Minimum wages & jobs

I woke up this morning with a slight headache, so I took a paracetamol and now feel fine. But if one paracetamol makes me feel OK then surely a hundred will make me feel fantastic.

You might spot an error in this thinking. It is, though, the same mistake that some critics of me (and Tim Harford and Martin Wolf and Ryan Bourne) are making when they question our hostility towards the proposed rise in the minimum wage.

I'll grant that most studies (pdf) of the impact of the UK minimum wage have found no significant impact upon employment - although (pdf) there (pdf) are exceptions to this (pdf). But there's a reason for this; the NMW has been set at a low level. The Low Pay Commission has helped ensure that the NMW has been administered in a safeish dose. But it does not follow that a higher NMW would be safe. Just as paracetamol is safe in a low dose but dangerous at a high one, so too are minimum wages. The fact that most - not all but most - international studies show that minimum wages do reduce demand for labour shows us that, where they are set carelessly, they can do harm.

Let's consider three possible ways in which this view might be wrong.

First, employers might simply accept a squeeze on profits. However, which this might be tolerable for small wage increases, it'll not be possible for bigger rises which might make the difference between profit and loss. Firms which struggled by on a modest NMW might shut if there's a higher one.

Secondly, firms might respond to higher wages by increasing efficiency; there's some evidence that this has happened, and it is possible because there is a long tail (pdf) of badly managed firms where efficiency gains might be made. Three things, though, make me question how far this is possible:

 - Whilst it might be possible for firms to raise productivity by one or two per cent, the big gains necessary to offset a 13% rise in the NMW (on the OBR's estimate) might be harder to find.

 - Efficiency in this context often means work intensification: chambermaids cleaning more hotel rooms, care workers seeing more clients, and so on. This means workers might pay for higher wages with more stress.

 - If productivity is to rise without job cuts, then output must increase: this follows from the definition of productivity. But how will this extra output be sold? One possibility is that aggregate demand rises. But, in tightening fiscal policy, Mr Osborne has done nothing to permit this. The other possibility is that firms will cut prices. But the OBR expects the opposite to happen.

Another way in which a higher minimum wage might be consistent with rising employment is if there is monopsony - if workers are paid less than their marginal product.

Again, I'll concede that this might be true (pdf) in some cases. However, a much better way to tackle the problem of monopsony is to increase workers' bargaining power - through stronger trades unions, out-of-work benefits which are high enough to allow people to reject rip-off job offers or through a full employment policy. These allow wages to rise where workers are under-paid without forcing wages above marginal product, which would destroy jobs. However, Mr Osborne has rejected these alternatives in favour of the blunt instrument of a law which bears equally upon monopsony and upon competitive labour markets. This is surely sub-optimal.  

My point here is a simple one. The economy doesn't operate exactly as the textbooks say. Wages aren't exactly equal to marginal product and firms don't operate at maximal efficiency. Instead, as Adam Smith said, there is a great deal of ruin in a nation. This ruin provides room for minimum wages to rise a little without hurting jobs. But is it really plausible that there is so much ruin as to permit a big rise without adverse effects?

Mr Osborne has given us no reason to think this. The kindest thing one can say about his plan is that it is a bold experiment. There are less kind things.

Comments

[Bob]

"But is it really plausible that there is so much ruin as to permit a big rise without adverse effects?"
What adverse effects would there be?

[Neil Wilson]

The 'Why does the Mininum Wage Have No Discernible Effect on Employment Paper' seemed pretty good to me.

"But, probably the most important channel of adjustment is through reductions in labor turnover, which yield significant cost savings to employers."

http://www.cepr.net/documents/publications/min-wage-2013-02.pdf

[Dave Timoney]

One possible factor in Osborne's calculation is the current low level of inflation. Conceivably, some employers will simply pass on the wage rise through higher prices, particularly if they assume that their domestic competitors will do likewise. In other words, the Chancellor is once more being opportunistic.

[e]

It’s quite possible that I am excessively inclined towards seeing malevolent intent among today’s Tories, but the private provision of “welfare” is growing; why will this not result in a supply of unskilled labour being made available at a price below any minimum or living wage?

[Tim]

If a business is dependent on exploitation to survive should we support that business? Sad to see thoughtful economists backing inequality. :(

[Matt Moore]

I don't remember any Leftist commentators criticising Miliband's very similar policy.

