Tuesday, January 17, 2012

Minimum wages and living wages

Tim Harford argues that debates over the minimum wage are a sideshow relative to the larger problem: that some workers' output is insufficient to justify a living wage.
But if a young adult cannot produce enough of value to justify being paid a living wage, nothing we do to the minimum wage will help. He, the institutions which trained him and the society in which he lives, have far bigger problems
Harford's certainly right that the longer term solution to low pay is productivity increases; you can't mandate paying people more than their marginal product as firms will simply shift to more capital-intensive processes or to solutions through offshore outsourcing of labour-intensive components.

But not all wages need to be living wages. The 16 year old living at home working part time while going to school doesn't need one; and, his marginal product probably isn't enough to finance a real living. But the kid is learning valuable skills about workplace culture, showing up on time, dealing with customers - things that will help him be more productive in future. Note further that the minimum wage only counts pecuniary benefits; health insurance that comes bundled with many, but not all, US jobs is an increasing proportion of the overall salary package.

At least, as Harford notes, the UK Low Pay Commission, which advises on minimum wages, has let youth minimum wages stay relatively low. Workers aged 21+ are on a minimum wage of £6.08; workers aged 18-20 on £4.98; 16-17 year olds on £3.68; and, there's also an apprentice rate of £2.60.

Here in New Zealand, National's making it a bit to get younger folks onto the lower New Entrants' Wage; otherwise you have to pay the 16 year old, on his first day of work, no less than you'd pay any other minimum wage worker: $13/hour, (US $10.30 or £6.73).* Our youth unemployment rate isn't pretty, at least partially as consequence of the prior Labour government's decision to bring 16 and 17 year olds up to the adult minimum wage.

We can mandate that all wages are living wages, but we can't mandate that all the people who'd like to have work at that pay are able to find jobs.

And I worry Harford packs a bit into "market power" here when explaining Card & Krueger's results on minimum wages and employment in New Jersey:
If employers have market power in the labour market then they might actually offer a lower wage than the balance of competitive supply and demand would produce. Some workers would rather keep looking or sign up for welfare payments, and so employment is lower at this level. Introduce a minimum wage and both wages and employment increase, while profits fall.
Imagine a remote mining town with one big employer who pays the same basic wage to everybody. If you can't pay the new guy more than your existing workers, then you have incentive to abstain from hiring somebody whose output would cover his salary but wouldn't cover the amount you'd have to pay in salary increases to all your other workers. So increases in minimum wages can increase employment and wages in places with monopsonistic employers and low labour market mobility. But in low-skilled retail in suburban New Jersey where there's no way that hiring an additional student to stock shelves at the 7-11 forces you to push up your other workers' wages? Any retailer who's stuck with a labour shortage at current wage rates and the chance to hire an additional worker for a wage less than the worker's marginal product but above prevailing rates has incentive to defect from any cartel of employers. And remember that the theoretical argument works by having people enter the workforce in pursuit of the new higher minimum wage who were outside of the workforce previously; if we start with unemployment - people in the workforce who cannot get jobs at the prevailing wage - the theory can't really apply. I'm not sure that many of our current problems come from too many folks voluntarily sitting outside the labour force because prevailing wages are too low.

At last report, median hourly earnings were $20.38 (average $24.78). Our minimum wage is 63% of the median wage or 52% of the average; at these levels, we expect reasonable disemployment effects, especially among youths.

13 comments:

  1. Surely relevant here is Adam's Smith comment

    "We rarely hear, it has been said, of the combinations of masters, though frequently of those of the workman. But whoever imagines, upon this account, that masters rarely combine, is as ignorant of the world as of the subject."

    In the language of more modern economics, there are multiple equilibria and people develop conventions ("spontaneous order") that punishes those who break them. What else are "roundtables", "business lunches" and the rest but the attempt to create and maintain local monopolies (monopsonies)?

    David S

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    1. David: that works among a small number of employers. But think about how large the "combination of the masters" would really need to be in retail in order to exercise collective monopsony power. I don't think it's possible to have a combination large enough to exercise collective monopsony power but also small enough to avoid detection. Again - can buy it for small mining town; can't for New Jersey retail.

