The Political Economy Of The Minimum Wage (Some Wonking Going On Here)

Recent Anonymous comments have set Wonks Anonymous thinking about the minimum wage. Which thinking, for a card carrying liberal and a card carrying economist, is bound to lead to discomfort. The simple fact is that the minimum wage, if it does anything, acts to raise the wage above the market level. This lowers employment and output. We would all be better off if we let the market set wages and we supported the income of the poor with a generous income supplement for the employed. If we did this we would not waste human resources.

Consider the graph below: A labor market where demand by employers of unskilled labor is described by:
Labor Demand = 11,000 - 200 wage
I assume that any amount of labor can be had at any wage.

The initial minimum wage is set at $5.00 per hour. If we drop the wage to $4.50 an additional 100 workers are employed. This implies that a 10% decrease in wage results in a 1% increase in labor demand. The wage elasticity of labor demand is -0.1. Which elasticity Wonks Anonymous believes is reasonable for labor markets.

The 10,000 workers who were employed before the wage lose a total of $5,000 per hour worked, which loss is redistributed to employers. Note that this box extends well to the left of the graph area. If the x axis had started at zero the changes would be simply too tiny to see.

Employers gain an additional small triangle. The area here is ($0.50 x 1000))/2 since this is a triangle. That would be $25 per hour worked. Because this output was not produced under the minimum wage it is a social gain.

Unemployed workers gain $450 per hour worked, assuming that they have zero alternative earnings. This is also a social gain.

Note please the relative magnitude of the social gain. $475 per hour worked is less than 10% of the redistribution of income from the employed to their employers, $5,000 per hour worked.

Which settles a question that has been bothering Wonks Anonymous for about a year now. Why is it that we may see cuts in the minimum wage but we never see compensation being offered to workers who lose by these cuts? The simple fact here is that the political game is not about increased efficiency. Employers could care less about the gains for the unemployed and the amount that they gain by increased output is minuscule.

The prize is the $5,000 per hour redistributed from the employed workers to the employers. If we were to ask employer to give it back then the reform would not be worth their while. 

Efficiency is just an excuse. As a good economist Wonks Anonymous wishes that it weren't so.


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  • 12/10/2008 10:11 AM Anonymous wrote:
    While shifting $5,000/hr from the employees to the employer might not be a great idea when the company is making a profit greater than $5,000/hr, it is a wise idea for the company when they are losing $5,000/hr because of lack of demand. Would the employees rather take a 10% paycut now or a 100% paycut when the company files for bankruptcy?

    Low wages are also good for successful companies in a downturn because they can expand their businesses more cheaply by hiring workers at lower wages. If wages are forbidden from falling or are simply too sticky for reasons of expectations or whatever, then we will simply have more unemployment instead of cheap expansion of successful businesses which will lead to increased employment at moderately lower wages.

    My argument is static. You are assuming that the demand curve is shifting, due to the recession I suppose. In a dynamic world wage cuts might work, if we assume that there is something other than consumer spending that will provide a strong floor for demand. I am not convinced that this is true.

    Lower wages are good for individual firms. They allow the firms to capture gains in productivity. Their utility for the economy as a whole has not been demonstrated.


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