Smart Ph.D. Economists and the Minimum Wage

When I saw this post on monopsony power in labor markets at Atrios:

With the minimum wage in the air, I see the Econ 101 trolls are out in force. Look, unless you believe that the labor market is accurately characterized as perfectly competitive then not only is it the case that the minimum wage doesn't necessarily, reduce employment, it's actually quite possible that small increases in the minimum wage will increase it. To the extent that firms have market power, and there's plenty of reason do think they do, the impact of small minimum wage increases can potentially be either "paradoxically" to increase employment or to just basically be a wash. ...

And especially this:

[I]f I'm extra inspired later I'll given you the Econ101 version of monopsony (sadly, not always actually taught in Econ101) so that even smart Ph.D economists can understand.

I almost responded, but PGL at Angry Bear beat me to it. One very smart Ph.D. economist, David Altig, saw PGL's post and has this to say about the minimum wage:

Modern Labor Economics And The Minimum Wage, macroblog: As I continue in my futile quest to catch up with all the blog reading that I have let slip, this post from early last week at Angry Bear caught my eye...:

Duncan [Black] also recommends Monopsony in Motion: Imperfect Competition in Labor Markets by Alan Manning:

Much of labor economics is built on the assumption that all the workers will quit immediately. Here, Alan Manning mounts a systematic challenge to the standard model of perfect competition.

Simply because my aim here is to inform as best I can -- at least about the things I think I am qualified to be informative about -- I think it worthwhile to point out that this doesn't really describe the state of modern labor theory.  For a description of that, I'll turn to Rob Shimer, one of the guys at the top of the list of people actively creating modern labor theory:

I begin by describing the simplest version of the Mortensen-Pissarides matching model...

A central feature of this model is that the matched worker and firm are in a bilateral monopoly situation. That is, an employed worker could always leave her job and find another employer; however, because search is time-consuming, workers are impatient, and all jobs are identical, she prefers to work for her current employer. Likewise, a firm could fire an employee and attempt to hire another one, but this will take time and will not yield a better match. There are many wages consistent with the pair agreeing to match, and so the model provides little guidance as to how wages are determined...

...My point in highlighting this passage is, of course, that the challenge to the perfectly-competitive spot market view is already well under way (even in macroeconomic models).  And as you can see, that theory is not built on the assumption that "workers will quit immediately."  Nor is it built on the assumption that employers will fire immediately.

What, then, does modern labor economics have to say about the minimum wage?  A complicated question that.  Here is a sampling of abstracts, generated by my highly scientific method of typing "minimum wage matching model"  into Google --

From Adrian Masters (in a paper published in a good peer-reviewed journal), the argument that wages may indeed be too low:

This article focuses on wage formation in an equilibrium (two-sided) model of search with match-specific heterogeneity. Despite a large number (a continuum) of employers, search provides sufficient isolation to generate market power. By posting wages, employers, without collusion, capture most of the surplus that accrues to any match. The equilibrium wage is below that which maximizes employment...

But be careful. From Michael Pries and Richard Rogerson:

So what happens when a policy, such as a minimum wage, interferes with that equilibrium wage rate? If the imposed minimum wage is higher than what the equilibrium wage would be, says Rogerson, there will be cases in which firms no longer want to enter the match to test it out. 

The reason, says Rogerson, is that raising the minimum wage raises the minimal level of match quality that a firm will accept to test out the relationship. The firm will still enter into some matches at above-minimum wage, but only those that show a higher potential of being good matches.

Rogerson explains the phenomenon through a car-buying analogy. "Imagine that a law was passed that said you could no longer test-drive a car," Rogerson says. "That deprives you of an important source of information..." So what would the outcome of a test-driving prohibition be? "People would be less likely to find the car that best suits their needs, implying a loss in economic welfare."

Policies like the ones Pries and Rogerson analyze -- minimum wages, unemployment insurance, dismissal costs, and taxes -- are not the same as imposing a ban on test-driving automobiles. But their effect is to make test-driving an employee (hiring him to see through experience if he will be a good match) more costly, which means that firms will do it less often.

...The effects of other policies by themselves, including dismissal costs, unemployment insurance, and taxes, are minimal, write Pries and Rogerson. But the effects of those policies combined (as they often are in the real world) are quite large.