Anyway, this policy clearly hurts the worst off. So does the existing NMW. That fact that the impact isn't "measurable" shouldn't mean much to you Chris, since you frequently and admirably point out the limit of our possible economic knowledge.

Wage floors cause unemployment. There is emphatically no monopsony power in the unskilled labour market. In the case of a low wage floor, it harms only a small number of very marginalised people.

[Steven Clarke]

You say, "The kindest thing one can say about his plan is that it is a bold experiment", linking to an article which says quite rightly that we understand policies better when we experiment with them.

However, it's usually not a good idea to roll out bold experiments nationwide.

Hopefully, there will be some better experiments coming from the States, where some cities are implementing a $15ph minimum wage:

http://www.bloombergview.com/articles/2015-05-27/finally-an-answer-to-the-old-minimum-wage-question

[Dinero]

A high NMW can also reduce employment with an employer finding a way for one employer to do the job of two employees, of course though on the other hand that is progress in productivity.

[Denis Drew]

Marginal utility of labor? How about a closer fitting labor market paradigm: wild, wide swinging leverage?!

A firm which may lose 5% of sales when it hikes prices 5% -- leaving a wash if the last 5% of sales is the profit (of course product prices would normally be pushed to this equilibrium point) ...

... OTH, if labor is 10% of costs and raises its price 50% -- which raises product price 5% -- labor is way ahead ...

... OTH, if the same firm above can squeeze labor costs from 15% to 10% it can double its profit.

Conclusion: Labor, like capital, cannot charge too much because the customer will not pay -- cannot charge the customer unfairly absent some arm twisting (always illegal) setup. Labor OTH can be paid too little if it cannot bargain effectively by withholding its portion of production (which in the US is always legal). Minimum wage just mimics bargaining of course.

System wide solution in the US: make union busting the same kind of felony that every other form of market leg breaking is. The de-unionized US labor market has become one big Walmart.

[Blissex]

Obviously the government scores all proposal as to their regional impact.

Cutting benefits will impact mostly the North, and raising the minimum wage will not impact much the costs of businesses in the South, but will impact more the businesses in the North, where I would expect the percentage of jobs paying minimum wage to be much higher.

The consequence will eventually be to boost the economy and this the house prices in the South.

[Blissex]

«raising the minimum wage will not impact much the costs of businesses in the South,»

The cost of renting commercial premises usually is far more important in the South for many types of businesses that hire minimum wage workers.

[greg]

Nobody seems to be looking at the macroeconomic effects. The demand for goods and services by labor is equal to the wage bill for labor. If the equilibrium of supply and demand for labor is in the inelastic region of the demand curve, then a minimum wage above the equilibrium point, (up to the point of unitary elastic demand for labor,) will increase the wage bill. This will increase the demand for goods and services by labor, and thus indirectly increase the demand for labor itself. The point of unitary elastic demand for labor would thus seem to be a socially desirable point, since at this point labor's purchasing power is maximized.

Conversely, allowing this equilibrium point to fall into the inelastic region of the demand curve for labor would seem to be economically undesirable. Any decrease in wages in this region would decrease the total wage bill, and thus the amount of demand for goods and services that labor provides. This would further decrease the demand for labor, resulting in a vicious and destructive cycle which only other factors might mitigate.

[ben findlay]

Been reading your blog for some time. Always interesting, usually persuasive. Would be very interested in your thoughts on Daniel Finkelstein's recent argument that political reality of cuts beimg difficult means sound economic policy along the lines that you espouse is not really possible. How much of a point do you think he has?

[Christian]

Your point about work intensification seems the only hope that this policy might be a success. The fact that it would help to explain the UK productivity paradox if it did is some sort of empirical evidence to support it.

Another way of seeing the intensification is that low paid workers are currently preferring more congenial jobs on NMW because they can afford to take them, but only as long as they receive working tax credit. Once this subsidy is withdrawn they will switch to more intensive, more productive jobs since the alternative is unemployment.

In other words employers offering harder but more productive jobs are being outcompeted by employers offering an easier working life who are being subsidised to do so by benefits.

The presence of pay-subsidising tax credits moves this debate away from the classical economic arguments about the destructiveness of statutory minimum wages, because the policy subsidises firms that offer higher non-wage benefits against those that don't.

