Labor Economics

Labor Market Regulation – The Minimum Wage

(Sources:  Various references - common knowledge, DiLorenzo, Tullock and McKenzie, Williams, etc.)

Government Regulation of Labor Markets: The Minimum Wage

In the real world, government policies bear little resemblance to the kinds of "corrections" economic theory points toward.

Except through monetary policy (decreasing the real wage) it is hard to find governments that try to force wages down.  Instead, governments around the world deliberately push wages up and prevent market adjustment.

So in some cases, one arm of the government actively tries to undo the harm done by the other arm.  One branch raises the (nominal) minimum wage, the other tries to reduce the (real) minimum wage via inflation!

Classic example: The Minimum Wage.

Why:  To assist the working poor.

Fair Labor Standards Act – 1938 – was 25 cents per hour (approximately $3.75 today).

FROM the U.S. Dept of Labor Web Page:

Some History:  http://oregonstate.edu/instruct/anth484/minwage.html

Some states have minimum wage:  http://www.dol.gov/esa/minwage/america.htm

In the U.S., the minimum wage itself is fairly low (less than 5% of the U.S. workforce earns it).  In other countries like France, the minimum wage affects a large percentage of the workforce.

List of minimum wage by country:  http://en.wikipedia.org/wiki/List_of_minimum_wages_by_country

    Currency Calculator:  http://www.x-rates.com/calculator.html

The following Analysis is from Tullock and McKenzie: 

 “The predicted effects of minimum-wage laws have generally, but not universally, been supported by empirical studies.”  AND “Almost every serious scholar of minimum wages would argue (on the basis of available evidence) that wage minimums have reduced employment for those who would otherwise earn low wages, particularly teenagers.”

Most famous (and somewhat recent) study that did not show an increase in unemployment was a series of case studies that were put in the book, Myth and Measurement: The New Economics of the Minimum Wage, by Princeton University economists David Card and Alan Krueger.

Critiques:  Method and short vs. long term effects.

Standard Model:

The loss of employment opportunities is explained in three ways:

1. some jobs do not produce sufficient market value per hour to cover the minimum wage some workers are paid.
2. there are some workers who do not have the necessary skills that would enable employers to make a profit by employing them at the minimum wage.
3. by raising the cost of labor, the minimum wage will cause a substitution of machines for workers.

Economists note that if there are small effects it is because:

1. the legislation applies to a small portion of the total labor force
2. the demand for menial labor tends to be unresponsive to wage hikes
3. the minimum wage is typically not all that far removed from the true market wage

The conventional model misses several points:

If employers are profit maximizers:  will find combination of labor and capital, of money wage and other means of payment that are efficient.

Employers can pay with:

Dollars, benefits, good working conditions, nice managers, safety, air conditioning, etc.

The employers expenditures on different working conditions or fringe benefits will have different effects on supply of, and demand for, labor.

So an employer should be indifferent to spending an additional dollar on wages or an additional dollar on air conditioning or some other condition of work.

Example:  Company picnic.  May not increase worker productivity – but can increase the supply of workers, which can decrease wages.  So expenditures on picnics might be worth it (if it is more than off set by decrease in wages).

Other changes can change worker productivity – In that case – want to increase expenditures until the last dollar spent is equal to the additional revenue received by the improvement in productivity plus the reduction in the wage bill.

Job satisfaction should increase the supply of labor and a decrease in job satisfaction should decrease the supply of labor – and wages should change accordingly.

Graph:

Basically:  firms will be forced to find a cost-minimizing combination of capital, labor, fringe benefits, and working conditions.  Otherwise – good bye.

The Impact of Minimum Wages

Minimum wage laws establish a legal floor for money wages – but not for the effective wage (including money and non-money benefits).

So the impact will depend upon the ability of the employer to adjust the non-money conditions of work or fringe benefits in response to a required pay change.

The standard analysis – assumes only money wage is paid.

Suppose the equilibrium wage is $10/hr.  If the government imposes a minimum wage of $15/hr., there will be unemployment.  Employers will want to hire fewer people than want to work at the market wage.

Graph:

“This analysis may still be fully applicable to those few labor markets in which money is the only form of compensation and in which employers can do little or nothing to change the skill and production demands imposed on workers.”

But it seems reasonable that employers could adjust other working conditions in response to the labor market surplus.  Indeed, they might have to (if they require a certain number of workers, for example).

So they might eliminate workplace picnics, reduce fringe benefits, or increase production demands.

Employers can be expected to reduce their labor costs in non-money ways until they are no longer confronted by a surplus – until labor markets clear again.

Two General Cases:

Case 1:  Changes in Fringe Benefits that Do Not Affect Labor Productivity

Eliminate company picnics, etc.  By reducing these benefits, the labor costs are reduced from what they would otherwise have been and nothing is lost in the way of reduced labor productivity.

These benefits no longer justify themselves in terms of an increase in labor supply.  And some employers might have to cut them to remain competitive.

