Making Sense of the minimum wage

Recently the Cato Institute put out a new Policy Analysis (No. 867) on Making Sense of the Minimum Wage: A Roadmap for Navigating Recent Research by Jeffrey Clemens. Clemens is an associate professor of economics at the University of California, San Diego.

Executive Summary:

The new conventional wisdom holds that a large increase in the minimum wage would be desirable policy. Advocates for this policy dismiss the traditional concern that such an increase would lower employment for many of the low-skilled workers that the increase is intended to help. Recent economic research, they claim, demonstrates that the disemployment effects of increasing minimum wages are small or nonexistent, while there are large social benefits to raising the wage floor.

This policy analysis discusses four ways in which the case for large minimum wage increases is either mistaken or overstated.

First, the new conventional wisdom misreads the totality of recent evidence for the negative effects of minimum wages. Several strands of research arrive regularly at the conclusion that high minimum wages reduce opportunities for disadvantaged individuals.

Second, the theoretical basis for minimum wage advocates’ claims is far more limited than they seem to realize. Advocates offer rationales for why current wage rates might be suppressed relative to their competitive market values. These arguments are reasonable to a point, but they are a weak basis for making claims about the effects of large minimum wage increases.

Third, economists’ empirical methods have blind spots. Notably, firms’ responses to minimum wage changes can occur in nuanced ways. I discuss why economists’ methods will predictably fail to capture firms’ responses in their totality.

Finally, the details of employees’ schedules, perks, fringe benefits, and the organization of the workplace are central to firms’ management of both their costs and productivity. Yet data on many aspects of workers’ relationships with their employers are incomplete, if not entirely lacking. Consequently, empirical evidence will tend to understate the minimum wage’s negative effects and overstate its benefits.

Tyler Cowen interviews Russ Roberts

What are the virtues of forgiveness? Are we subject to being manipulated by data? Why do people struggle with prayer? What really motivates us? How has the volunteer army system changed the incentives for war? These are just some of the questions that keep Russ Roberts going as he constantly analyzes the world and revisits his own biases through thirteen years of conversations on EconTalk.

Russ made his way to the Mercatus studio to talk with Tyler about these ideas and more. The pair examines where classical liberalism has gone wrong, if dropping out of college is overrated, and what people are missing from the Bible. Tyler questions Russ on Hayek, behavioral economics, and his favorite EconTalk conversation. Ever the host, Russ also throws in a couple questions to Tyler.

The employment effects of minimum wages

A brief summary of the state of play.

First, the evidence on the disemployment effect of minimum wages is contested, and there clearly are studies that find no employment effect – both in the United States and in other countries. However, the preponderance of evidence indicates that minimum wages reduce employment of the least-skilled workers. Earlier estimates suggested an ‘elasticity’ of about -0.1 to -0.2. Many estimates are still in this range, some are closer to zero, and some are larger. To be clear, some researchers may have reason to put more store in the types of estimates that tend to find no employment effects – typically the research designs that I have labeled ‘close controls’. I have indicated reasons I am somewhat skeptical of these designs, but also indicated that the jury is still out. More definitively, though, it is indisputable that there is a body of evidence pointing to job losses from higher minimum wages. Characterizations of the literature as providing no evidence of job loss are simply inaccurate.

Second, there are two kinds of changes in minimum wages about which we know a lot less. The first change is the adoption of much higher minimum wages – as is happening in the United States with serious movement toward a $15 minimum. There is a great deal of uncertainty about the employment effects of a $15 minimum wage. One thing we do know is that it would impact far more workers than the current minimum wage, especially in lower-wage states and lower-wage areas of most states. More speculatively, my sense is that the costs of a much higher minimum wage are likely to be understated by simply scaling up the effects based on employment elasticities in the existing literature, because the much higher share of workers affected will reduce employers’ ability to partially offset minimum wage increases by changes in margins other than employment.

The second kind of change about which we know relatively little concerns the introduction of a new minimum wage – like in Germany. There is some evidence from the introduction of a new minimum wage in the United Kingdom. Some of this evidence points to job loss, but the evidence is mixed. And, of course, the institutional setting is not the same.

From "The Econometrics and Economics of the Employment Effects of Minimum Wages: Getting from Known Unknowns to Known Knowns" by David Neumark, German Economic Review, Forthcoming.

Coase and Plant on the market versus the firm

In a 1937 paper, "Centralise or decentralise" Arnold Plant writes,

"[...] centralisation is the means by which the collaborating enterprises secure the advantage of specialised services or equipment which would not otherwise be available to them on such favourable terms, if at all. If the service or merchandise in question is freely bought and sold on any scale in a well-organised market, there will be no need for centralisation of firms. It is the absence of a well-organised market which may justify firms in pooling their requirements".

He sees a clear trade-off between market provision and in-house production. When markets are available and relatively cheap their use makes sense. But when they are expensive, or unavailable, production in a firm makes sense. Today we would express this by saying when transaction costs are high we use the firm but when they are low we use the market.

Plant's line of argument has a somewhat modern, Coaseian, feel to it. The question this gives rise to is, For how long had Plant been thinking in this way? And did he discuss this line of reasoning in classes that Coase took? Or does the causation run in the opposite direction? Plant's paper was published in 1937 and we know that Coase's analysis of the firm was largely complete by 1932. Did Coase discuss his approach with his former teacher? Or did the two of them reach similar conclusions independently?

I'm not sure we know enough to answer these questions, but it does raise an interesting possibility about the development of Coase's ideas on the firm.

Ref.:

• Plant, Arnold (1974). 'Centralise or decentralise?'. In Arnold Plant, "Selected Economic Essays and Addresses (174-98), London: Routledge & Kegan Paul. First published in Arnold Plant (ed.), "Some Modern Business Problems: A Series of Studies", London: Longmans, Green and Co., 1937.

The 2018 trade war

Has the trade war with China been good for American businesses and consumers? The first results are in, and David Weinstein tells Tim Phillips who the winners and losers are.

Latest Blogwatch column

My Blogwatch column from the latest issue (Issue 63, December 2018) of the NZAE magazine Asymmetric Information

Being neoclassical before it was cool to be neoclassical: the case of the theory of the firm

This paper looks at the contribution made by pre-1870 writers in economics (proto-neoclassicals) to what would later become known as the neoclassical theory of the firm. In particular we briefly consider the work of Dionysius Lardner, Johann von Thunen, John Stuart Mill, Charles Ellet, Jr. and Antoine Augustin Cournot. This paper shows that the proto-neoclassical "theory of the firm" gave rise to the neoclassical theory of markets.

Being neoclassical before i... by on Scribd

The division of labour and the mainstream theory of the firm

This paper looks at the influence (or lack of influence) that ideas to do with the division of labour have had on the mainstream economic theory of the firm. The notion of the division of labour goes back at least to the ancient Greeks and ancient Chinese but it took two thousand years before the division of labour was used to create a theory of the firm. It was only in the 20th century that such a theory started to be developed.

The division of labour and the mainstream theory of the firm by Paul Walker on Scribd