In fact, we should probably be thinking about labor market policies as a collection of interventions, rather than taking the piecemeal approach that characterizes how many of our policies are actually implemented. From Pierre Cahuc and Andre Zylberberg:

We analyze how wage setting institutions and job-security provisions interact on unemployment. The assumption that wages are renegotiated by mutual agreement only is introduced in a matching model with endogenous job destruction à la Mortensen and Pissarides (1994) in order to get wage profiles with proper microfoundations... the assumption of renegotiation by mutual agreement allows us to introduce a minimum wage in a coherent way, and to study its interactions with job protection policies. Our computational exercises suggest that redundancy transfers and administrative dismissal restrictions have negligible unemployment effects when wages are flexible or when the minimum wage is low, but a dramatic positive impact on unemployment when there is a high minimum wage.

Just to make things more difficult, observing outcomes that we generally interpret as negative -- such as rising unemployment -- need not mean that a policy is misguided. From Christopher Flinn...

... we analyze the effect of changes in minimum wages on labor market outcomes and welfare. While minimum wage increases invariably lead to employment losses in our model, they may be welfare-improving to labor market participants using any one of a number of welfare criteria... Direct estimates of the welfare impact of the minimum wage increase from $4.25 to $4.75 in 1996 provide limited evidence of a small improvement. Using estimates of the primitive parameters we show that more substantial welfare gains for labor market participants could have been obtained by doubling the minimum wage rate in 1996, though at the cost of a perhaps unacceptably high unemployment rate.

... and from a related paper (published in a very, very highly regarded journal):

Although minimum wage increases may or may not lead to increases in unemployment in our model, they can be welfare-improving to labor market participants on both the supply and demand sides of the labor market... We show that the optimal minimum wage in 1996 depends critically on whether or not contact rates can be considered to be exogenous and we note that the limited variation in minimum wages makes testing this assumption problematic.

So, is the minimum wage a good idea or not.  Our theories, and attempts to quantify them, speak clearly: It depends.

The point is that, contrary to popular belief, a minimum wage does not necessarily reduce economic welfare.

Comments

[mrrunangun]

This is an argument made in favor of EU employment policies. That the cost of 8-10% unemployment results in sufficient benefit to the remaining participants in the labor market that the cost should be borne by society. Businesses increasingly vote with their feet, outsourcing to asia or to the new EU entrants with lower labor costs, as the costs are not worth bearing to individual businesses though they may be worth it to society as a whole. As long as there are enough employers left in the society in question.

[Bruce Wilder]

At the risk of being rude, I would like to point out a few things.

1.) The "popular belief" is that a minimum wage, even at rates above the current Federal minimum, enhances welfare. This has been demonstrated in several State referenda in recent years. Only, reactionary economists, and the right-wing nuts they nurture, think the minimum wage is hurting working folk.

2.) The question, whether a minimum wage is a good policy, and the question, how high should the minimum wage be, should be logically separable questions. That a minimum wage could be too high, is not an argument against a minimum wage set at a reasonable level.

3.) Atrios was making a point about how the way economics is taught at the lowest levels ("Econ101"), is used to bolster reactionary politics. So, although I am really glad to hear that Atrios' comment is not an accurate reflection of "the state of modern labor theory", he wasn't trying to convey the state of modern labor theory. Atrios was making reference to the state of "Econ 101" pedagogy and its role in politics.

4.) Reactionary economists are real and prominent, and they regularly reinforce the misuse of the perfectly competitive spot market analysis. Here's a reference to one of many posts made by Greg Mankiw, Econ 101 textbook author, on the minimum wage:
http://gregmankiw.blogspot.com/2006/11/minimum-wage-as-symbol.html
Professor Mankiw regularly makes or implies claims about the state of professional opinion among economists or the state of thinking and research, to bolster his reactionary claims. In the above cited Mankiw post, he links to a post by the Nobel winner, Gary Becker, where Professor Becker makes similar claims in support of an extreme right-wing position in opposition to the minimum wage, including arguments from authority, which imply that the idea that the minimum wage is a bad thing is a consensus view among economists well-informed on the subject.

[Cyril Morong]

I always cover monopsony in my principles of micro class and demonstrate how the number of workers hired can be increased if a minimum wage is imposed. But I also say that there are very few examples of pure monopsony out there. After all, it means just one buyer. If it is not just one buyer, then how many is it? Those who bring up the monopsony angle have a responsibility, I think, to say how competitive or ucompetitive labor markets are. Are there 10 companies that each hire about 10% of the workers? Is it 20 and 5%?

