by Jim Rose in Alfred Marshall, applied welfare economics, David Friedman, labour economics, minimum wage Tags: David Card, interpersonal comparision of utility, Milton Friedman, minimum wage, offsetting behaviour, The fatal conceit, The pretense to knowledge

Raising the minimum wage by a substantial amount would price working poor people out of the job market. A far better way to help them would be to subsidize their wages or – better yet – help them acquire the skills needed to earn more on their own… Raise the legal minimum price of labour above the productivity of the least skilled workers and fewer will be hired. If a higher minimum means fewer jobs, why does it remain on the agenda of some liberals? A higher minimum would undoubtedly raise the living standard of the majority of low-wage workers who could keep their jobs. That gain, it is argued, would justify the sacrifice of the minority who became unemployable. The argument isn’t convincing. Those at greatest risk from a higher minimum would be young, poor workers, who already face formidable barriers to getting and keeping jobs. Indeed, President Reagan has proposed a lower minimum wage just to improve their chances of finding work. New York Times, 14 January 1987

What does the New York Times say in 2014?

The minimum wage is specifically intended to take aim at the inherent imbalance in power between employers and low-wage workers that can push wages down to poverty levels.… The weight of the evidence shows that increases in the minimum wage have lifted pay without hurting employment

Both the White House and the New York Times are not the best of Bayesian updaters because the author of the one study on which they are very much hang their hats for their policy conclusions about no job losses from a minimum wage increase interprets his results with very much less zeal than they do:

I think careful research on the topic has found that for this range of minimum wage increase, the almost unmistakable conclusion is that there will be little in the way of job losses, while the wages of low-end workers will get a boost (his underlining).

The claims of the White House and the New York Times that the minimum wage can be lifted without hurting employment are a long bow from what Andrajit Dube said about small changes in the minimum wage having small adverse effects on unemployment:

What Andrajit Dube said s not much different from everyone else on the minimum wage – Nuemark is an example:

a 10 per cent increase in the minimum wage could reduce young adult employment by up to 2 per cent

David Card was always very careful amount about how his pioneering research was about how small increases in the minimum wage not reducing employment in the presence of search and matching costs:

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.

There is always offsetting behaviour: Barry Hirsch found that when the federal minimum wage went up in 2007, businesses just made their employees work harder to justify the expense.

I am always surprised that people might think that the minimum wage will have anywhere near its intended effects after market participants have had time to act to counter its effects as Peltzman explains:

Regulation creates incentives for behaviour to offset some or even all of the intended effect of the regulation… Regulation seldom changes the forces that produces the particular results the regulators seek to change. So we need to ask whether the regulation really changes result or only the form in which the market forces assert themselves.

Is a minimum wage increase a Pareto improvement – a policy action done in an economy that harms no one and helps at least one person?

Obviously there are winners and losers from a minimum wage increase and these wins and loses must be summed up in some way as they are for all public policy changes.

When there are winners and losers from deregulation, the only thing seems to matter to many of those who support a minimum wage increase are the losses to the incumbent industry and its often well-paid workers rather than the gains to consumers, rich or poor.

For there to be a Marshall improvement, the sum of all of the gains and losses must sum to a positive.

A Marshall improvement from a minimum wage or any other change is measured by adding utilities as if everyone receives the same utility from a dollar. A dollar is a dollar to everyone as David Friedman explains:

A net improvement in the sense used by Marshall–what I have elsewhere called a Marshall improvement–is a change whose net value is positive, meaning that the total value to those who benefit, measured as the sum of the number of dollars they would each, if necessary, pay to get the change, is larger than the total cost to those who lose, measured similarly.

The advantage of the Marshall improvement criterion is we commonly observe people’s values of different things by seeing how much they are willing to pay for it.

Alfred Marshall was aware that treating people as if they all had the same utility for a dollar was a stretch but this was considered less relevant for policy changes that affect large and diverse groups of people. Individual differences could be expected to cancel out over a broad suite of policies in a well-functioning democracy so that most people gain in net terms through time. David Friedman explains:

I prefer to use the Marshallian approach, which makes the interpersonal comparison explicit, instead of hiding it in the ‘could be made but isn’t’ compensating payment… a change that benefits a millionaire by $10 and costs a pauper $9 is a potential Pareto improvement, since if combined with a payment of $9.50 from the millionaire to the pauper it would benefit both. If the payment is not made, however, the change is not an actual Pareto improvement. The ‘potential Paretian’ approach reaches the same conclusion as the Marshallian approach and has the same faults; it simply hides them better. That is why I prefer Marshall… It is worth noting that although a Marshall improvement is usually not a Pareto improvement, the adoption of a general policy of ‘Wherever possible, make Marshall improvements’ may come very close to being a Pareto improvement… Add up all the effects and, unless one individual or group is consistently on the losing side, everyone, or almost everyone, is likely to benefit.

This is the latest review of the minimum wage research from David Neumark:

The potential benefits of higher minimum wages come from the higher wages for affected workers, some of whom are in poor or low-income families. The potential downside is that a higher minimum wage may discourage employers from using the low-wage, low-skill workers that minimum wages are intended to help. If minimum wages reduce employment of low-skill workers, then minimum wages are not a “free lunch” with which to help poor and low-income families, but instead pose a trade-off of benefits for some versus costs for others. Research findings are not unanimous, but evidence from many countries suggests that minimum wages reduce the jobs available to low-skill workers.

George Stigler set-out the conditions for a minimum wage to achieve its purported objectives in 1946, which have not been bettered:

If an employer has a significant degree of control over the wage rate he pays for a given quality of labour, a skilfully-set minimum wage may increase his employment and wage rate and, because the wage is brought closer to the value of the marginal product, at the same time increase aggregate output… This arithmetic is quite valid but it is not very relevant to the question of a national minimum wage. The minimum wage which achieves these desirable ends has several requisites: 1. It must be chosen correctly… the optimum minimum wage can be set only if the demand and supply schedules are known over a considerable range… 2. The optimum wage varies with occupation (and, within an occupation, with the quality of worker). 3. The optimum wage varies among firms (and plants). 4. The optimum wage varies, often rapidly, through time. A uniform national minimum wage, infrequently changed, is wholly unsuited to these diversities of conditions.

The case for a minimum wage was therefore hung, drawn and quartered in 1946 by Stigler. Not every cause and effect is open to policy manipulation because of the lack of the necessary knowledge about the relationship and insufficiently deft policy tools to exploit that knowledge in a timely fashion and as circumstances change. This information and organisational burden is such that the process of setting minimum wage increases is an example of public policy making that is groping about in the dark. Success can be neither appraised in advance nor later retrospectively determined.