We have had a sighting of an man employment eating beast right here in North America! And this one doesn’t seem to have the tail of poisonous spines or multiple rows of teeth.
And what is this vicious creature? A reduction in the minimum wage. Paul Krugman castigates the Focks news crowd for thinking that lowering the minimum wage might expand employment. No longer is it OK to recognize that labor demand curves, like every demand curve in human history, is downward sloping. To say that a labor demand curve is downward sloping simply recognizes that when the cost of employing workers increases, firms reduce how much labor they use, and therefore when the cost of employing workers falls they use more workers.
Apparently when you win the Nobel Prize you get to call people who understand this knuckle dragging economic luddites. Why? He argues that while this may in fact be true for any particular firm or sector of the labor market, it is not true for the entire labor market.
Note that I have a PhD in Labor Economics and I am confused.
But if everyone takes a pay cut, that logic no longer applies. The only way a general cut in wages can increase employment is if it leads people to buy more across the board. And why should it do that?
For the record, before I begin, let me say that I am not all that obsessed with employment – I’d prefer a world where I had the same goods and services I command now and had the opportunity to work less – employment for the mere sake of it is not desirable. Further, I do not think the magnitudes in this discussion are all that economically relevant, but being as I believe the minimum wage is a violent, ineffective and immoral policy, I would favor abolishing it even if the “benefits” of doing so did not materialize in a macroeconomic sense. OK, so where does that leave us? In perhaps increasing order of importance:
- Reducing the minimum wage will certainly raise the relative cost of other workers in the economy. So I could certainly see where there would be decreases in employment for workers that are near substitutes for current or prospective minimum wage workers, Who might these workers be? How about various subsectors of the unionized workforce. The last I checked, the average wage of an SEIU member was in the $10 per hour range. You might ask what unions ever support minimum wage legislation in the first place for especially since their raison d’etre is to raise wages well above the measly minimum wage level? Well, it is because when minimum wages rise, it makes the relative price of union work lower, and it is relative prices that matter for decision making at the margin. So, lowering the minimum wage would be expected to have firms substitute out of now more costly union workers and into less costly minimum wage workers. Of course, I would never expect a respectable liberal to support a policy that might disadvantage their sugar daddies.
- Contrary to what Krugman seems to be arguing, firms do not have to increase output when wages fall. Firms care about maximizing profits. The profit maximizing condition for firms is to use a capital and labor mix where the marginal cost of expanding output using one more unit of labor is exactly equal to the marginal cost of expanding output using one more unit of capital. A reduction in labor costs means simply that firms can reallocate inputs without adjusting output and make larger profits – but does it follow that when profits increase, output increases?
My point is that you do not need to see an increase in output across the board in order to see an increase in employment. And Krugman himself (or so I thought) was a fan of digging ditches – so wouldn’t this be an attractive option? To think of this another way, up until very recently the grass on the grounds near the Taj Mahal was cut by women using very sharp shears, by hand. Today, that same amount of grass is cut, but far fewer people (thankfully) are employed doing it, and that is because the relative cost of labor and capital have changed.
- If a minimum wage worker accepts lower wages, Krugman is assuming that there will be a cascade effect were everyone in the economy accepts lower wages. First, I do not think this has ever happened in human history. Second, why would we expect it to happen? It can only happen if a cut in the minimum wage (which is, after all, a distributional mechanism) made everyone else … less productive. I do not see how that happens. In fact, if everyone can accept lower wages now, why then don’t employers just cut wages now? Are they suddenly not the greedy, evil people that we thought they were? And don’t the Keynesians argue that wages are sticky downward? Why would they not be in this case? So, I don’t see how his “what if” scenario applies. He seems to argue that a “liquidity trap” changes everything all the time … but I am not persuaded. I am not requiring a real balance effect here – because I do not understand the need to have higher output to get higher employment. It is a much longer discussion (some other day) to explore whether monetary policy is powerless to affect output when interest rates are zero …
- Lowering the minimum wage is not the same thing as saying, “all existing minimum wage workers will get pay cuts.” Again, don’t Keynesians argue that wages are sticky downward? When the minimum wage is lowered this would allow more people to enter the labor market who are not currently employed at current wages. And hasn’t the current recession been very harmful to the employment of people who would be in this category (teens and workers with just a high school education)?
- Maybe Krugman has a monopsonistic labor market model in his head. When there are frictions in the labor market there is a small range of wages over which mandated wage increases can actually increase employment (more in a future post on how … and how likely this is) – if this is true, then decreases in wages within this range could decrease employment … but only in those wage ranges.
Truth be told, I really don’t have much of a clue what he is talking about. For someone who is such a great communicator (I mean that sincerely, right now I am reading his excellent book, “The Return of Depression Economics“) I really can’t make up from down out of that post. Perhaps they will take away my PhD for publicly admitting this – maybe I should just believe the great one, he does sing such a beautiful song, with all that stuff about real balances, outside money, traps, and the like … but …
Like the legendary manticore:
Manticores have a melodious call, like the lower notes on a flute blown together with a trumpet. Despite the beauty of the sound, most animals know to flee when they hear it. Humans would do well to follow their lead.