What empirical evidence should we trust? By Scott Sumner

Noah Smith has a piece in Bloomberg discussing recent empirical research, some of which (not all) suggests that higher minimum wage rates do not have negative effects on employment. He then suggests that these studies also discredit the competitive model of labor markets, in favor of alternative (monopsonistic) models where employers have lots of market power.

Textbook writers and instructors should respond by changing the baseline model of labor markets that gets taught in class. Students ought to start with a model of market power, in which a few companies set wages below levels found in a competitive market unless prevented from doing so. That model is about as easy to work with as the traditional supply-and-demand setup, but matches the data much better.

I’m not totally convinced by this line of reasoning, for a number of reasons.

1. The replication crisis in the sciences, and the social sciences.

2. Conservative studies seem able to explain the very low levels of hours worked in Europe much better than progressive studies. And the studies that Smith cites are progressive studies. That doesn’t mean progressives are wrong, but until progressives are able to explain Europe’s labor market, I’ll continue to have trouble taking them seriously.

3. Most importantly, Smith overlooks the fact that empirical research is just as unfriendly to the monopsony model of labor markets as it is to the competitive model of labor markets. AFAIK, almost all the empirical studies of the minimum wage suggest that higher minimum wages do not come out of profits, but rather are passed on in terms of higher prices. That result is 100% consistent with the competitive model of labor markets, and inconsistent with the monopsony model (which suggests that if employment doesn’t fall then product prices do not rise.)

Thus empirical studies show that when a minimum wage increase forces grocery stores to pay higher wages, they pass on the increased costs in the form of higher prices.

Now I suppose that progressives could argue that demand curves don’t slope downwards, and that the higher prices will not reduce sales. In that case, a higher minimum wage need not reduce employment. But as soon as you abandon downward sloping demand curves, you are faced with other dilemmas. For instance, why should progressives oppose “regressive” consumption taxes? After all, if demand curves don’t slope downwards, then higher prices would not reduce consumption. And since living standards depend on consumption, regressive taxes would not reduce the living standards of the poor.

Of course we know that demand curves do slope downwards, and we know that regressive taxes tend to adversely impact the poor. What we need to figure out is whether higher minimum wages raise prices and reduce sales. So far, the empirical evidence suggests that they do.

To summarize, the empirical evidence on the effect on minimum wages on employment is mixed. The empirical evidence on the effect of minimum wages on prices is pretty clear—it raises prices. That means that, on balance, the empirical evidence is more supportive of the competitive labor market model than the monopsony model.

This doesn’t mean that firms have no monopsony power—they almost certainly have some. The question is how much, and whether the short and long run labor demand elasticities differ.

I would add that the question of whether higher minimum wages are desirable is very different from the question of whether they affect employment levels. There are other important issues to consider, such as the impact of minimum wage laws on working conditions.