Economics is not as certain as some people make out – the minimum wage

In economics theories come into fashion, wane, get tossed onto the junk heap and sometimes dusted off and given another run around the block. For example, the minimum wage:

A common claim is that wages are like any other price and as such obey the economic laws that govern supply and demand. Therefore, raising the minimum wage (or having any minimum wage, actually) is a bad idea because it causes some people to be too expensive to employ, leading to unemployment.

As a counter to the conventional argument, consider this:

Historically New Zealand has had no unemployment for many years (till recently) as we were living under a regime that made lowering unemployment to zero a priority. (At zero unemployment there will still be approximately 2% unemployment because of churn.  On average everybody spends one year in fifty looking for a new job whilst not working). When the government ensures that zero unemployment exists, the simple supply-demand model breaks down and raising the minimum wage does not increase unemployment, it simply transfers wealth from the who invest to those who labour.

The idea that raising the minimum wage will shut down businesses is not true in our economy.

Not to say there do not exist examples of businesses that would close – because we aim for zero unemployment that frees up resources for new businesses to start – but we are talking *macro* economics here.  In our economy the people being paid minimum and near minimum wage are doing jobs that must be done.

Subway’s existence does not depend on paying its workers $12.75 an hour.  Same for cleaners, bus drivers etcetera.  Almost as many of those people will be employed at $5 per hour as at $15 per hour, because the roles they fill are not ‘nice to haves’, like landscape architects or interior decorators.

Lastly:

Raising the minimum wage is a transfer of wealth from those who invest to those who labour.  Those who labour tend to spend their income where they live (food and housing making up a much larger proportion of their income) causing a local boost to the economy.

I hope that is enough to demonstrate that economics is hard and often counter intuitive.  It is also beset by conflicts of interest (e.g. economists employed by banks or governments), embedded values and ideology.

I am not an economist and don’t pretend to be able to pass expert judgement on the subject. I present this as an example of an alternative economic theory, to demonstrate that economics is mostly made up of competing theories and ideas, not hard facts and proven mathematical models that apply in every situation.

It’s not like physics or chemistry where fundamental laws are discovered which are eternal and that apply throughout the universe – there are people involved, and people are messy. People change, and economics needs to change with them.

22 thoughts on “Economics is not as certain as some people make out – the minimum wage

  1. In the past we didn’t allow much foriegn labour so that (eg) having Fijians grub nasella tussock was a big deal. Now 1/3rd (?) of Queenstowns service workers are foriegners (but look who has made all the money: property owners).

    Tourism employs 1 in 10 workers and is a very cost sensitive industry; a Japanese guide going to Milford sound for the day used to earn about $150 ten years ago whereas now it is about $100 the cost cutting starts at the original country of origin as people pick and choose.

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  2. I think rather than working on minimum wages the Greens should look at land tax to deflate property prices as affordable property is the most important issue for working people.

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  3. It is nice to read a considered argument for minimum wage, Frog. Your reasoning around the “zero unemployment” level sounds very plausible, though I seriously doubt if Labour policies had anything to do with the low unemployment rate – most first world countries enjoyed a similar low unemployment rate at this time, indicating it was more likely induced by a favourable global economy.

    There are two major problems with your argument. Firstly, the youth unemployment rate was never zero (and is unlikely ever to be) and is currently sitting at over 20%. A cursory glance at youth unemployment figures shows a sharp spike in unemployment at the time of the abolishing of youth rates, indicating that youth unemployment is, indeed, price-sensitive.

    The second problem with your argument is the strange notion that “Almost as many of those people will be employed at $5 per hour as at $15 per hour, because the roles they fill are not ‘nice to haves’, like landscape architects or interior decorators.” This shows a fundamental lack of understanding of how businesses work, especially large franchises (that employ most of the minimum wage workers). In the business world, there will always be branches that are marginally profitable. These will simply close, rendering their workers redundant.

    You might think that “Raising the minimum wage is a transfer of wealth from those who invest to those who labour”, but the hard reality is that investors who are not making a buck on their investment will pull the plug on it.

    The converse is also true, of course. If the minimum waged dropped to $5 an hour, it is highly likely that investors would be willing to support expansion of their business into less profitable areas. The subway that closed just down the road from me might open again!

    Not that the minimum wage could ever be set at $5/hour – the unemployment benefit pays better than that!

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  4. Frog-
    lovely!

    Have you been talking to Helen Dew, by any chance?

    She sold me a copy of Diedre Kent’s Healthy Money, Healthy Planet at the 2006 AGM, and it got me through a 300-level economics paper one summer, quite handily (taught by that other alternative economist, Prue Hyman).