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    2. Would you employ the same logic to trade unions?
      ie only unions with a few dozen people can be effective, so big unions should be powerless...? (Adam Smith's other point, that combinations of workers are always treated as more threatening.)

      David S

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    3. I'd put it differently. If there are lots of competing unions, and laws don't force employers to be bound to any particular union for provision for any particular service, then no union can exercise market power. But if there are only a small number of unions and companies are forced to handle labour relations through a union, then we're back into the market power scenario.

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    4. In the case of New Jersey employer/employee relations, I would guess extra-judicial mechanisms of enforcement are probably the most important bits of the spontaneous order ("An offer you can't refuse...?")

      More generally, the argument I am offering is that this is a co-ordination game where players care which equilibrium they end up at (something like a battle of the sexes game). The interpretation of Card and Kruger is then that margins were high enough to support a number of different wage rates (a limited number of locations for Jersey shopping malls reduced competition?) and the intervention shifted expectations to an equilibrium that gave a higher payoff to employees.

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    5. @Anon: Maybe. But in the scenario described in Harford's piece, a monopsonist holds wages down to keep salaries lower for all the inframarginal workers; the marginal worker would provide marginal revenue in excess of his wage but winds up staying out of the labour market because wages don't hit his reservation price. If those workers do produce marginal revenue in excess of wages paid, surely in a market with lots of small firms making hiring decisions, lots of those small firms would have a sufficiently small inframargin that bidding up salaries a bit would be privately optimal. And then I don't see how we fail to get to the higher wage equilibrium even absent minimum wage hikes. I suppose you could do it if you specify that it's only for a few large firms that those workers provide that excess surplus, but I'm not sure I'd buy it.

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    6. The key argument is not whether or not there is an incentive to cheat, because there clearly is, but whether conventions are strong enough to deter cheating. I buy Hayek's view that markets are about information and its use: If employers need a credible mechanism to maintain a hiring monopsony then some entrepreneur will find it.

      On the Hartford, it is not clear there is some given "marginal product" characteristic of an individual. The most effective (and cost effective) welfare reforms are ones that make being on benefit uncomfortable, and the vast majority of those who shift from benefit end up in work. This suggests the constraint is not the individual's marginal product, but the incentive to achieve that marginal productivity. Clearly the difference is irrelevant to an employer given current policy settings, but it suggests policy makers are not properly using the tools available to increase employment.

      David S
      (PS I use anonymous in your "reply as" option box because none of the other options worked for me)

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    7. @David S: You can go at it either way: policy reduces the reservation price by making the reversion option less attractive, or firms increase offered wages and entice workers out of the reversion option. In the monopsony world, though, we still wind up with labour sitting out whose marginal product exceeds wages. I still don't believe that a small firm would refrain from increasing its salary offer to bring in net-profit-increasing workers just because of social conventions. Would a small town diner with a "Help Wanted" sign on the window never think to bump up the hourly pay a bit to draw somebody into the labour force if the expected net benefits are still positive?

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    8. Certainly they would think about it, but a person running a small town diner is in a repeated game with the people they and their family will have to interact with in all kinds of contexts. An extreme example is the way the segregated south made sure 'coloureds only' sections of precisely those kinds of diner were always less comfortable than the sections for whites. Mostly that was maintained by social convention.

      Less dramatically, experiments on prisoners' dilemmas, ultimatum games and dictator games, all suggest social conventions are a powerful counter motivation to financial incentives, even in a context when the potential disapprobation is trivial.

      David S

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    9. David, I'm with you on the power social convention. But New Jersey of the 1980s is hardly Birmingham of the 1940s. Would there really have been informal social pressure on the owner of a small shop who paid a nickel or dime above the minimum wage? You need a strong social norm that's widely shared.

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    10. If that looked like breaking the monpsony, yes. What is surprising about the experiments is that the environments are designed to minimise the social cues that re-enforce norms (like knowing who you are interacting with), yet people still respond to them.

      A norm among small business operators that was something like "don't do anything that lets those people get one over us" would be enough. Thomas Schelling's "micromotives and macrobehaviour is good on this.

      David S.

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  2. I thought Card Kruegers work on fast food employment was debunked. I recall that their measure of employment was shoddy and that their data collection method was dodgy.

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    1. There's been subsequent work by others finding similar results, like the Dube study. See this post...

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