Should we cut the minimum wage?

by on December 16, 2009 at 3:11 pm in Economics | Permalink

Yes.  Bryan Caplan has the answers:

Paul [Krugman] does address the real balance effect, but he still ignores the main arguments I've made before:

1. Cutting wages increases the quantity of labor demanded.  If labor demand is elastic, total labor income rises as a result of wage cuts. 

2. Even if labor demand is inelastic, moreover, wage cuts reduce labor income by raising employers' income.  So unless employers are unusually likely to put cash under their mattresses, wage cuts still boost aggregate demand.

An even simpler way to explain it: Imagine every firm divided its existing payroll between a larger number of workers.  How is that bad for aggregate demand – or anything but good for employment?

P.S. If you prefer specific facts to textbook arguments, see Scott Sumner's legendary Table 12.2 on wages and the Great Depression.

As Bryan titles his post: "Cutting the Minimum Wage Really is Good for Aggregate Demand."  The actual arguments in Krugman's blog post concern an overall downward spiral in wages and prices, not minimum wage cuts at all.  The chance that minimum wage cuts set off such a spiral is very, very small.  Krugman's third paragraph makes perfect sense but the fourth paragraph and onwards is simply discussing a different topic.

I would add two points.  On Bryan's #1, workers at the current minimum wage are unlikely to receive nominal wage cuts if the minimum wage were lowered, for the usual morale and efficiency wage and lock-in reasons.  So the chance that total labor income rises is very high.  Second, no I don't believe in an upward-sloping AD curve, but in any case multipliers from production increases plus wage bill increases are likely to be more potent than multipliers from aggregate demand increases alone.

Addendum: Will Wilkinson offers relevant comment.

Adam December 16, 2009 at 3:35 pm

If wages are inelastic, which they seem to be, then cutting the minimum wage won’t do much good for employment, but will transfer wealth from people working on minimum wage, i.e poorer people, to richer employers. Even if this won’t happen immediately because nominal wage cuts are unlikely; future people employed at minimum wage will be worse off.

Alex R December 16, 2009 at 3:45 pm

How many laid-off workers would still be working if they had taken a wage cut from what they were previously paid, say twenty thousand dollars per year, down to fifteen cents shy of the current minimum wage. My horse sense regression, calculated on my organic supercomputer, tells me somewhere around zero. Not one of those people would have accepted such a wage cut.

The fundamental problem of the economy is that the lending mechanism is non-functional because it is bankrupt, and it is bankrupt because its nominal liabilities far exceed its assets.

What does a minimum wage cut have anything to do with the lending mechanism? How would lowering the general price level help resolve this fundamental problem?

In other words, who cares who is right in this ridiculous story. The result has no practical significance, whatsoever. And regardless of whether you or Bryan or Paul is right, the aggregate economic benefit and/or cost is so trivial that there would be no way to properly measure who was correct anyway.

My guess is that the real stakes here are political. We aren’t arguing magnitudes, we are arguing over which economic framework matters.

No sense in wasting more breath on the point.

Bernard Yomtov December 16, 2009 at 4:01 pm

Even if labor demand is inelastic, moreover, wage cuts reduce labor income by raising employers’ income. So unless employers are unusually likely to put cash under their mattresses, wage cuts still boost aggregate demand.

I second Adam. If wage cuts simply transfer money from workers to employers, how does that increase aggregate demand? Wouldn’t it reduce it, as you are transferring money from people with lower incomes to those with higher ones. Take a dollar away from a janitor at Microsoft and give it to Bill Gates and their combined consumption would go down, wouldn’t it?

Doug December 16, 2009 at 4:05 pm

Marty,
There are many cases where three people working in one shop can produce more than two, but not quite 50% more than two. In that case, it may make sense to hire a third at a lower wage if you can, even if it doesn’t make sense to hire a third at the same wage as the first two. Think of cooks in a restaurant for example. It might be nice to have three cooks on the line, and if they get orders out fast enough, three may even increase spending at the restaurant. Still, adding a third cook is not likely to increase production by 50% over two cooks. The same would be true at factories where extra workers can increase the output of machines somewhat, but the machines still limit the amount that can be produced, such that there is not a linear relationship between number of employees and output.

Even if there is a linear relationship, in your “widget” example, your current employees may be able to fulfill your current demaned, but you may know that there are additional widget production contracts you could win if you could lower your marginal cost by a few percent. Again, in such a case, it may make sense to hire new staff only if you can get them at a lower cost than your current staff.

Chuck December 16, 2009 at 4:14 pm

I thought this was a relevant link…

The minimum wage machine…
http://accidentalmysteries.blogspot.com/2009/12/minimum-wage-machine.html

Doc Merlin December 16, 2009 at 4:35 pm

@Scott-Heron
That is due to fed buying.

