Thursday, August 26, 2010

Asking the wrong questions about the minimum wage

Often discussions of the minimum wage center around its aggregate effect on employment—under a certain minimum wage, is total employment higher or lower than it would have been otherwise? Basic economic intuition says that the answer should be "lower", but alternative models are less clear, and empirical evidence is ambiguous.

Upon further examination, this isn't even the right question. Total employment isn't all that matters—among other things, we want to know who is holding the jobs. In a model of imperfect competition, a minimum wage has two effects. First, it decreases employment by putting a wage floor above some workers' marginal product of labor; second, it increases employment by inducing more people to enter the labor force. While the aggregate outcome may involve either higher or lower total employment, this will hide important shifts in the composition of the workforce.

What are the welfare effects of these shifts? Consider the group of people induced to enter the labor force by a small increase in the minimum wage. Since this group, by definition, consists of people who would opt to stay out of the labor force under a slightly lower wage, it gains relatively little utility from working—members of the group are still close to being indifferent toward work. Workers who lose their jobs because of the minimum wage, on the other hand, are likely to derive much higher utility from work. In particular, since they will tend to be individuals from poor backgrounds with little education, they are typically in special need of the income from a steady job.

This doesn't mean that the minimum wage is necessarily a bad idea. From a social welfare perspective, it's still possible that the direct income-increasing effects of the minimum wage will outweigh the disemployment effects. But it is critical that we know what those disemployment effects are, and looking at aggregate employment alone won't tell us.


Norman said...

Given how small a part of the labor force is subject to the minimum wage, combined with the number of aggregate shocks the labor market is prone to have, it never seems surprising to me that it's difficult to accurately identify an aggregate effect.

A much more important approach in my mind is whether introducing slack in some jobs gives employers of these positions enough slack to engage in things like racial discrimination (or to engage more freely than they could otherwise), as conventional theory suggests. Unemployment rates for teen in different racial groups seems to suggest this is the case, but that's far from conclusive evidence.

Alan said...

The minimum wage is an obvious foundation in the eco structure. The distribution of eco activity is or was based on activity at the lower tier of the eco strata. The best example in history was the Souths insistence on the preservation of slavery to support there prosperity. I would not therefore negate the aggregate effects of the that portion, of substail size and its impact on the tiers of our eco system. OOPL