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.

4 comments:

Roehlano 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.

Anonymous 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:

http://econlog.econlib.org/archives/2005/05/infinite_contra.html

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).

Roehlano said...

Anonymous,

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.