    It is only by shifting paradigms from the neoliberal agenda that we will see our way out of the current gridlock in financial liquidity brought about by the failure of the North American banking system; at least in NZ we have the choice to consider that option, since our banks are nowhere near as badly affected as the MNC’s overseas.

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  5. A little history and perspective on the issue – from wikipedia follows.

    First enacted in New Zealand in 1894,[6][7] there is now legislation or binding collective bargaining regarding minimum wage in more than 90% of all countries.[8]

    One complicating factor is possible monopsony in the labor market, whereby the individual employer has some market power in determining wages paid.

    has low-wage labor markets characterized as monopsonistic competition wherein buyers (employers) have significantly more market power than do sellers (workers).

    Through this model, Fields shows the typical theoretical argument to be ambiguous and says “the predictions derived from the textbook model definitely do not carry over to the two-sector case.

    Under the monopsonistic assumption, an appropriately set minimum wage could increase both wages and employment, with the optimal level being equal to the marginal productivity of labor.[23] This view emphasizes the role of minimum wages as a market regulation policy akin to antitrust policies, as opposed to an illusory “free lunch” for low-wage workers.

    Another reason minimum wage may not affect employment in certain industries is that the demand for the product the employees produce is highly inelastic;[24] For example, if management is forced to increase wages, management can pass on the increase in wage to consumers in the form of higher prices. Since demand for the product is highly inelastic, consumers continue to buy the product at the higher price and so the manager is not forced to lay off workers.

    Three other possible reasons minimum wages do not affect employment were suggested by Alan Blinder: higher wages may reduce turnover, and hence training costs; raising the minimum wage may “render moot” the potential problem of recruiting workers at a higher wage than current workers; and minimum wage workers might represent such a small proportion of a business’s cost that the increase is too small to matter.

    Today, the International Labour Organization (ILO)[8] and the OECD[28] do not consider that the minimum wage can be directly linked to unemployment in countries which have suffered job losses.

    Until the mid-1990s, a strong consensus existed among economists, both conservative and liberal, that the minimum wage reduced employment, especially among younger and low-skill workers.[13]

    Nobel laureate Paul Krugman, has argued in favour of the Card and Krueger result, stating that Card and Krueger;[62]

    … found no evidence that minimum wage increases in the range that the United States has experiences led to job losses. Their work has been attacked because it seems to contradict Econ 101 and because it was ideologically disturbing to many. Yet it has stood up very well to repeated challenges, and new cases confirming its results keep coming in.

    Until the 1990s, economists generally agreed that raising the minimum wage reduced employment. This consensus was weakened when some well-publicized empirical studies showed the opposite, but others consistently confirmed the original view. Today’s consensus, if one exists, is that increasing the minimum wage has, at worst, minor negative effects.[67]

    http://en.wikipedia.org/wiki/Minimum_wage

    Because China has won the global market “on price” of goods, price inelasticity in the domestic services area of the OECD economy and lack of fairness in the area of unskilled/low skilled labour where unemployment exists – a rising minimum wage is the means to social justice and has little negative impact on unemployment levels.

    On the issue of youth unemployment, providing (low skilled) full-time jobs to young people at 16 and 17 would only take jobs off others (who will require more welfare expense) and have a perverse impact on the future lives of the young concerned (if they remain in unskilled owrk they will be in poverty for life) – they should be education or work related training till 18, it is after all government policy to deny them the dole till 18.

    How many people are “unemployed” at 16 and 17 anyway?

    Most of those youth counted as unemployed are over 18 – and they will find it harder to find work if people at 16 or 17 are preferred by employers (and leave school or training to get the jobs).

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  6. To some extent the minimum wage encourages automation.

    Jobs that “must be done” are eventually priced to a point to either automate them or to find ways to do shortcuts.

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  7. And of course low wages discourage investment of capital and thus maintain low productivity.

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  8. What surprises me is all the talk of ‘cost to business’ of the minimum wage. For the larger companies, huge savings could be gained if the highest paid execs took a more realistic salary.

    I saw an (American?) company HR policy years ago that seemed perfectly simple, elegant, and effective: the highest-paid employee of the firm could only be 9 times the rate of the lowest paid [citation required ;) ]. So, in our case of $12.50/hour that still gives a salary of $234,000 to the CEO. Would the CEO be happy to drop to $94k when they drop the cleaner to $5/hour?

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  9. gsv_nfa, if you accept that there is competition for good executives out there, then the choice to slash your own executive’s salary is probably not a good one.

