per hour, the firm will instead use two skilled workers and produce for $16 as opposed to the $18 cost of using unskilled workers. ” _David Neumark

If there were no minimum wage imposed, and if each of the 5 workers agreed to work for $3 per hour, would the 5 be hired by the firm, or would the firm still hired only the 2 skilled ?

P.M.Lawrence July 23, 2009 at 7:46 pm

Lowell Sherris wrote “Apparently Professor Swales believes he is smart enough to fine tune subsidies for millions of people so that he can restore rather than distort price signals. Those of us who have read Mises and Rothbard know that is impossible.”

Lowell Sherris, DavidH, you didn’t pick up on what Nick realised: “By making it the government legistlating, the employer, and the employee it has deliberately excluded part of the government activity, taxation and benefits. Until that’s taken into account, its irrelevant.”

So, there already are distortions in the labour market and it would help to offset them. It is not necessary to fine tune things, only to improve them – and the amount of benefits and of taxes or the equivalent funding them tells us what a good first step would be. The fallacy in your reasoning is to make the perfect the enemy of the good and suppose that leaving things alone from here on is a free market approach, when it merely leaves existing distortions in place.

Daniel C, the way I read Art Carden’s remark was that introductory economics courses actually teach people “…the idea that a minimum wage leads to a reduction in the demand for labor and an increase in the supply of labor in the relevant market…”, because the mere familiarity with the concept is available even without any introduction.

It’s worth mentioning that the effect Art Carden describes, of average wages going up when people are ruled out of lower wage work, is a case of a well known bias in statistics that has a name, “survivor bias”. It’s why releasing people from hospital early improves hospital statistics (just as shooting the sick would improve sickness figures), or driving farmers off the land makes farmers better off (because only the remaining farmers get counted, and they each have a larger market share).

Jack July 24, 2009 at 1:15 am

No real economist would want to outlaw a subset of the spectrum of profitable voluntary transactions.

Putting people in jail or killing them (if they resist) just because they are doing a profitable transaction that benefits both people is cruel. And it’s poor economics.

ganpalou July 24, 2009 at 7:51 am

I think Nick has a point. He rightly includes government in the transaction. Any government that wishes to survive must interject itself into the economic frabric of the culture. The problem for government is to insert itself in a manner which increases the health and prosperity of the taxpayers under its domain. A taxpayer who is sick, broke, or unemployed is no taxpayer at all. The problem for government is to disguise its desire for increased tax income stream as a commitment to increase the prosperity of taxpayers. In that regard, laws and regulations which prevent theft, fraud, and outright robbery of accumulated wealth are equivalent to minimum wage laws; they provide a secure tax base.

In the late ’60s, a sociology theory was proposed which divided transactions into “two party” and “three party” transactions. “Free market” proponents prefer two party transactions as their “freedom to contract” defines both parties as satisfied. A problem with the “two party” concept is that a party who survives armed robbery is assumed to be satisfied with surviving. “Three party” proponents see every transaction as having: 1. a victim, 2. a persecutor, 3. a rescuer. People who see all contracts as being lopsided thus see the need for the third party. The concept is diagrammed as a triangle, and like the triangle, it is eternal (actually it is reiterated with all parties changing roles); a victim in one transaction (robbery) may become the persecutor (complainant) in the next. The rescuer (arresting officer) may become victim (witness subject to discredit, or excessive force allegation, or civil rights violation, etc.) in the next. The second rescuer (judge) may become victim (subject to appeal). And so it goes.
As we make decisions to enter transactions with each other, we choose whether we need a third party. Those that choose “two party” transactions, do not include government; they barter or work “off the books.” Those that choose “three party” transactions, must establish “standing” to get government involved in their transactions. Minimum wage is irrelevant to those who employ or work “off the books.” This phenomena is clearly seen in the U.S. “undocumented alien” controversy.
Thus, minimum wage can only negatively affect businesses and transactions wherein the business owner has sought third party, government, protection. To whine about the restrictions is merely to define oneself as playing “victim” in the second phase of the reiterating triangle.

Walt D. July 24, 2009 at 11:26 am

Why not set the minimum wage as the salary plus benefits of a US Senator? “For each according to his ability .”

Tim Fowler July 24, 2009 at 4:38 pm

ganpalou – re: “Three party” proponents see every transaction as having: 1. a victim, 2. a persecutor, 3. a rescuer.

If “three party proponents”, see ordinary economic transactions as always or at least typically involving a victim, and see government intervention as being a rescue, then that doesn’t say much for “Three party theory”.

