Tuesday, January 13, 2015

The Minimum Wage, Employment, and Social Choices

The standard explanation for why increasing the minimum wage will decrease employment is based on the assumption that labor participates in a perfect market where increased costs for labor will diminish demand.  Thomas Piketty adds a little nuance to that argument and suggests that raising the minimum wage is the only way to increase income at the bottom of the pay scale.  Piketty’s reasoning is found in Capital in the Twenty-First Century.  Piketty has posted the tables and figures from the book here.

“To an even greater extent than other markets, the labor market is not a mathematical abstraction whose workings are entirely determined by natural and immutable mechanisms and implacable technological problems: it is a social construct based on specific rules and compromises.”

There is rarely a scarcity of low-skilled workers that might drive up wages at the bottom of the wage scale.  Consequently, without a floor on hourly earnings, employers have little economic motivation to not lower wages as much as possible.  A minimum wage provides that floor, but it can also act as justification for keeping wages at that floor value.  There need be no implicit or explicit collusion among employers to establish a target salary, the minimum wage provides it for them and sets up a situation Piketty refers to as a monopsony. 

If the established minimum wage is too high it can lead to a decrease in employment, but if it is too low it can also have a negative economic effect.  Underpaid workers are not injecting sufficient demand back into the economy.

“….if a small group of employers occupies a monopsony position in a local labor market (meaning that they are virtually the only source of employment….), they will probably try to exploit their advantage by lowering wages as much as possible, possibly even below the marginal productivity of the workers.  Under such conditions, imposing a minimum wage may be not only just but also efficient, in the sense that the increase in wages may move the economy closer to the competitive equilibrium and increase the level of employment.”

“Various studies carried out in the United States between 1980 and 2000, most notably by the economists David Card and Alan Krueger, showed that the US minimum wage had fallen to a level so low in that period that it could be raised without loss of employment, indeed at times with an increase in employment….On the basis of these studies, it seems likely that the increase in the minimum wage of nearly 25 percent (from $7.25 to $9 an hour) currently envisaged by the Obama administration will have little or no effect on the number of jobs.”

Piketty has looked at how the bottom 10% of wage earners have fared in both France and the US.  It seems that only by increasing the minimum wage can the lowest paid keep up with the average increase in wages for the population as a whole.

“Inequalities at the bottom of the US wage distribution have closely followed the evolution of the minimum wage: the gap between the bottom 10 percent of the wage distribution and the overall average wage widened significantly in the 1980s, then narrowed in the 1990s, and finally increased again in the 2000s.”

To make this trend clear, Piketty provides this plot of minimum wages in the US and in France, both represented in 2013 currency.

Note that until 1980 the US minimum wage was more generous than that in France and was maintained at a level roughly consistent with the $9 target set by Obama.  After 1980 a sequence of Democratic presidents raised it and a sequence of Republican presidents held it down.  When we have Republican presidents the poor do not fare well.

Piketty referred to the labor market as “a social construct based on specific rules and compromises.”  The same could be said for economic policies as a whole.  They are not determined by “natural and immutable mechanisms,” but by decisions made by voters and their representatives.

Consider this chart of the share of the top 10% of income ladder of the total income (or wages) over time.

Note that income inequality was lowered considerably in the period from the 1940s to the 1970s.  Note also that 1980 was again a turning point.  The ascendency of free-market mythology and the acceptance of it by Republican presidents changed our world.  A new set of rules and compromises were put into place and the rich got richer and the poor got poorer.  This is not economics; this is politics.

Until the Democrats get off their tails and come up with a counterrevolution to the counterrevolution of the 1980s and convince the nation that there is a better way, we are stuck with what we have now.

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