    I think Dick Hubbard may have used a similar system, but in that case he was the executive who owned the company.

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  10. @StephenR. True, if we’re talking pure free market economics. Add in the Social/ethical/political factors and you then get into the realm of public perception and how that affects business profitability.

    Hubbards being a case in point: part of his business success is promoting an ethical business model. The whole greenwash is another example of this. The idea of a fair (ethical?) company structure can be seen as another ‘selling point’ for both consumers and those interesting in being associated with such branding.

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  11. I wouldn’t say I was talking “pure free market economics” as this incentive system is the case pretty much everywhere, while pretty much nowhere is “pure”. Anyway.

    Correlation or causation there? :-) That reminds me – on the talk of automation above, Hubbard *definitely* chose at some point (as opposed to my “may have”) to employ more people where it would’ve been more efficient to use a machine on the basis that otherwise the locals wouldn’t get money = bad. Ignored poor ol’ machine makers but I doubt he’d mind.

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  12. “Subway’s existence does not depend on paying its workers $12.75 an hour. Same for cleaners, bus drivers etcetera. Almost as many of those people will be employed at $5 per hour as at $15 per hour, because the roles they fill are not ‘nice to haves’, like landscape architects or interior decorators.”

    So your argument is that the demand for labour for people who work on the minimum wage is perfectly inelastic – as a result in the market, the wage is determined by the minimum the “last worker” is willing to work for. If the minimum wage was higher in this case we get no deadweight loss – the same number of people are hired and it is a transfer from the employer to the employee.

    Of course there are two issues here:

    1) Is demand for low skilled labour perfectly inelastic?
    2) If demand for low skilled labour is perfectly inelastic, what does this tell us about the goods market? It probably tells us that these are jobs where the cost of higher wages can be passed on to the consumer – so in the end it is a transfer from consumers to workers.

    I agree that there are wider issues to look at when thinking about a minimum wage – but I don’t think the above assumption of perfectly inelastic demand is fair. Furthermore, this is definitely not optimal policy for alleviating policy – which should be the goal of these sorts of policies methinks.

    Finally, one question:

    “When the government ensures that zero unemployment exists, the simple supply-demand model breaks down and raising the minimum wage does not increase unemployment, it simply ”

    Who said this, as it isn’t a complete argument – increasing the minimum wage increases unemployment, even if demand is perfectly inelastic. As higher wages increase the supply of labour. Having a general set of policies that target unemployment does not break down supply and demand – that is a random statement for sure.

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  13. Cheers frog for opening the full debate here.

    As your post and the subsequent responses indicate this is about shades of grey rather than black and white.

    My thoughts:

    Firstly, having a minimum wage has subsequently produced the debate on who is eligible. Why have a minimum wage in the first place?

    Minimum wage legislation is government intervention in the Labor market to help ensure workers can receive adequate payment to live on. However adequate is different for a married teenager living with mom and dad than for a married 18 year old supporting a partner and child. Also, since the teenager at home is subsidized by mom and pop, they also have the ability to drive down wage rates.

    Having minimum wage legislation, and then discriminating on eligibility on the basis of age is obviously wrong. However the argument that a basic living wage is different for different people is equally valid.

    In my view, it is the responsibility of the state to redistribute money on the basis of social needs, and the state already has practices and systems to assess individual needs.

    Providing a minimum wage is more a popular political appeal to workers, that enables the state to outsource its social responsibility and places an additional burden on firms – which in NZ are primarily SMEs.

    If it is ok to apply minimum wages in a discriminatory manner – why not also subsidise SME’s who have to pay them – since as previously noted it is govt intervention that is setting wage rates, which then burdens some firms more than others, just as some people would be burdened more than others without a minimum wage.

    All very bureaucratic and overcomplicated – which also produces an opportunity cost for MPs etc in sorting out all this complexity – when perhaps there is a simpler way, and MPs could get on with other Things.

    Perhaps Gareth Morgan’s idea to give everyone a basic allowance untaxed would be a simple way to sort this issue out too? Low wage workers would then be subsidised by the state, and we wouldn’t be wasting time trying to sort out who gets what under a minimum wage intervention – with the usual political messyness and failures.

    What does Gareth Morgan say about this?

