Wednesday, 25 September 2013

Greg Mankiw makes some observations on the minimum wage (updated)

At his blog Greg Mankiw has posted some observations on the minimum wage debate. Mankiw was discussing the topic of the minimum wage with a fellow economist who supported the idea. During the conversation this economist referred to a paper "Optimal minimum wage policy in competitive labor markets" by David Lee and Emmanuel Saez in support his argument in favour of a minimum wage. Mankiw comments,
What was notable to me about this paper is the incredibly strong assumptions they need to make their case. In particular,
Assumption 1. Efficient rationing: Workers who involuntarily lose their low-skilled jobs due to the minimum wage are those with the least surplus from working in the low-skilled sector.
Later they point out:
Finally, the desirability of the minimum wage hinges again crucially on the “efficient rationing” assumption. Under “uniform rationing”, where unemployment strikes independently of surplus, the minimum wage cannot improve upon the optimal tax allocation, a point formally proven in Lee and Saez (2008). Indeed, with efficient rationing, a minimum wage effectively reveals the marginal workers to the government. Since costs of work are unobservable, this is valuable because it allows the government to sort workers into a more socially (albeit not privately) efficient set of occupations, making the minimum wage desirable. In contrast, with uniform rationing, as unemployment strikes randomly, a minimum wage does not reveal anything about costs of work. As a result, it only creates (privately) inefficient sorting across occupations without revealing anything of value to the government. It is not surprising that minimum wages would not be desirable in this context.
Rather than providing a justification for minimum wages, the paper seems to do just the opposite. It shows that you need implausibly strong assumptions, such as efficient rationing, to make the case. I cannot see any compelling reason to believe that in the presence of excess supply of workers, the market will somehow manage to efficiently ration the scarce jobs.
Note Lee and Saez admit that unemployment will be caused by the minimum wage - the standard argument against the minimum wage - but argue this is desirable if the government values redistribution toward low wage workers and if the unemployment induced by the minimum wage hits the lowest surplus workers first, as highlighted by Mankiw.

The basic idea can be seen in Figure 1 from the Lee and Saez paper. Note that the unemployed have to be the low surplus workers.

Update: David Henderson also comments on the Lee and Saez paper here and Don Boudreaux does so here.

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