Bill December 16, 2009 at 4:42 pm

We live in a world market.

If domestic wages are inelastic, and employer pockets the money, he doesn’t have to purchase in the US. He can use the money to expand abroad, or go out and purchase a foreign TV. Or, I can get a dividend, and go out and buy that foreign TV.

Also, what appears to be missing from the discussion is the work that Princeton economist Alan Kreuger has done dispelling the argument that minimum wages reduce employment. Sometimes facts matter, not just theory.

Matthew December 16, 2009 at 5:16 pm

Doc,

The fed is buying longer-maturity treasuries, not short bonds and T-bills.

Cliff December 16, 2009 at 5:24 pm

Bill,

If you go and purchase a foreign TV, the foreigner who made the TV has to spend your dollars in the U.S. As long as you are using dollars, it does not matter where you buy. Even if the TV guy buys something in Brazil with you dollars, eventually the dollars have to comeback to the U.S. And if instead the guy burns them? Well then the purchasing power of the dollar goes up, enriching everyone.

Michael Cain December 16, 2009 at 5:48 pm

Speaking from a public policy perspective, is there a benefit to creating minimum-wage (or sub-minimum-wage) jobs?

Back at the beginning of the year, I was listening to a meeting of one of our state legislative committee holding hearings on job creation. After several witnesses from the “business community”, the chair basically lost her temper and blew up. To paraphrase her remarks, she asserted that the state had no interest in creating minimum-wage jobs because in most cases, that wasn’t enough to move people off Medicaid, or their children off CHIP, or to get them off Food Stamps, and they generated essentially no revenue for the state (minimum wage is pretty much below the level where the state income tax kicks in, and much of what the money would be spent on is exempt from the state sales tax).

The chair requested that only people with proposals for creating jobs that paid enough to disqualify workers from public assistance come forward; there was no further testimony.

sp6r=underrated December 16, 2009 at 5:52 pm

Nice post Michael Cain.

I agree with the chair.

Yancey Ward December 16, 2009 at 6:23 pm

We clearly need to raise the minimum to $30/hr.

CBBB December 16, 2009 at 7:17 pm

I think the whole minimum-wage-is-too-high paradigm is the wrong way to look at this unemployment problem. sp6r=underrated and rob have the right idea. The job market has become such that take on enormous amounts of debt to finance an education is the basic requirement for entry into the job market. Are these indebted, over-educated individuals really going to pursue minimum wage or sub-minimum wage paying jobs which won’t even allow them to make the base payments on their student loans? What’s the point of working if the pay is less then subsistence?

Andrew December 16, 2009 at 7:45 pm

Sometimes I think my advisor is putting me on.

I get the same vibe from Krugman.

sort_of_knowledgable December 16, 2009 at 8:40 pm

Obviously creation of jobs that are several times minimum wage are better than creation of jobs paying minimum wage. But just because the state doesn’t benefit financially does it mean it should not try create minimum wage jobs if that doesn’t conflict with creating higher paying jobs?

Mike December 16, 2009 at 8:58 pm

well can’t we use the same arguments to introduce a confiscatory tax scheme at high wages? why split wages on the bottom over many people — why not split wages at the top over many people?

Bon December 16, 2009 at 9:13 pm

Cutting or eliminating the minimum wage alone is a non-starter. What we need to do is at the same time introduce a negative income tax, or even better a basic income, so that people can survive at whatever an efficient market wage may be.

ryan December 16, 2009 at 9:26 pm

Jim: Is this different than France imposing a 35 hour work week?

They couldn’t be more different. Imposing a shorter work week reduces production while maintaining the same wage expense, thus lowering productivity. Reducing wages while maintaining production levels (or, at least not reducing production as much as wage expense) increases productivity and leaves cash available for other uses.

Mike S December 16, 2009 at 9:55 pm

How do you explain this?

http://en.wikipedia.org/wiki/Minimum_wage#Statistical_Meta-analyses

Statistical Meta-analyses
Several researchers have conducted statistical meta-analyses of the employment effects of the minimum wage. Card and Krueger analyzed 14 earlier time-series studies and concluded that there was clear evidence of publication bias because the later studies, which had more data and lower standard errors, did not show the expected increase in t-statistic (almost all the studies had a t of about two, just above the level of statistical significance at the .05 level).[60] Though a serious methodological indictment, opponents of the minimum wage virtually ignored this issue; as Thomas C. Leonard noted, “The silence is fairly deafening.”[61] More recently, T.D. Stanley has criticized Card and Krueger’s methodology, suggesting that their results could signify either publication bias or the absence of an effect. Using a different methodology, however, he concludes that there is statistically significant evidence of publication bias and that correction of this bias shows no relationship between the minimum wage and unemployment.[62] In 2008, Hristos Doucouliagos and T.D. Stanley conduct a similar meta-analysis of 64 U.S. studies on disemployment effects and concluded that Card and Krueger’s initial claim of publication bias is still correct. Moreover, they concluded, “Once this publication selection is corrected, little or no evidence of a negative association between minimum wages and employment remains.”[63]