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  14. McTap –

    as much as Mr Morgan is being seen as the poster-boy for realistic evaluation of the current economic crisis, I doubt very much that simply swapping ‘What would Gareth Morgan do/say’ is much of a cognitive tool; just as WWJD (‘what would jesus do’) failed to be much use to the teenagers of the 90’s, despite a nifty marketing campaign and the introduction of those rubber wristband thingy’s to remind teens of their pledge…

    I’d rather use Brian Easton’s analysis as a starting point – he’s very readable, and often uses language that the average punter in the street can understand (ie: he’s relatable to more than just the 5% on the rich list…), try
    http://www.listener.co.nz/issue/3639/columnists/14898/an_l-ish_future.html

    The concept of a jobless recovery has not filtered through to Mr Morgan yet; perhaps because he’s not providing jobs to anyone else, or working in an office where jobs have been lost, as a majority of NZ citizens currently are.
    Mr Key would do well to think twice about the impact of policies that further depress employment, if he’s at all serious about pulling NZ out of the global recession.

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  15. Katie… your assessment that the thrust of my thinking it to hand the matter to Gareth Morgan is inadequate – as is the current system.

    I am seeking alternative ideas and Gareth Morgan is a creative thinker who has recently put forward an idea with merit that may also have application for this issue. Gareth’s idea does more than tweak at the edges of the status quo, and such thinking, combined with the ability to publicise it is very rare.

    Cheers for the Easton link – I’ll check it out later.

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  16. One weakness of a national minimum wage, or any national wage agreement is that it doesn’t reflect the large differences in living cost between say Auckland and Invercargill.

    Does anyone know of any reliable studies done in other countries on the impact of minimum wages?

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  17. The only real difference in cost is housing – and the accommodation supplement is there for those renting.

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  18. jh, a land tax would be add to the cost of owning property. There are other ways to diminish home values relative to income without placing a charge on homeowners.

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  19. This is a perfect example of the economic ignorance of the Greens. The policies they advocate as a result of this ignorance hurt the very people they are genuinely trying to help.

    Frog admits: “I am not an economist and don’t pretend to be able to pass expert judgement on the subject.” Say what you want about the Greens but at least they are honest. And the author has highlighted some important logical fallacies that lead to support for minimum wage laws.

    First, saying that New Zealand had low/no unemployment until recently is false. This is because the government “padded the stats” using taxpayer-funded make-work schemes like the railways. This required taxing wealth-producing industries and diverting the money into loss-making projects that consumed capital, making the country poorer.

    The second problem is this statement- “In our economy the people being paid minimum and near minimum wage are doing jobs that must be done. Subway’s existence does not depend on paying its workers $12.75 an hour… almost as many of those people will be employed at $5 per hour as at $15 per hour, because the roles they fill are not ‘nice to haves’, like landscape architects or interior decorators.”

    The distinction between “jobs that must be done” and “nice-to-have” jobs is arbitrary: do we “need” to have Subway? Consumers exercising demand for products/services, be they Subway sandwiches or landscape gardening, decide what gets offered. If the cost of providing a good/service is greater than the price consumers are willing to pay for it then it will soon stop being provided. The most “needed” goods/services are the ones people choose to spend their limited resources (money) on.

    The other major flaw in the argument is this: “Raising the minimum wage is a transfer of wealth from those who invest to those who labour. Those who labour tend to spend their income where they live (food and housing making up a much larger proportion of their income) causing a local boost to the economy.”

    The problem is the people who “invest” are the ones who actually increase the value of labour by inceasing the capital stock of the economy, allowing workers to produce much more in an hour of work. So by taking wealth from the vaguely titled “investors” you flatten the structure of production and lower real wages, which have everything to do with how much you can buy and nothing to do with the number on your pay packet.

    The second part of the argument, that it boosts the “local economy”, is nonsensical. The market allocates resources to their most profitable use and people generally don’t want to drive for an hour to go shopping so as a rule it is better to set up businesses close to where people live, “boosting the local economy” in the process. Of course, the “smart growth” policies that Greens love often prevent this meeting of supply and demand, forcing people to pump out carbon driving to the shops.

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  20. The wealth transfer due to an inadequate minimum wage is from the good employers (tax) to directly padding the pockets of poor employers (benefits to their employees). The poor employer pays less tax proportionately.

    The wicked irony, of course, is that the poor employers may be the good employers competitors.

    But most capitalists are too preoccupied with arguing the low wages are good for employment that they fail to notice they’re been had by their competitors…

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  21. Kleefer

    I am not ignorant of economics and I am a Green.

    Your statements, however, use an old, overly simple and dogma ridden economics.

    Let’s take your contributions one at a time and see where the truth really lies.

    First, saying that New Zealand had low/no unemployment until recently is false. This is because the government “padded the stats” using taxpayer-funded make-work schemes like the railways. This required taxing wealth-producing industries and diverting the money into loss-making projects that consumed capital, making the country poorer.

