The minimum wage is a contentious issue among economists, and yet it enjoys near-universal support among the public. In my view, public views of the minimum wage are simply the result of a lack of careful thought by most people. Daniel Kahneman’s theory that people, when faced with a difficult question, substitute a simpler question that they can easily answer, applies particularly well in this case. People answer the question of whether they would like people to earn more when the real question is whether government should mandate higher wages (I first heard this argument from Bryan Caplan on EconLog).
A purely empirical argument for or against the minimum wage is methodologically wrong-headed because empirics do not speak for themselves. Sound theory must be the economist’s first tool in understanding the effect of a policy such as the minimum wage.
Before we can understand something like the minimum wage, we must understand the role of prices in allocating factors of production to their various uses. The price of a factor signals to entrepreneurs that that factor is scarce, that it is needed elsewhere in the economy, and that the entrepreneur who can reduce his usage of relatively more scarce factors in favour of relatively less scarce ones can earn profits, while entrepreneurs who fail to do so earn losses. I give the example of a sandwich shop during an oil boom; the high price of labour caused by the oil boom leads the sandwich shop to substitute away from labour in various ways. (more…)
One thousand internet points to the commenter who can correctly identify this image!
Here’s a conversation between a reporter and one of the alleged beneficiaries of Seattle airport’s $15/hour minimum wage:
“Are you happy with the $15 wage?” I asked the full-time cleaning lady.
“It sounds good, but it’s not good,” the woman said.
“Why?” I asked.
“I lost my 401k, health insurance, paid holiday, and vacation,” she responded. “No more free food,” she added.
The hotel used to feed her. Now, she has to bring her own food. Also, no overtime, she said. She used to work extra hours and received overtime pay.
What else? I asked.
“I have to pay for parking,” she said.
This may have come as a surprise to some, but not to those of us who are familiar with economic theory. The minimum wage hike here was large and sudden, so the impact was dramatic and visible.
It should be noted, however, that sound economics does not draw causal connections between events (such as a minimum wage hike and a cut in workers’ benefits) because of examples like this one. If A and B happen to coincide, we cannot say whether this was a coincidence, or whether some third event, C, caused both A and B, or whether A and B will continue to coincide outside of the particular context in which they were observed. The thesis that a minimum wage hike will lead to cuts in workers’ benefits where possible rests on a solid, timeless theory derived from known premises about human action and the nature of economic competition.
The unhampered market is a selective process that selects for those entrepreneurial strategies that can generate the highest possible returns. If an entrepreneur directs capital such that his costs exceed his revenues, he must change his approach or face continual losses and eventual bankruptcy. If an entrepreneur directs capital such that his revenues exceed his costs, he can plow his profits back into his business and he can get greater sums from creditors, so he will come to control more capital in the future. The outcome of this process is to move the task of allocating resources from less able hands to more able hands.
Entrepreneurs hire factors of production (including labour) when their expected marginal revenue products exceed their costs. If they didn’t behave in this way, the selective process described above would “retire” them from entrepreneurship. If an entrepreneur expects a return of $12 for an additional hour of cleaning services, and he can hire a cleaner at a wage of $10, he will do so. He will continue to hire cleaning services until his expected return for the next hour of cleaning services falls below $10.
Employee benefits simply fold an additional transaction into this process. Rather than paying for cleaning services and then contracting separately for the cleaner’s parking space (which will often come with additional costs), the entrepreneur can purchase a different service, cleaning services with parking space, the expected marginal revenue product of which will be lower than the expected marginal revenue product of only cleaning services by the cost of providing the parking space. However, since cleaners value parking, they will also accept lower wages when the employer provides parking. If the cleaners are willing to accept a wage cut for parking that is greater than the cost to the employer of providing that parking, both parties can exploit additional gains from trade by contracting with the parking benefit.
Now, consider what happens when the government imposes a price control such as the minimum wage. The minimum wage applies to contracts with and without benefits. Employers provide benefits because, although these benefits cost more to provide, employees are willing to accept wage cuts that are at least equal to the cost of the benefit. At the imposed higher wage, the employee cannot legally accept a wage cut in return for a benefit, so those gains from trade must be foregone.
This is precisely what happened to the worker quoted above. However, since we derived the result from sound economic theory, we can generalize the result beyond this particular worker, beyond this particular wage hike, and far beyond the Seattle airport. We can generalize it to any time and place where people buy and sell factors of production under competitive market pressures.
One thousand internet points to the commenter who can correctly identify this image!
Here’s a conversation between a reporter and one of the alleged beneficiaries of Seattle airport’s $15/hour minimum wage:
“Are you happy with the $15 wage?” I asked the full-time cleaning lady.
“It sounds good, but it’s not good,” the woman said.
“Why?” I asked.
“I lost my 401k, health insurance, paid holiday, and vacation,” she responded. “No more free food,” she added.
The hotel used to feed her. Now, she has to bring her own food. Also, no overtime, she said. She used to work extra hours and received overtime pay.
What else? I asked.
“I have to pay for parking,” she said.
This may have come as a surprise to some, but not to those of us who are familiar with economic theory. The minimum wage hike here was large and sudden, so the impact was dramatic and visible. (more…)