[Maxamillian]

Pay people a basic income for fuckssake. Or have a job guarantee of sorts that provides an employer of last resort. Job done - so to speak. All this other crap is tinkering.

[Deviation From The Mean]

I love the paracetamol analogy! But...

There is not much empirical evidence in this article and for good reason, it doesn't really exist!

You may say, but wait I have very reliable logic to back up the assertions so I don't really need any empirical evidence here.

But in reality all you have are some stupid basic models with a few curves, which are totally dependent on limited variables and which almost certainly won't play out as expected in the real world, where the variables go onto infinity.

So this is an article of faith, though many of the critical comments above fall into this trap of stupidity masquerading as certainty.

Evolution ALWAYS exists in a certain environment, a different environment will create a different evolutionary outcome. The minimum wage can be used to create an environment where a certain outcome would be achieved, possibly firms that rely on poverty wages would die out for example but who knows what the overall impact would be.

Free your minds from the free market straight-jacket.

Create your own environment!

[nick ford]

Every now again in public life some clown creates a piece of spin purporting to be economic analysis and it takes hold, and results in bad policy. This is what has happened here.
The Showman Clown in question is Steve Hilton, the amateur economist who has David Cameron's ear.(At least Mrs Thatcher's advisers like Patrick Minford were vaguely competent).
The piece of spin is that by paying tax credits, the government is 'subsidising' employers who pay low wages, implying such employers are making massive excess profits. The conclusion the receiver of this spin is supposed to make is that the minimum wage can be raised and the only losers will be these excessively profitable employers. This piece of bullshit has been allowed to gain traction because no politicians have had the courage to challenge it, for fear of being thought to be on the side of these odious but largely non-existent employers.
There is no doubt raising the minimum wage will benefit those recipients of it who retain their jobs. But because most employers operate in competitive markets they will pass on these extra costs; goods and services that are produced with a high content of low skilled labour will rise in price relative to goods and services that use little low cost labour. The bill for this higher minimum wage will largely be paid by the rest of the population via higher prices and taxes. It will not be paid by some fictional group of billionaire tight fisted capitalists as Steve Hilton likes to pretend.
There is therefore no saving to the rest of the population by raising the minimum wage and reducing tax credits. They will simply pay a different way.
Further, the measure will inevitably result in higher unemployment amongst the less able, as Chris points out. The taxpayers will have to pay for this unemployment eventually, and so will eventually be worse off.
David Cameron would do better to replace Steve Hilton with Paris Hilton, for at least the latter's vacuous ideas will not damage the economy.

[aragon]

George Osbourne's motivation was to move costs from Government to Employers, Hence the even larger cut in Tax credits (to employees) as he proceeds in his crusade to balance the budget (through Austerity) and give even more wealth to the rich,(Inheritance Tax Cut.) all of which as 'greg' points out destroys aggregate demand.

As 'e' noted, the Tories are in favour of privatising welfare, Ian Duncan Smith advocating workers save for sick pay (and BBC's 75 years old+ licence fee waiver).
http://www.mirror.co.uk/news/uk-news/david-cameron-thinks-tories-should-6060474

I advocated making the minimum wage a living wage! (Steve Hilton is innocent)

I am with 'Maxamillian' having advocated both a Job Guarantee and a Citizens income.

If you don't want to subsidise low wages, (and I don't) offer employment (Job Guarantee), or ensure a minimum income (Citizens Income) or enforce a National Minimum Wage.

I regard tax credits as sub-optimal subsidy for low pay and don't understand economists apparent support for this policy. As 'Tim' said, we should not support business in the exploitation of Labour.

Labour cannot be expected to compete with automation at any price. Automation increases productivity but can, in many cases, undercut Labour eventually at at any cost. Higher Labour costs can increase automation and higher productivity, potentially making goods and services cheaper.

Employers clearly exert oligopsony or monopsonistic competition with regard to unskilled Labour with further pressure on the reserve activity, Benefits (Welfare), and excess supply through immigration. Therefore an increase in the minimum wage results in an increase in social welfare (The reduction in Tax Credits does not).

Stronger Trade Unions - Government Policy to reduce Union power. (Changes to voting)

Higher Benefits - Government Policy to reduce benefits (Tax Credit Cuts).

Higher Minimum Wage - Government Policy to reduce benefits supported and shift costs from Government and does not affect Union Power.