Yes, the silence is deafening.

mwilbert December 16, 2009 at 10:17 pm

Adam’s argument seems like the correct one. Assuming decreasing the minimum wage doesn’t increase aggregate demand for labor, which is certainly possible in an extremely slack economy, then it decreases the wages paid to labor and increases wages to owners, which presumably moves income from people with higher propensities to consume to people with lower ones.

Also, Bryan isn’t answering the “lower wages mean lower prices mean a higher real rate of interest when you are at a zero nominal rate” argument.

I doubt this policy change would have any significant effect in any case, but if it did, I don’t see why it would be good.

P December 16, 2009 at 11:12 pm

Perhaps one thing to consider is the possibility that shifting income from labor to profit in the long run would reduce aggregate demand, as poor people would spend their money on stuff, producing a decent multiplier and encouraging investment and innovation in the sale and production of stuff, while if it goes to profit, it will all be flushed down the toilet bowl that is the global financial casino.

Chris December 17, 2009 at 3:56 am

The way this article is worded seems to suggest that lowering minimum wage will allow companies who currently employ workers at a much higher wage a chance to hire workers into the same jobs at a much lower wage. Besides creating havoc in an office this flies against wage gap concerns that have been so prevalent among large companies in the last ten years. Not to mention, hiring people at such low wages when the expectations for the jobs don’t change means that there will be a dramatic rise in employee dissatisfaction which may result in a new union boom even among white collar workers. The psychological benefit of knowing a minimum wage exists is enough to negate the benefit of removing such a minimum. Of course that is an argument from a sociological point of view.

V R December 17, 2009 at 9:48 am

More bonuses for the wall st… and wage cuts for the main st. Yay!

Cynthia December 17, 2009 at 11:49 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.

qwerty December 17, 2009 at 2:57 pm

This is the kind of argument that shows how far economics has to go.

“Even if labor demand is inelastic, moreover, wage cuts reduce labor income by raising employers’ income. So unless employers are unusually likely to put cash under their mattresses, wage cuts still boost aggregate demand.”

What happens to the money paid to the employees? does that disappear, or is it spent buying things, leading necessarily to hiring of more workers? Without consideration of all the flows from the minimum wage, and the propensity of employers to hire, and the propensity of workers to spend, … you have proved or solved nothing.

What the last decade or so have shown is that economics based on absolute assumptions with binary outcomes is insufficient, and at times, leads to incorrect results. Economists’ models resemble rats in an experiment, push button A or push button B. The world is far more complex than that, and this type of argument is not helpful.

bil. A. December 18, 2009 at 1:56 am

It is sad that so many people keep trotting out Card and Kruger as if their work has not been totally demolished.

Here is a random sample overview, from http://oldfraser.lexi.net/publications/pps/14/part_1.html

“Moreover, many scholars are doubtful about the quality of Card and Kreuger’s empirical work. Rather than use traditional econometric techniques to estimate the employment effects of minimum wage increases, Card and Krueger use survey data to conduct “natural experiments† that do not control adequately for the various factors that affect the relevant variables. The particular methodology employed by Card and Krueger (1994) in their study of employment in fast-food restaurants in New Jersey and Pennsylvania has been criticized sharply by Daniel Hammermesh (1995), who argues that the timing of Card and Kreuger’s surveys bias their results. Finis Welch (1995), meanwhile, argues that by restricting their attention to fast-food restaurants, Card and Krueger neglect to consider the overall employment impacts of New Jersey’s increase in the minimum wage, which could very well have been negative. Finally, a study using official payroll data shows that employment did, in fact, fall in New Jersey following the increase in the minimum wage (Neumark and Wascher 1995a). Hence, there are a number of reasons to question the validity of Card and Kreuger’s conclusions. “

BGP December 18, 2009 at 5:52 pm

Ironically, Krugman’s statements are so obviously politicized that when he says something so patently wrong (stupid?) people feel the need to make all kinds of formal analysis to politely bring that to our attention. That way they are less likely to be accused of being right-wing attack dogs. If he were just a middle of the road guy doing honest economics we would just note that Krugman said something laughably incorrect.

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