Here is a blurb from one of the links listed above: "Monopsony in Motion stands apart by analyzing labor markets from the real-world perspective that employers have significant market (or monopsony) power over their workers. Arguing that this power derives from frictions in the labor market that make it time-consuming and costly for workers to change jobs, Manning re-examines much of labor economics based on this alternative and equally plausible assumption."

People change jobs fairly often. I think it is once every three years on average. We have sites like monster.com. People can move easily. Employers may have less power than it seems on the surface. Also, how do we know the governemnt will set the right minimum wage, even if significant monopsony power exists? What if the government sets a minimum wage and then the market power of the firm in question erodes. Will the government rescind the minimum wage? The right minimum wage in one city might be wrong for another. Will the government have to set one for each city? At the very least, let cities do it themselves instead of states and the federal government. We are more likely to get things right and we can see what the results are.

The following link summarizes some of the evidence against the minimum wage

http://thedangerouseconomist.blogspot.com/2006/12/symbols-and-minimum-wage.html

[pgl]

As I told David: (1) we call have lots to read; and (2) those who think anyone in favor of higher minimum wages suffers from a lack of economic literacy must be very behind in their reading.

[cm]

Bruce Wilder: I'm not sure your point (1) describes the situation accurately. Judging by the rhetoric I have been observing it strikes me that the concern is generally not "workers are hurt", but "the bums don't deserve it".

[cm]

Cyril: Few would prefer to hire job-hoppers for the (IMO legit) concern that they are going to jump soon. Also often in practice there are factors other than just face-value transaction cost -- even in low-wage jobs every environment is different, one has to get up to speed, prove oneself and obtain respect/stature from scratch, and the interpersonal relationships with colleagues and place-specific work/management culture are always a matter of chance and not reliably judged before making the move.

[Cyril Morong]

cm:

I understand what you are saying. But people are getting hired while changing jobs frequently. I guess the question is when people get a different job how often is after the were laid off or their company went under and how often were they the ones who intentionally moved. Maybe someone can fill us in.

[cm]

Cyril: Probably most of the data is anecdotal. Perhaps it depends on the "statefulness" of the job. Perhaps if somebody can contribute 100% after 1-2 weeks, it's not so bad when they jump after 6-12 months. In my line of work getting up to speed takes significantly longer, and having changed jobs after a short while, esp. recently, without plausible explanation is definitely a bad mark. Often the chance to present the explanation is not extended as such candidates likely won't be interviewed.

[Bruce Wilder]

My objection to the monopsony argument in Econ 101 is the same as my objection to the monopoly argument, as traditionally presented.

The perfectly competitive market model is necessary to establish some critically important economic concepts. As long as neither student nor teacher mistakes it as a general model for how actual and particular markets work, I'm fine with it. The monopoly/monopsony model, however, is conceptually incoherent, for reasons Cyril cites and several more; if that incoherence is not acknowledged, it leads to all sorts of ridiculous and imprecise handwaving, which leaves students with only a vague intuition, unsupported by any capacity for rigorous thinking.

Obviously, students have to be acquainted with models applicable to actual markets, where firms are making strategic choices. I don't see how you can avoid game theory. In a game theory context, the mere fact that employers, in most labor markets, are able to make the "first move" with take-or-leave it policies, gives employers considerable power to win whatever "negotiation" or bargaining goes on, (in the absence of unions). Without a lot of yada-yada about how much "power" a particular unspecified "degree" of monopsony does or does not confer, even a tiny bit of game theory goes directly to why employers seem so much more powerful than employees and job-seekers, in the experience of most employees and job-seekers. And, of course, your students get a glimpse of how actual labor market theory is being done.

[cm]

Bruce Wilder: One aspect of "take it or leave it" is non-discrimination (with the proviso "minimum required by law" of course). That applies even to salary, where there is the largest leeway. Typically the only way to pay somebody more (or less) is to classify them in a higher (lower) grade level, or "adjust" the job description.

Otherwise re the difficulties with monopsony/monopoly, I'd say it's not incoherence but "purely" economic models running into limits by neglecting "soft" social matters.

I have witnessed at least a few months in a dotcom-style environment with the free massages, "work-life balance", and other goodies. It's a game of Musical Chairs, and much of it comes down to who is a player and who is a chair, or aggregate perceptions thereof. Since back then, the tables have simply turned for my likes.

[pgl]

Check out Menzie over at Econbrowser as he adds to David's reading list. Gee, Atrios and I tossed out one textbook and the flood gates of things we need to read has opened. This is why we blog!

