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Monday, February 18, 2013

The Minimum Wage and Employment when Employers Have Market Power

Richard Green:

Where's the monopsony?: President Obama, Paul Krugman and Robert Reich have all been pushing for an increase in the minimum wage. I want to agree with them, and Krugman is certainly correct that the preponderance of empirical evidence shows that the minimum wage's impact on total employment is negligible.
But the question is, why? Krugman's statement that human beings are not Manhattan apartments is true, and allows him to support the minimum wage while being appropriately skeptical of rent control, but it doesn't give a satisfactory answer as to why putting a floor on the price of labor would not create excess supply of labor.
There is in economic theory a set of circumstances, however, under which an increase in the minimum wage might raise employment. If an employer has a market largely to itself--if it has monopsony power--then it will both pay its workers less than their productivity warrants and not hire enough workers to be at the most efficient level of employment. Raising the minimum wage would then both increase pay and induce more workers into the labor market, hence increasing employment. If government could nail the minimum wage to the marginal revenue product of the least productive workers, the minimum wage could produce a first-best outcome--one where pay and employment levels were efficient.
For the argument to work, the demand for labor needn't be perfectly monopsonistic, but rather less than perfectly competitive. The fact that wages and labor productivity seem to have less and less to do with each other is evidence that the demand for labor is not competitive, but it would be nice to have further, detailed evidence of the industrial organization of labor demand.

David Card agrees with the monopsony perspective. Here is part of an interview of him (from 2006) by Douglas Clement of the Minneapolis Fed where he discusses this issue (in particular, see the part about "each employer has a tiny bit of monopoly power over his or her workforce," his comments on advocacy are also interesting):

Minimum Wage
Region: Your research on the effects of raising the minimum wage, much of which was compiled in your book with Alan Krueger, generated considerable controversy for its conclusion that raising the minimum wage would have a minor impact on employment.
Have you continued to conduct research on the impact of raising the minimum wage? And do you have an opinion about "living wage" legislation and the petition that's been circulated recently with 650 or so economists calling for an increase in the minimum wage?
Card: I haven't really done much since the mid-'90s on this topic. There are a number of reasons for that that we can go into. I think my research is mischaracterized both by people who propose raising the minimum wage and by people who are opposed to it. What we were trying to do in our research was use the minimum wage as a lever to gain more understanding of how labor markets actually work and, in particular, to address a question that we thought was quite important: To what extent does the simplest model of supply and demand actually describe how employers operate in the labor market? That model says that if an employer wants to hire another worker, he or she can hire as many people as needed at the going wage. Also, workers move freely between firms and, as a result, individual employers have no discretion in the wages that they offer.
In contrast to that highly simplified theoretical model, there is a huge literature that has evolved in labor economics over the last 25 years, arguing that individuals have to spend time looking for job opportunities and employers have to spend time finding employees. In this alternative paradigm a range of wage offers co-exist in the market at any one time. That broader theory is, I think, pretty widely accepted in most branches of economics. The same idea is used to think about product markets where two firms that sell very similar products may not charge exactly the same price. The theory explains a lot of things that don't seem to make sense, at least to me, in a simple demand and supply model.
For example, what does it mean for a firm to have a vacancy? If a firm can readily go to the market and buy a worker, there's no such thing as a vacancy, or at least not a persistent vacancy. During the early 1990s, when Alan and I were working on minimum wages, it was our perception that many low-wage employers had had vacancies for months on end. Actually many fast-food restaurants had policies that said, "Bring in a friend, get him to work for us for a week or two and we'll pay you a $100 bonus." These policies raised the question to us: Why not just increase the wage?
From the perspective of a search paradigm, these policies make sense, but they also mean that each employer has a tiny bit of monopoly power over his or her workforce. As a result, if you raise the minimum wage a little—not a huge amount, but a little—you won't necessarily cause a big employment reduction. In some cases you could get an employment increase.
I believe that that model of the labor market is correct. There are frictions in the market and some imperfect information. It doesn't mean that if we raised the minimum wage to $20 an hour we wouldn't have massive problems, if we enforced it. Realistically, of course, the U.S. is never going to enforce a draconian minimum wage, nor is one ever going to be passed. However, our results don't mean that minimum wages in other economies couldn't have some effect.
I think economists who objected to our work were upset by the thought that we were giving free rein to people who wanted to set wages everywhere at any possible level. And that wasn't at all the spirit of what we actually said. In fact, nowhere in the book or in other writing did I ever propose raising the minimum wage. I try to stay out of political arguments.
I think many people are concerned that much of the research they see is biased and has a specific agenda in mind. Some of that concern arises because of the open-ended nature of economic research. To get results, people often have to make assumptions or tweak the data a little bit here or there, and if somebody has an agenda, they can inevitably push the results in one direction or another. Given that, I think that people have a legitimate concern about researchers who are essentially conducting advocacy work. I try to stay away from advocacy of any kind, but that doesn't prevent people from being suspicious that I have an agenda of some kind.
I've subsequently stayed away from the minimum wage literature for a number of reasons. First, it cost me a lot of friends. People that I had known for many years, for instance, some of the ones I met at my first job at the University of Chicago, became very angry or disappointed. They thought that in publishing our work we were being traitors to the cause of economics as a whole.
I also thought it was a good idea to move on and let others pursue the work in this area. You don't want to get stuck in a position where you're essentially defending your old research. I certainly think it's possible that someone will come up with credible research documenting a situation where raising the minimum wage has a significant employment effect. I rather doubt we will see that right now because minimum wages are fairly low, at least in northern California where I live. My guess is that small raises in the minimum wage won't have much of an effect.
I think the monopsony power argument is correct (an argument I made in a job market paper long, long ago in trying to explain the correlation between wages and productivity).

    Posted by on Monday, February 18, 2013 at 10:44 AM in Economics, Income Distribution, Regulation, Unemployment | Permalink  Comments (41)

          


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