More Krugman on the minimum wage

by on December 17, 2009 at 2:36 am in Economics | Permalink

Krugman offers a response to a few critics, including I believe myself.  His latter two points are on the macro model, his first point is trying to establish the relevance of the macro model for the minimum wage analysis:

1. Why did I go from minimum wages to overall wages? Clearly, a cut in minimum wages –which only apply to some workers – can raise the employment of those workers at the expense of other workers. But the advocates of a cut are claiming that they can raise overall employment. The only way that can happen is if a reduction in average wages raises employment.

There is a simple story here.  Lower the minimum wage and firms with market power will in general hire more labor.  (Sethi's critique refuses to consider that mechanism but simply shift the MC curve and watch it happen.)  In the most straightforward setting the total wage bill increases, even if the average wage falls.  With a higher total wage bill, there is no downward deflationary spiral.  This general equilibrium point was emphasized by Jacob Viner in his very careful 1937 review of Keynes but it remains a neglected insight.

The negative scenario, namely the total lower wage bill, can possibly occur if employers use the lower legal minimum wage to lower wages for currently employed workers who were at the previous minimum.  A few observations here:

1. Even then the net effect is indeterminate and not necessarily in the Keynesian direction.  The total wage bill still could go up or even if the total wage bill goes down the total flow of purchasing power need not decline, given that employers just don't sit on their extra money.  (This same point applies to all other second-best scenarios.)

2. The model already has assumed short-run wage stickiness, so it would be odd to suddenly relax that assumption as a way to get the total wage bill to fall.  

3. Given that minimum wages don't cover so many workers, the AD effects are likely quite small in any case.

4. The new workers may well be collecting EITC, which will strengthen any aggregate demand effect from their employment.

5. The increase in aggregate supply — more work goes on! — itself has a positive effect on aggregate demand through subsequent Hutt-like, supply-side multipliers.  It would be unusual if velocity shifts were completely neutralizing with respect to this increase in production.

6. The "then why don't we raise the minimum wage to $30 an hour" meme is an overrated "right-wing talking point" in a lot of policy debates.  Still, in this context, it remains a good question from a purely analytical point of view.  Such a change would not boost aggregate demand in most plausible models and from that admission you can work backwards.

Mixing up average wages and the wage bill is a common Keynesian confusion; they're not always moving in the same way, though they may seem to in some very simple models.  Krugman's #1 is assuming a link between the micro and macro change that simply doesn't have to be there.  

That all said, it's a fair enough point to note that changes in the minimum wage will likely bring only small positive effects in any case.

1 Commenterlein December 17, 2009 at 3:15 am

I don’t have anything clever to add, so let me just say – great post!

2 RepresentativeAgent December 17, 2009 at 3:53 am

Tyler,

What about the “tagging” justification for the minimum wage? Under certain assumptions, the minimum wage rations jobs to those that need it the most. The people who needs the jobs least such as teenagers get rationed out. The minimum wage then simply allows the government to identify “low” types and help them.

3 NPTO December 17, 2009 at 8:04 am

Has anyone actually established that the chances of a reduction in MW causing a downward spiral in wages overall is non-significant?

4 Russ Nelson December 17, 2009 at 8:24 am

First, it must always be repeated that Krugman is no longer an economist, so his drooling need be taken no more seriously than that of anyone else who refuses to think like an economist.

Second, the minimum wage’s harm is limited by the number of workers to whom it applies. Thus if cancelling it would produce an increase in aggregate demand, that increase would be very limited,just as the number of jobs destroyed by the MW is very small.

5 mattmc December 17, 2009 at 8:57 am

What about a company competing with overseas competitors with lower wages? Couldn’t a lower minimum wage help that company survive and thus prevent all of its jobs from disappearing (or at least moving to a lower wage market?)

6 Bill December 17, 2009 at 9:50 am

How about cutting the minimum wage for executives when their earnings drop since we are, afterall, talking about the total wage package of a firm, not just one class of workers? Talk about sticky compensation.

7 LonelyLibertarian December 17, 2009 at 10:03 am

I am not sure it is even charming – it is certainly misguided – more health care is not a guarantee of longer life – read some of the recent research on prostate cancer treatment – it makes a pretty strong case for more treatment REDUCING both the length and quality of life…

As for the MW argument – I think we are missing the impact on the individual. Allowing a worker to EARN a wage can have benefits on self esteem and one’s future when compared to the alternative. The worker who can get hired at 90% of the minimum wage but not at 100% is being harmed by the policy IMHO.

8 Bill December 17, 2009 at 10:30 am

Nice equation, but what about Card and Krueger’s work.

9 anon December 17, 2009 at 10:48 am

How about cutting the minimum wage for executives when their earnings drop since we are, afterall, talking about the total wage package of a firm, not just one class of workers? Talk about sticky compensation.

Ah, written like a true central planner (or employee of a non-profit or government entity) – because it is you Oh Wise One who would decide when and who needs the cutting, correct?

Anyone living in a free market system who has had to meet a payroll for longer than a year or two would never make such a moronic statement.

Drag yourself kicking and screaming out of the paradise of 1930’s central planning and into the 21st century.

Unlike many people, I am very optimistic about the long term future. The historical tendency is toward more liberty, not less.

You are a relic, sir, even if you and your ilk win a few battles here and there. Because your centrally planned system is going to collapse.

Entropy as liberty.

“There are those inclined to liberty–freedom of the individual to live his life or her life in any peaceful way. And there are those who are inclined to mastery–permitting others to live their lives only as another sees fit.” Louis Carabini

10 Philo December 17, 2009 at 11:05 am

“The ‘then why don’t we raise the minimum wage to $30 an hour’ meme is an overrated ‘right-wing talking point’ in a lot of policy debates. Still, in this context, it remains a good question from a purely analytical point of view.”

I don’t understand your point here. What is special about “this context”? What other points of view do you have in mind besides the “purely analytical”? What are some examples of right-wingers wrongly deploying this meme? In deploying this meme yourself, how are you escaping whatever criticism you would level at the “right-wingers”?

11 anon editor December 17, 2009 at 11:16 am

Uh, what is the compostion of the workforce that is unemployed?

Uh, Google is your friend. What do we look like, your research assistants?

But use this query: “composition of the workforce that is unemployed”

http://lmgtfy.com/?q=%22composition+of+the+workforce+that+is+unemployed%22

12 Cynthia December 17, 2009 at 11:51 am

I’d be in favor of dropping the minimum wage if it would cause wages at the top to drop, too. But common sense tells me that this isn’t likely to happen. If anything, dropping wages at the bottom will cause wages at the top to go up even further. So unless you are looking forward to living in a middle-classless society, a society with only haves and have-nots, you shouldn’t favor a drop in the minimum wage.

13 holmegm December 17, 2009 at 12:07 pm

The “then why don’t we raise the minimum wage to $30 an hour” meme is an overrated “right-wing talking point” in a lot of policy debates.

Why? What exactly is wrong with the question?

14 Cliff December 17, 2009 at 12:18 pm

Cynthia, Why would you want wages to go down? Isn’t that evil? Do you want more people to be sad and to die early, as well? The post said that reducing the minimum wage would INCREASE total wages, not lower them.

15 sp6r=underrated December 17, 2009 at 1:17 pm

holmegm wrote
“The “then why don’t we raise the minimum wage to $30 an hour” meme is an overrated “right-wing talking point” in a lot of policy debates.”

Why? What exactly is wrong with the question?

As anyone knows, plenty of things can be beneficial in small doses and significantly harmful in large doses (for example: medicine, red wine).

Mr. E wrote:

They should take you at your word and start to advocate for the elimination of legal protections for owners on personal liability for corporate actions. In other words, sue the shareholders of AIG for their personal wealth to payoff the government for the money we gave to them. Go after the prince for his personal wealth for BoA.

It would be the logically consistent for them to hold both positions. But of course they don’t.

16 q December 17, 2009 at 1:46 pm

“It would be the logically consistent for them to hold both positions. But of course they don’t.”
I’m not a libertarian, but it’s pretty clear you’re wrong. To a hardcore libertarian, “liability” that is not contracted for is a creation of the state. After all, after a court’s judgment of liability, it is the state which enforces the order. So in a libertarian paradise, you wouldn’t be able to go after AIG’s shareholders because they’d have likely contracted for limited liability.

17 Bill December 17, 2009 at 5:17 pm

@anon editor,

Before I posted the question of what is the composition of the unemployed, I did google that; and also what is the composition of those who receive the minimum wage.

That’s why I posed the question. To point out depressing the minimum wage isn’t going to help a laid off engineer or software programmer or architecht, or 55 year old laborer.

Also, what I find interesting in the abstract treatment of this issue–is the lack of recognition of a differentiated labor force; equations that treat labor as a single variable undifferentiated homogenous commodity would not work, for example, in business, where you are trying to sell differentiated products–not even yogurts are undifferentiated, so to say changing the price of a minimum wage unskilled worker is going to increase demand without know the demand for unskilled labor, and then to say lowering the wage rate for unskilled labor is going to clear the market for skilled labor, is all very, very abstract, and unconnected to the real world.

18 David Wright December 18, 2009 at 3:44 am

There is a simple way to think about this. The heart of the Keynesian argument is sticky prices. In the case of the labor market, that means sticky wages. There is excess labor capacity, i.e. unemployment, because wages would need to fall to clear the market, but wages are sticky so they don’t fall. Well, since it was created by fiat, the minimum wage is one wage we can make fall, by fiat. Shouldn’t we do that in order to at least clear the market for unskilled labor?

19 ryan December 18, 2009 at 1:29 pm

I read Krugman’s update, quoting Rajiv Sethi:

“What I cannot understand is why people of considerable intelligence persist in conducting a partial equilibrium Walrasian analysis of the labor market, as if we were dealing with the market for oranges. Please stop it.”

My comment:

Wait a minute. Isn’t the MAIN lesson from general EQ not to f with prices? Any movement back toward the non-f’ed price vector has to be an improvement. Case closed.

20 Bernard Yomtov December 21, 2009 at 4:28 pm

The “then why don’t we raise the minimum wage to $30 an hour” meme is an overrated “right-wing talking point” in a lot of policy debates.

Why? What exactly is wrong with the question?

What is wrong is that no one is advocating a $30/hr minimum wage. Some things, many things, are beneficial, but become harmful when overdone. Just because I suggest that swallowing two aspirin may make a headache go away doesn’t mean I think swallowing the whole bottle is a good idea. Or, in an economics example, if someone suggests (not today) the Fed should raise rates to ward off inflation it would be sort of stupid to say, “Well, if 5% is good why isn’t 50% better?”

Economic policies, like aspirin, have a variety of effects – good and bad – and these vary with the dosage.

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