Friday, September 16, 2005

Evaluating hyperwage theory - or, what have you learned from your basic economics? (3)

In this post, I examine the economic adjustments ensuing in the aftermath of a hyper minimum wage. First, businesses would be able to pass on some of their higher cost to their downstream buyers. That way they spread around, at least in part, the redistribution in purchasing power I was talking about. So this passing on of cost gets measured as the inflationary effect of the hyperwage. This is a one-off price increase, unless (as I explained earlier) driven by money creation.

So far it sounds like redistribution of purchasing power, but the same economic output. Sorry, it's not as benign as that. Let's look at the second effect.

As labor becomes more expensive, employers cut down on their use of labor. (The problem is worsened if the minimum wage is set in real terms; even the offsetting effect from cost-push inflation will fail to materialize.)

This is because demand curves for labor slope downward. It really can't get much simpler than that. Many middle class households will have to say goodbye to their helpers. Too costly. What will they use instead? In the home, substitute household help with work done by household members themselves. (Poor Mommy!) In the factory, substitute with machinery or computerized systems. Or just simply shrink your business if you can't afford this either.

So the economic output will not remain the same. Because workers have been thrown out of work, economic output falls. Hyperwage theory is really better called hyper-unemployment theory.

Why would output fall? Because resources are idle. Why are resources idle? Because labor has been made artificially expensive by the minimum wage law. Workers would be willing to work at a lower wage than the minimum. (This is an unquestionable fact, look at the market right now.) They would prefer it to having zero labor income from being unemployed.

It gets worse - who would be the workers who remain in the work force? Why only the best and brightest, from whom employers are getting their money's worth at the hyperwage. The brunt of the unemployment problem would fall on the unskilled, i.e. the poor. So we can also call hyperwage a hyper-poverty theory.

This concludes our lesson on Basic Economics in Action: the case of the Hyperwage theory. Class dismissed.


old doctor said...

Yes, so far for the basic economics, but empirical evidence sometimes contradicts your statements.
For example:
Myth and measurement

In Myth and Measurement, David Card and Alan Krueger examine the claim that minimum wages will hurt low-wage workers. They found, for example, that after New Jersey's minimum wage increased in 1992, low-wage employment rose faster than in neighboring Pennsylvania, where there was no boost. In Texas, after a federal minimum wage increase, they found faster employment growth at fast-food restaurants affected by the hike than at those where wages were already above the new minimum. They wondered why economic theory failed in these cases and speculated that minimum wage increases sparked higher productivity, partly because of reduced employee turnover and partly because employers were forced to ensure that employee time was used more efficiently.

Econblogger said...

Yes, I have read some of the earlier papers by Krueger, Katz, and Card. Their work is controversial and contradicts a wealth of evidence in the other direction.

Tom Leonard of Princeton University has a very thoughtful review of the minimum wage controversy here. I go with the labor economists who find the "evidence" too fragile to upset previous empirical work and the wider body of economic theory.

Even if the minimum wage did, within the bounds of the NJ-PA study, result in higher employment, this is nowhere near the ten-fold+ increases contemplated in hyperwage theory.

f said...

Even David Card himself contradicts his own findings in the NJ-PA study with the new study on the impact of immigration on wages. Bryan Caplan a while back outlines a very simple illustration why such results are suspect:

old doctor said...

econblogger: wonderful stuff from Tom Leonard. Thanks!

f: on Bryan Caplan

I like the fourth remark (from dsquared) in the discussion under Caplan's post:

... [caplan's] results imply that the supply curve/demand curve Marshallian partial equilibrium model is not a good way to think about labour markets.
In order to make all these statements about elasticity, you basically have to ignore the fact that labour is not bought and sold in a spot market."

I agree, and also take issue with the direct application of these models to labor markets. There's a definite limit to their explanatory power, if only because of information assymetries and contract laws (which are a form of state coercion, but I remember even Caplan not being that hardcore libertarian).
Several countries with minimum wage laws have enjoyed in the nineties 'full employment' (in very different political settings such as Norway, Sweden or the U.S.). The 'minimum wages create unemployment' argument is a pure ceteris paribus reasoning.
And one of the things 'not being equal' is that contract laws that enforce minimum wages (and make it harder for them to fire someone) can force the employers to invest in a more efficient use of their labor.

On a constructive note I also agree with the other side of the argument that says that the lack of liquidity of for example european labor markets (read: it's harder to hire or fire someone, with variations across nations -- check ) you do indeed create disincentives for a rapid responce to shifting economic realities.

Anonymous said...

What variable is most important for Keynes? Sorry but your reading of GTEIM is also wrong.. here is the correct position of Keynes.. pls avoid wrong statements bec it lowers your good credibility..

Keynes (1933, 1936), by his elaboration of Richard Kahn's earlier (1931) argument, thus exalts consumption spending to a magical significance in macroeconomic analysis, contrary to the classical emphasis on production and saving for investment in order to promote the growth of output and employment (Ahiakpor 1995).

Econblogger said...


Sorry, but I can't see my misreading of Keynes, unless you would care to elaborate your objection. The "magic" arises only because of the existing underemployment; without underemployment, then the classical emphasis on savings and investment holds.