[Idaho_Spud]

Well, I know what my past and present employers would *prefer* to pay me for my labor, given a choice ;) That's one reason why I'm in favor of having a healthy floor in place for wages.

It sets the minimum standard of compensation that they are required to live up to (excluding health benefits and the now mandatory safe working conditions).

[cm]

Germany doesn't have a minimum wage (although after recent unemployment benefit "reforms" it is being discussed), but supposedly more generous welfare programs. But then how can it be that German grocery retail, notorious for its low margins, has manned (OK, mostly womanned) checkouts, and I'm seeing "self checkouts" in US grocery stores? Can Albertsons not afford checkout operators, are US customers less prone to cheating at the checkout (AKA shoplifting), or does automation work better in the US? I refuse to believe that German grocery workers are paid less than in the US, in purchasing-power terms.

[cm]

My bad. Plastic money is far less prevalent in Germany. Somebody's gotta take your cash, and give change. And denominations up to EUR 2 are coins. Back there I was carrying a coin purse and would make an effort to give exact change, or an amount minimizing small change. Far quicker than signing a credit/debit card slip. Card users were occasionally frowned at for taking time.

[Movie Guy]

cm,

I am sure that you know that the big box stores (and many other stores) in the USA have all those plastic mirrored domes in the ceilings. The shoppers don't know which ones have cameras behind them. So, the stores can minimize on floor employment.

Besides, that gray-haired woman or man at the door (the greeter) is there to check receipts on the way out, too.

Story humor:

A friend over the weekend was telling me about a problem he encountered in a Sam's Club last week. He rolled his cart up to the checkout, the clerk scanned all of his purchases. He paid the bill. Then the clerk handed him the receipt. He looked at it and notice that he had been overcharged for a couple of the CDs that he purchased along with a lot of other stuff. He was still at the register, so he asked the clerk to correct the bill and restore a credit to his credit card. The clerk told him that he would have to go to the customer service counter to have the bill corrected. My friend wasn't happy about that. The clerk refused to fix it. Finally, he went to the customer service desk and they corrected the error. He had to sign one of their forms. Now, he really wasn't happy. So, finished with all the store "tasks", he started to the exit. Yep, the greeter wanted his receipt copy. She had to bounce the receipt off of the goods in his cart. That did it. He looked at her and said, "No, I don't want to give you my receipt. I just contracted for this purchase of goods and our business is done." Ha ha. She was startled. Then he remembered the cameras and knew that they could call the police. So, he showed the receipt and told her what happened. She replied, "Yes, sir. We screwed at those registers. I hear it all the time."

Oh, man. Too funny.

I can't wait to try that line.

[cm]

MG: I'm glad we don't have store surveillance in Germany (same domes), and neither the nice uniformed security personnel at the door who double as greeters. No conspicuously placed gray-haired women too. Guess they fetch social security or pre-retirement extended unemployment benefits.

[cm]

BTW I was specifically referring to grocery retail. My experience from Germany is mostly pre-2000 and a little after though. Hereabouts I didn't start seeing self-checkouts prior to 2004/5, but it so happened I didn't frequent the stores that have them so much due to "geographic" happenstance (others are closer to my home, or on my route, or have the stuff I'm used too).

[cm]

MG: One should think in "high wage" Germany they have more automation (in fact they do -- caveat, the bar for passing is higher so automation actually has to perform to pretty high standards, or so I prefer to believe anyway). Perhaps there is enough retail competition (certainly more than here where I live) so that customers have so many alternatives that no store wants to make the first move reducing service (without reducing price, and this is where margins come in). Not that Albertsons, which has self-checkouts, is appreciably cheaper than Safeway which doesn't.

[Peter Schaeffer]

The solution here is obvious. Raise the minimum wage to the point where it does eliminate jobs. Then remove the illegal alien population and restrict legal immigration to make sure that the higher wage jobs go to American workers.

Former Presidential candidate Michael Dukakis has made this point in the NYT. On the right, Alex Tabarrok has agreed that the logic of this idea is unimpeachable. However, he emphatically favors low wages to create more jobs for illegal immigrants rather then the reverse.

[callahan]

Let's all just live off the land and end this crazy eek-a-nomics stuff huh? Some call it economics, I call it eekonomics cause I'm trying to eek out a living, get it?

Minimum wage is but a standard by which illegals will work for less.