    It is true that NZ had unemployment lately, but recently it had almost disappeared. In 2008 NZ’s unemployment was about 3.5% (The statistics department has good figures which I looked up just the other day but do not have to hand). Economists usually say 2% unemployment is no unemployment – as people generally spend 1 year in 50 with out a job, looking for one. At times of low unemployment people get picky. 3.5% is not quite there but it is close. I expect (anybody know how to check this?) that most of the unemployment was sectoral. Perhaps teenage PI women had high unemployment south of the Waikato river. I do not know. But anyhow there was very low unemployment. Not due to the Railways, though. Probably mostly due to the huge subsidies paid to employers in the form of Working For Families. This made it possible for people to live on the wages offered. A good thing and a bad thing but off topic.

    BTW The railways and the post office, until the reforms of the ’80s, were charged with mopping up the unemployed. I am an economist not a historian so am not qualified to opine (but will anyway). That policy was instituted after the horrors of unemployment in the depression. Horrors.

    The distinction between “jobs that must be done” and “nice-to-have” jobs is arbitrary: do we “need” to have Subway? Consumers exercising demand for products/services, be they Subway sandwiches or landscape gardening, decide what gets offered. If the cost of providing a good/service is greater than the price consumers are willing to pay for it then it will soon stop being provided. The most “needed” goods/services are the ones people choose to spend their limited resources (money) on.

    Yes and no. To the shareholders of Subway (Restaurant Brands?) the front line workers at Subway simply cannot be replaced. In a recession outfits like Subway do well – so they will pay what they have to, as little as they have to, for the unskilled workers – barely skilled in assembling subway sammies. Market competition will limit how far they can raise their prices but I suspect wages make up about 30% of their costs (anybody know for sure?) so increases in the pay will hurt. Poor them.

    Consumers exercising demand for products/services, be they Subway sandwiches or landscape gardening, decide what gets offered That is a bit naive. Consumers want food. Subway supplies it. If Subway were to pack up and go home (good idea) then some one else would. Fish and chips anybody?

    The most “needed” goods/services are the ones people choose to spend their limited resources (money) on That is very wrong. People have hierarchy of needs that has nothing to do with the market.

    The problem is the people who “invest” are the ones who actually increase the value of labour by increasing the capital stock of the economy, allowing workers to produce much more in an hour of work. So by taking wealth from the vaguely titled “investors” you flatten the structure of production and lower real wages, which have everything to do with how much you can buy and nothing to do with the number on your pay packet.

    It is not just people who invest who increase the value of labour. Investment is required, true. But there is less productive investment of domestic capital in NZ than desired, because this group of people prefer to invest in housing (for very sound tax reasons. Shame on successive governments). But what we also need is for the labourers to become better educated and more productive themselves. Paying them better would help as they could substitute time being educated for time working. I have not checked lately but a few years ago about 50% of the economic surplus in NZ was paid out as dividends, and 50% as wages. Wage earners are the vast bulk of the population. So that is unjust, and we need a shift from those who invest to those who labour. Simple.

    The second part of the argument, that it boosts the “local economy”, is nonsensical. The market allocates resources to their most profitable use and people generally don’t want to drive for an hour to go shopping so as a rule it is better to set up businesses close to where people live, “boosting the local economy” in the process. Of course, the “smart growth” policies that Greens love often prevent this meeting of supply and demand, forcing people to pump out carbon driving to the shops.

    Golly! Stage II economics is not the beginning and end! The market is not good at allocating resources to their most profitable use for all sorts of reasons. Monopolistic and oligopolistic behaviour for one thing. The cost of and limits to information flow for another.

    It is well known that money in the pockets of the poorest will get spent straight away. The middle class are more likely to save (though who will save them?) and the upper classes hide it from the taxman. That is why raising the minimum wage is good for the local economy. More money gets spent in those local shops.

    peace
    W

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  22. Frog says “In our economy the people being paid minimum and near minimum wage are doing JOBS THAT MUST BE DONE.”

    This is obviously not correct.

    Take EVERY minimum wage factory job for an export company. Pretty much any could be shifted out of NZ.

    What about cafe workers, restaurant staff, etc.

    And work like cleaning, garden maintenance etc, can be cut back, rather than employing the same nunber of people.

    It is a simplistic and misleading attitude that raising the minimum wage will only be positive. There are some positive aspects, but also some very negative aspects to a move like this.

    i.e. companies will be LESS competitive, LESS likely to survive, LESS likely to spend on expanding and creating more jobs, LESS likely to employ people, LESS likely to be able to compete internationally, LESS likely to export, MORE lilkely to have to raise prices.

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