Joel July 24, 2009 at 6:37 pm

I was really disappointed to hear Thursday on the radio some reporter claiming the evidence is mixed on whether raising the minimum wage reduces employment. This is like horse & rabbit stew — the evidence on the reduction side is more sizable than that on the no effect side.

ganpalou July 25, 2009 at 7:10 am

Tim Fowler -You got it. The problem is that we conduct far too many transactions with the idea that the other guy is “a perpetrator,” and that government will rescue us when we feel “victimized.” We dont bother to assure ourselves that we will be satisfied doing business with the next man. The quintessential example is the bundle of “financial guarantees” issued by FIDC, SEPC, Fannie Mae, and Freddy Mac, and the implied guarantees of the rating agencies, which fueled the “liquidity bubble” and “housing boom.” When they stretched derivitives beyond the guarantees, the bankers and brokers refused to do business with each other. The great government rescuer then issued guarantees of liquidity backed by present value of future tax stream. The government rescue doesnt address the problem of engaging in transactions that we are satisfied with. I dont know if the bankers are right, that the other bankers are all crooks, but minimum wage is merely pocket change in this financial environment.

Gerry Flaychy July 25, 2009 at 12:20 pm

With or without a minimum wage law, it seems to me that skilled workers will always have an advantage over the unskilled. Without minimum wage law, if unskilled workers can lower their price, the skilled ones can do it too. Thus, at the end of the ‘battle’, there should be more unskilled workers unemployed than skilled ones.

What was the case before the minimum wage law was instituted ?

Pat Miketinac July 26, 2009 at 8:40 pm

Is it possible that the minimum wage has fallen so far behind other wages that raising it is irrelevant if nobody can live on it without subsidies? Taxpayers pay one way or the other. I read that Congress raised their pay ten years in a row while the min. wage stayed the same.

Nick Bradley July 27, 2009 at 2:14 pm

When the issue of the minimum wage came up in one of my grad-level econ courses, I asked the professor if minimum wage laws caused unemployment. Being the Univ. of Chicago grad that he was, he said that minimum wage laws increase unemployment unless monopsonistic conditions exist. If they do exist, wages can be raised by fiat without reducing demand for employment.

The method he used to describe this situation was an island plantation with only one major employer. He said that in such a situation, the government could implement a slight hike in wages without unemploying anybody.

Anybody else’s thoughts on this?

Nick Bradley July 27, 2009 at 2:22 pm

Further on the Monopsony issue, I haven’t seen abymbody at Mises refute the argument that the labor market is monopsonistic/oligopsonistic in nature and information on prices is very poor. For most jobs, you don’t even know the salary and total compensation until after you interview. Also, information on what the true nature of the job will be once you start is very poor.

http://www.associatedcontent.com/pop_print.shtml?content_type=article&content_type_id=270103

Can anybody give me a link to an Austrian refutation of this?

Tim G. June 24, 2010 at 10:43 am

Don’t know if it’s Austrian, per se, but:

http://www.youtube.com/watch?v=02n9SIllNcM#t=284“Now, many people who argue for a minimum wage law will cite the theory of monopsony labor markets. They will point out that many labor markets are monopsonistic, and as a consequence it’s possible to raise the wage rate and increase the number of workers that are hired. But you must also realize that there are many competitive labor markets, and the net effect of the minimum wage will be the difference between the negative employment effects in the competitive labor markets versus the potential positive employment effects in monopsony labor markets.”The question is: why are we assuming that more people are employed in monopsonistic labor markets than competitive labor markets?

Also Walter Block wrote “An Austrian Critique of Neo-Classical Monopsony Theory”: http://mises.org/journals/scholar/Block12.pdf . I have not yet been through it myself. It is very technical….

P.M.Lawrence July 27, 2009 at 7:06 pm

Nick Bradley, that’s roughly the exception area Lippsey’s Positive Economics brought out, that I mentioned above. Only, I would categorise it as applying where the labour market is oligopsonistic (few significant buyers, here employers as buyers of labour) rather than monopsonistic (only one significant buyer). That makes it more likely to come up in real life, e.g. for low paid work in small towns.

I didn’t go into detail but only referred people to the text because it’s hard to show here; the graphs in the book help. Lippsey did point out that the effect – raising both wages and employment – only works for certain minimum wage levels, and that empirical studies suggest that unions generally take things to levels where wages go up but employment falls. Roughly speaking, what happens is that, without a minimum wage, employers stop hiring before the wage rises to a point where the marginal gain from new employees matches the wage. That’s because each new employee doesn’t just add the cost of his own wage but also the cost of the wage increase (needed to get him to join) for all the other employees. With a minimum wage or without monopsony/oligopsony that doesn’t happen, but the cost of the new employee himself is that much higher with a minimum wage. The graphs show just when and how the incentives for more or less employment work out, according to which parts of the effects dominate.

So it’s all a marginal costs thing, which is not the same thing as the minimum wage as such. If you can achieve a minimum wage through methods like the ones I linked to that don’t hurt that, it doesn’t harm employment (though if you set it at levels that are too high you harm GDP – but in fact you increase it if you choose levels that offset other distortions in the economy, e.g. from interactions of the tax and welfare systems, which are of known amount). Discussions that simply say “minimum wage bad” are oversimplifying, although most of the time it’s a perfectly adequate criticism of the equally oversimplified government approaches to a minimum wage.

newson July 28, 2009 at 4:28 am

to nick bradley:

http://www.brookesnews.com/071012hrns_print.html

gerry jackson often deals with monopsony from an austrian perspective.

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