Because of these cuts – the supply curve of labor can expect to shift to the left (decrease) because of the cuts in non-money benefits.

This shift will be equal to labor’s dollar evaluation, on the margin, of the adjustments made in employment conditions.

And the demand curve for labor will shift right – because of the reduced expenditure per unit of labor on non-money benefits.

However:  the shift left in the supply curve will be greater than the shift right in the demand curve.  Why?

Non-money benefits will be provided as long as their cost to the firm per unit of labor is less than the reduced wage rate -- 

Cost to firm = M (money wage) + NM (non-monetary benefits)

Will shift into NM if the increase in cost is less than the decrease in M – so that overall cost decreases.

n      which means that the labor’s evaluation of the NM benefits lost is greater than the firms’ costs (so that the firm can offer the NM benefits for a lower cost than offering a money wage).

So the decrease in NM benefits is a greater loss to workers – of higher value (shift in supply curve) than it is reduction in costs to the firm (shift in the demand curve).

So the market clears at the minimum wage (employers will keep decreasing NM benefits until market clears at the wage required by law).

Also:  clears at a lower employment rate.

Graph (from T and M):

So the surplus of labor is eliminated (the unemployment) –

But labor is worse off because of the wage floor and adjustments in fringe benefits. 

After the vertical distance between the two supply curves, (labor’s dollar evaluation of the fringe benefits lost) is subtracted from the minimum wage, the effective wage paid labor is reduced.

In short – when labor is paid in many forms, a minimum wage reduces, not increases, the effective payment going to affected workers (since they would have preferred to have the market mix of M and NM before the minimum wage).

But unemployment is lower than under the conventional analysis.

Case 2:  Changes in Fringe Benefits that Affect Labor Productivity

Because of the surplus caused by the minimum wage – employers can increase the production demands placed on their workers.  This can increase the productivity of labor.  So the demand curve for labor will shift to the right.

However, the new demands on the workers will cause some to leave the market – so the supply curve shifts to the left.

So the analysis is the same as in Case 1.

Employment opportunities can be expected to fall on balance because:

• the minimum wage law increases the cost of labor relative to other variable resources and induces some substitution of other factors for labor and
• the law increases the overall cost of production and reduces the quantity of the final product sold.

Employers can react to the higher minimum wage by making changes in workplace conditions – such as air conditioning – that can lower productivity of labor.  Firms will make such adjustments so long as the change in the money wage is greater than the dollar value of the change in labor productivity.

These changes will cause the supply curve of labor to shift until it intersects the demand curve at the minimum wage rate.

The effective wage and employment opportunities are then reduced as before.

Differences from the Conventional Analysis:

1. The effective wage rate for all workers declines – not that some remain employed at a higher wage.
2. The market clears.
3. Actual job losses might be very small – as employers can adjust to the surplus of labor in different ways.
4. Number of new workers who want work does not expand – instead workers move down their supply curve as their effective wage falls.
   1. many might leave the labor market too for better alternatives – in illegal markets.  Since employers will require more from workers – the less advantaged will go into criminal activities (what do you think)?

5. Minimum wage puts people in higher tax brackets (esp. if second income).  But this not only happens – and increases the money portion of their pay –and hence taxable income portion of their effective wage.

Other Possible Effects From Minimum Wage:

Walter Williams

Says - Before minimum wage legislation black youth (teenage) unemployment was the same as non-black teenage unemployment.

What happened?

1.)               Minimum wage causes employers to make other kinds of substitution:  machines for labor, changes in productive techniques and elimination of certain jobs altogether.

2.)               Substitution for higher skilled workers – out of lower skilled.

(Relative wage argument)

3.)               Increase Discrimination

Because both white and black paid the same (cannot discriminate economically) so discriminate other ways.

The cost of the discrimination falls with the minimum wage:

4.)               Equal Pay for Equal Work laws are a variation of the minimum wage laws.

Lower cost of discrimination

If have to pay the same wage leads to them discriminating in other ways.

5.)               Unions support minimum wage.  – and all other government subsidy programs such as Job Corps, Summer Work Programs, CETA, food stamps, etc.  Why?

7.)        Some Businesses support minimum wage – Why?  Decrease competition.

                        The northern senators have always been greater supporters of federal minimum wage in order to protect northern jobs from cheaper southern labor.  If all paid the same – then less likely to move company south.

Other Supporters of Minimum Wage:

Arguments:

1. Employers will “exploit” workers – especially in labor markets where there are a “surplus of workers” anyway.

2. The market wage doesn’t always keep people above the poverty level.  Supporters say that most of those affected by a minimum wage increase are adults aged 20 and over, and more than half of all teenagers earning the minimum wage are in households with below-average incomes.

3. There should be a redistribution of wealth from employers to workers.

4. Americans overwhelmingly support increasing the minimum wage

5. Not all economists think the minimum wage is harmful. 

    6.   The minimum wage will increase technological advancement:  

The Latest Proposal:

From Phoenix Business Journal (Jan. 26, 2009) article: