Oh dear, Gittins thinks he’s getting with the program

Actually, Ross, the debate on the minimum wage has come and gone and Gittins is the one looking the goose.  And here’s the thing: I am a labour market economist and you are not.

For a while there, the work of Card and Krueger (Card refuses to have anything to do with minimum wage research these days) was often trotted out as an excuse to raise the minimum wage.

Based on a fairly dodgy questionnaire of managers of fast food outlets in contiguous states with different minimum wages (the US arrangement is that the federal minimum wage must be met, but states are able to set higher rates), there seemed to be some doubt whether lifting the minimum wage would reduce employment.

Needless to say, there was a very vigorous debate about this finding and more recent research has not borne out their conclusion.  In fact, the recent modelling of the Congressional Budget Office predicts that half a million jobs would be lost if the federal minimum wage were to be lifted (in stages) to $US10.10. (It is currently $7.25, but it is higher in many states.)

Gittins also quotes the laughable dated work of Manning et al about monopsonybeig associated with a link between higher employment and higher wages.  The fatal problem for Manning’s work (which is now ignored by the labour economics profession) is that the prevalence of monopsonies (single employer, many workers) is extremely low.  (Perhaps some regional towns and one big employer, but even here, employment tends to be spread across a number of employers).

And as for the argument about transaction costs, this is just theory.  In the case of Australia, there are no information problems because low paid workers have regulated pay and information is readily available.

Neumark and Wascher (2006) are probably the best single reference on the economics of the minimum wage.  They make the point that for those minimum wage workers who keep their jobs (and hours of work), then lifting the wage is an obvious gain.  For those who lose their jobs, whose hours of work are cut, who lose their health insurance, whose training and promotion prospects are cut, there are clearly downsides.

From a policy point of view, the pluses and minuses can be added up.  But bear in mind, it is the more marginal workers (poor education, patchy employment record, time in jail, etc.) who are most likely to lose their jobs.  This is an important equity consideration to be borne in mind when tinkering with the minimum wage.

On this point, the CBO thinks that 900,000 people would be lifted out of poverty if the minimum wage were lifted to $10.10 per hour.

Contrary to Gittins’ assertion, the economics profession in the US is deeply divided about lifting the minimum wage.  There are group letters signed by eminent economists supporting both the for and against case.

One important point to note  is that in the US, the number of workers earning the federal minimum wage of $7.25 is now very small and with all the talk about raising the rate (this discussion has been going on for years), the initial impact on employment of raising the rate (expected to be in three stages) should be minimal, which of course does not disprove the case that higher minimum wages (such as in Australia) are very damaging the employment prospects of the most marginal workers.

Even Joe Stiglitz was a bit wary about making predictions about raising Australia’s very high minimum wages.

Here’s is the incoherent piece by Gittins (who has had the ACTU whispering in his ear):

When the Fair Work Commission announced a 3 per cent increase in the national minimum wage to more than $640 a week – or almost $16.90 an hour – from last week, employers hinted it would lead to fewer people getting jobs and maybe some people losing theirs.

And to many who’ve studied economics – even many professional economists – that seems likely. If the government is pushing the minimum wage above the level that would be set by the market – the “market-clearing wage” – then employers will be less willing to employ people at that rate.

That’s because market forces set the market rate at an unskilled worker’s “marginal product” – the value to the employer of the worker’s labour.

Almost common sense, really. Except that such a conclusion is based on a host of assumptions, many of which rarely hold in the real world. And over the past 20 years, academic economists have done many empirical studies showing that’s not how minimum wages work in practice. They’ve also developed more sophisticated theories that better fit the empirical facts. It’s all explained in the June issue of the ACTU’s Economic Bulletin.

As a result, there’s been a big swing in academic thinking on the question of the minimum wage. (No) Last year, researchers at the University of Chicago asked a panel of economists from top US universities whether they agreed with the statement that “the distortionary costs of raising the federal minimum wage to $US9 per hour and indexing it to inflation are sufficiently small compared with the benefits to low-skilled workers who can find employment that this would be a desirable policy”. Fully 62 per cent agreed and 16 per cent disagreed, leaving 22 per cent uncertain.

Earlier this year, more than 600 US economists – including seven Nobel laureates – signed an open letter to Congress advocating a $US10.10 minimum wage. They said that, because of important developments in the academic literature, “the weight of evidence now [shows] that increases in the minimum wage have had little or no negative effect on the employment of minimum-wage workers”.

The first such study, published by David Card and Alan Krueger in 1994, compared fast food employment in New Jersey and Pennsylvania after one state raise its minimum wage and the other didn’t. They did not find a significant effect on employment.

Since then, many similar US “natural experiments” have been studied and have reached similar findings. In Britain, the Low Pay Commission has commissioned more than 130 pieces of research, with the great majority finding that minimum wages boost workers’ pay but don’t harm employment.

There’s been less research in Australia, but one study by economists at the Australian National University, Alison Booth and Pamela Katic, suggests that the facts in Australia seem to fit the “dynamic monopsony” model of wage-fixing.

Under the simple textbook, “perfect competition” model of the market for labour, individual firms face a horizontal supply curve: each firm is so small that its demand for labour has no effect on the price of labour. It can buy as much labour as it needs at an unchanged price.

In the dynamic monopsony model, however, each firm faces an upward-sloping labour supply curve. This is because more realistic assumptions recognise the existence of “imperfections” or, more specifically, “frictions”.

Such as? Workers may not have perfect information about all the alternative jobs they could take and this could make them cautious about moving. Searching for a job may involve costs in time or money. Workers and jobs may be mismatched geographically, so changing jobs may involve greater transport costs. Workers – being humans rather than inanimate commodities – may not have identical preferences about the jobs available.

In other words, there are practical reasons why it takes a lot for a worker to want to leave their job.

These frictions, or “transaction costs”, are assumed away in the simple model. But their existence can result in employers having market power, which they can take advantage of to pay workers less than the value of what they produce (their marginal product).

Economists call such power “monopsony” power. Just as a monopolist is a single seller, so a monopsonist is a single buyer. But don’t take that word too literally. An employer with monopsony power doesn’t need to be a monopolist in the market for its product (the “product” market), nor the sole buyer of labour in the region or the industry.

“A single employer in a market with many employers can have monopsonistic power if workers bear costs of job search,” the article continues. In other words, it possesses a degree of monopsony power.

The point is, if a firm is facing an upward-sloping labour supply curve and wants to hire more workers, it may need to pay a higher wage than it is paying its existing workers. So, if it goes ahead with hiring, it will need to increase the wage rates of its existing workers.

And this means the firm’s profit-maximising level of employment and wages will both be lower than they would be under perfect competition.

In such a model, if the minimum wage rate is set at or below the marginal product of labour, this won’t cause employment to fall and may cause it to rise. Monopsonistic models don’t have an unambiguous prediction for the employment effect of a minimum wage.

A paper by Bhaskar, Manning and To, published in the Journal of Economic Perspectives in 2002,  concluded that “a minimum wage set moderately above the market wage may have a positive effect or a negative effect on employment, but the size of this effect will generally be small”.

It will be interesting to see how long it takes those many Australian economists who don’t specialise in studying the labour market to catch up with this change in their profession’s thinking.  (LOL)

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35 Responses to Oh dear, Gittins thinks he’s getting with the program

  1. vlad

    Monopsonybeig? I’m relieved that’s just a typo. For a moment or two I thought it was an actual word.

  2. vlad

    “won’t hurt jobs”.

    It won’t hurt Ross’s job whatever happens. If he thought it might, he might look into these things more closely.

  3. stackja

    Another SMH story:

    Monash University professor Jakob Madsen
    His final tip is to ignore the newspapers. “No offence,” he says. “But if you are always focusing on what’s just happened you are unable to consider what’s happening underneath.”
    Read more: SMH linky

  4. Rodney

    Raising the minimum wage will not reduce employment if two factors are met.
    1. That employers are extremely generous and will hapily pay higher wages regardless of costs.
    2. That employers have unlimmited funds.
    Although the first is no problem, the second unfortunately is not currently the case.

  5. stackja

    Liberty Quotes
    There is no such thing as “a right to a job”—there is only the right of free trade, that is: a man’s right to take a job if another man chooses to hire him. There is no “right to a home,” only the right of free trade: the right to build a home or to buy it. There are no “rights to a ‘fair’ wage or a ‘fair’ price” if no one chooses to pay it, to hire a man or to buy his product.
    — Ayn Rand

  6. PaulL

    I note the quote:
    .”if a firm is facing an upward-sloping labour supply curve and wants to hire more workers,
    .”it may need to pay a higher wage than it is paying its existing workers. So, if it goes ahead
    .”with hiring, it will need to increase the wage rates of its existing workers.

    The two statements don’t necessarily go together, I’ve worked in lots of companies that pay new workers more than existing workers. That’s one of the reasons why job hopping can result in pay rises over time.

  7. entropy

    Paul, I know of multiple cases where new public servants (with a specialisation) can be paid more than crusty old blokes who have done the same job for years with the same qualification.

  8. PaulL

    @entropy: yeah, that makes it sound like an award kind of thing. I’m more used to the simple market forces bit – my last employer always paid more to new hires, because that’s what we did to get them in the door. They then got poor pay rises until they equalised with the people who’d been around longer. But if you jump jobs every two years you miss those poor pay rises – you just get another “bonus signing pay rate”. The existing employees put up with it because they’re not sufficiently motivated to get a new job. Personally I think it sucks as an HR policy – annoying your existing employees so as to get new ones. But in practice it seemed to work OK.

  9. blogstrop

    Ross is damaged goods.

  10. Ant

    How many of the morons who push for increases to the ‘minimum wage’ have ever run a business employing people for any length of time?

  11. Dave Wane

    Just imagine a totally free labour market in Australia, ideally without a minimum wage? Supply and demand working as they should to determine the “price of labour”. Employers and employees (ideally all employees will be contractors of various types) negotiating productivity and remuneration deals together without the dead hand of government and without corrupt union thugs intervening unnecessarily.
    Who knows: we could possibly still have a car industry – exporting cars to other countries. We could still have plenty of other recently shut-down industries still operating if it were not for: the highest electricity prices in the western world, (obviously) the highest labour costs in the western world, the most over-regulated workplaces probably anywhere and a plethora of local, territory, state and federal red tape to comply with.

    Australia could be much more productive, a hell of a lot more competitive and far more prosperous if only freedom could prevail in all its forms right across the length and breadth of our wide brown land.

  12. Every dog has its day

    Rodney: “Raising the minimum wage will not reduce employment if two factors are met.”

    Nope. there are numerous other possibilities: employers can increase prices, they can reduce hours of work but not employment, they can get workers to work harder (its unit labour costs that matter), they can substitute one type of labour for another with no change in total number of workers.

  13. Alfonso

    You don’t need to fret about Gittens.
    He’s a Clive Hamilton type ABC apparatchik.
    Reality invalid.
    No more credible than Robin “100 metres” Williams.
    Keynes’s bum boy.
    As long as I’m not paying for that piece of shit….. all’s well.

    Alas I have to, until Tone gets it.

  14. What of the concept raised in the NCoA of setting the minimum wage on a regional basis? The effect of a minimum wage of $16.90 in Central Sydney is substantially lower than the same minimum set out bush, as the proportion of the wage curve affected is much smaller in the city.

    A couple of people have pointed out to me that the concept of tying minimum wage to the AWE in a region is a touch more difficult than it sounds, as the AWE calculations are skittish and not well formed in small regions. Still, something along those lines would be viable, with regions down at the SA2 or SA3 level, and I can’t help but think it would be a big step forward for regional Australia.

  15. AP

    I wouldn’t worry about him, Judith. He doesn’t even understand simple concepts like dividend imputation:

    Since the introduction of full dividend imputation in the late 1980s – under which Australian shareholders get a tax credit for the company tax already paid on their dividends – the main purpose of company tax has been to tax profits earned by foreign shareholders

    I can not understand why anyone would read his articles. I read a couple (including the one linked above) a few years ago and quickly realised it was a waste of my precious time. It stuck in my mind that here was a so-called economics editor who didn’t even seem to comprehend basic, bread-and-butter stuff.

  16. jumpnmcar

    This is why we need independent States.
    One could try upping the wage floor and another tries lowering and evaluate the difference.
    Lessons leant, adapt or perish, progress happens.
    This applies to every governing concept.
    Fuck federal dictated control.

  17. john constantine

    my families swampie crows about the high min wage, on the basis that everyone should work for the government, and anything that stops greedy people exploiting the workers for profit is furthering the cause.

    seriously, the swampies know it makes things hard for small business, and that is exactly what they intend.

    crony unionised big government, and crony unionised big business. the swampies hate small business with all the rage in their artless, fly-bitten worm crusted hearts.

  18. Infidel Tiger

    The US minimum wage is always cited as if everyone is on it. The reality is that only 2.5% of US workers are:

    http://www.forbes.com/sites/jeffreydorfman/2014/01/30/almost-everything-you-have-been-told-about-the-minimum-wage-is-false/

  19. Fisky

    The US should raise the minimum wage to $10/hour, and in fact that should be put on the Republican platform with strict workplace fines for violations. That should help them with white proles in the swing states while putting a lot of Mexican illegals out of work.

  20. wreckage

    Well, Drift, if it would greatly help regional Australia you can bet your arse it won’t get done.

  21. JC

    The US minimum wage is always cited as if everyone is on it. The reality is that only 2.5% of US workers are:

    My kid lives in NYC and takes baby sitting jobs. she gets paid between 15 & 20 bucks and hour with cab fare home if it’s late. Australian leftist morons seem to think that everyone below the grade of a Wall Street CEO is on the minimum wage in the US. Fucking imbeciles.

  22. JC

    The US should raise the minimum wage to $10/hour, and in fact that should be put on the Republican platform with strict workplace fines for violations. That should help them with white proles in the swing states while putting a lot of Mexican illegals out of work.

    Fisky, they should leave it alone. Very few whites are anywhere near the minimum wage in the US. Even wait staff are nominally paid 7 bucks an hour but the tips would kick that up to as high as 20 bucks an hour. The GOP can win by showing some unity and highlighting the dangers of a rogue Kenyan president. They don’t need to fuck around with the Labor market to attract whiteys vote.

  23. Infidel Tiger

    I think Fisk is right but also wrong. The a republicans should propose a minimum wage of $30 per hour. No one on minimum wage or almost close to it votes for them.

    They need to stir some shit. In fact they should propose a $100 per hour minimum wage. What’s the downside? Double down on theses fucks.

    They propose free health care. You propose paying people to visit the doctor. They propose free university. You propose a free degree without even needing to attend. Out free stuff the fucking cnuts until they admit they are lunatics.

  24. Fisky

    I think Fisk is right but also wrong. The a republicans should propose a minimum wage of $30 per hour. No one on minimum wage or almost close to it votes for them.

    This is a good idea. We’ll criminalize employment for the vast majority of Democrat voters.

  25. Dave Wane

    This is why we need independent States.

    Absolutely, jumpnmcar.
    #1378747, posted on July 12, 2014 at 10:18 pm

  26. Andrew

    For all her bluster about being ‘a labour market economist’ Judith doesn’t know much about the state of labour economics. First of all, the idea that Card and Krueger has been disproven is laughable. There have been a lot of studies on the minimum wage: some show no effect on employment, some show negative effects. As Judith concedes later on, there is no consensus in the field about the employment effects of minimum wage increases. The CBO point estimate, although certainly plausible, was quite uncertain, with huge error bands that don’t exclude the possibility of very negligible employment effects.

    And the notion that dynamic monopsony is ‘ignored’ by labour market economists is, again, incredibly ignorant (and the idea itself is poorly understood by Judith, going by her vague exposition of it.) She doesn’t seem to understand that it’s the transaction costs (note that she ignores labour mobility and search costs) that can give rise to monopsony power: it’s not just one-company towns.

    For example, some (by no means a comprehensive list) labour economics papers in the past two years that have drawn on dynamic monopsony:

    Alison Booth (2014) “Wage Determination and Imperfect Competition”, IZA Discussion Papers 8034, Forschungsinstitut zur Zukunft der Arbeit.

    Hirsch et al. (2013) “The cyclical behaviour of employers’ monopsony power and workers’ wages.” Diskussionspapiere, Universität Erlangen-Nürnberg, Lehrstuhl für VWL.

    Annaïg Morin (2013) “Wage dispersion over the business cycle.” EUI.

    Mackinson and Navarro (2013) “Monopsonistic behaviour in Chilean manufacturing”, Revista de Análisis Económico, 28(2) 91-108

  27. Edward Boosens

    Really boring that everyone talks up the US. More interesting are Asian examples that aim tom impose social outcomes and stability. In fact quite interesting that Singapore is presently focused on the gini coefficient.

  28. Peter S

    Read Ross G’s piece. Also the one before it. RG doesn’t exhibit much knowledge but certainly has fixed opinions. I just wish he would retire. He is still living in the 60′s and 70′s.

  29. .

    First of all, the idea that Card and Krueger has been disproven is laughable

    No, and you are really out of your depth. Nowhere in their study did Card and Krueger argue that the minimum wage does not cause unemployment. What they argued was that the elasticity was low at low levels. That has been disproven.

    As Judith concedes later on, there is no consensus in the field about the employment effects of minimum wage increases.

    Yes there is, for Australia anyway.

  30. Mother Hubbard's Dog

    What Andrew says Judith says “Card and Krueger has been disproven”.

    What Judith actually said “there was a very vigorous debate about this finding and more recent research has not borne out their conclusion.”

    What Andrew says Judith said “Judith concedes later on, there is no consensus in the field about the employment effects of minimum wage increases”.

    What Judith actually said ” the economics profession in the US is deeply divided about lifting the minimum wage. There are group letters signed by eminent economists supporting both the for and against case.” No sign that this is a concession, rather this is a correction of Gittins’ one-sided view of current US academic opinion.

    Not even a pass conceded, Andrew. You can do much better.

  31. youngster

    Fisky is wrong about the illegals. If the minimum wage goes up, the cash economy in the US will grow even bigger. Why would an employer stump up an extra $2/hour, when he can keep paying the same wages to illegal immigrants? There is practically no risk attached to doing so – the cash economy and hiring of illegal migrants in Southern California takes place openly.

  32. Manning’s work is not ignore by labour economists.

    He is reviewed in the top journals and he publishes in the top journals giving summaries of his monopsony approach to the labour market.

    Peter Kuhn did a great review of Manning book pointing out that the title Search Models with Ex-Ante Posted Wages in Motion, while a more accurate description of its contents and analytical framework, is certainly less catchy than the actual title Monopsony in Motion: Imperfect Competition in Labor Markets.

    Manning’s use of monopsony has really nothing to do with the old-fashioned use of the word monopsony.

    His framework is a house of cards that depends on labour market matching been in the form of random matching rather than balanced matching:

    as Manning himself acknowledges, if matching is balanced (which effectively amounts to constant returns to scale in the technology for recruiting new workers), all elements of monopsony disappear from the model and the neoclassical equilibrium again prevails: in the long run firms can expand without limit without needing to raise their wages.

    Thus it is absolutely critical to the search-based monopsony model at the core of this book that there be diminishing returns to scale in the technology for recruiting new workers.

    In other words, for the theory to apply, firms must find it harder to recruit a single new worker the larger the absolute number of workers they currently employ.

  33. I should add that Manning’s book starts with the great question which only Austrian labour economics can answer:

    What happens if an employer cuts the wage it pays its workers by one cent?

    Much of labor economics is built on the assumption that all existing workers immediately leave the firm as that is the implication of the assumption of perfect competition in the labor market.

    and

    That important frictions exist in the labor market seems undeniable: people go to the pub to celebrate when they get a job rather than greeting the news with the shrug of the shoulders that we might expect if labor markets were frictionless. And people go to the pub to drown their sorrows when they lose their job rather than picking up another one straight away. The importance of frictions has been recognized since at least the work of Stigler (1961, 1962).

    manning’s analysis of the minimum wage is perfectly even-handed pointing out that some firms will close and that must be balanced against any other positive effects you might see in it.

  34. PaulL

    I would have thought that friction explains a difference between long run and short run behaviour. When my employer cuts my pay by 1c I probably don’t immediately leave my job, nor probably when they cut it by $5. But when I do get a new job, I’ll choose between those offered and probably choose one that is paying market salary.

    Similarly, if I’m an employer (particularly a small employer) I’m unlikely to fire all my staff when the minimum wage is raised. But it might stop me from hiring an additional staff member in 6 months time, and I might get some technology instead. It might stop me from opening a new business. So all friction tells us is that raising the minimum wage won’t immediately put people out of work, but it says nothing about the long term impact.

    As I noted further above, I’ve worked in companies where existing staff are paid less than newly hired staff, it’s pretty common in many industries. But when you get around to changing jobs, you get evened up – and people who change jobs a lot get evened up more frequently.

  35. thanks PaulL, the difference between the long-runn and the short run as you describe leads to rents or a capital value arising from every employment relationship that is lost of people quit or are fired.

    much of the search and matching literature is about how bargaining takes place that splits the rents from employment relationships – the durable asset formed by every employment relationship.

    Manning makes a very specific assumption about how the match surplus from every employment relationship is split through bargaining:

    there seems little alternative but to grasp the nettle and make some assumption about the way in which the rents are divided.

    One should choose an assumption that is a reasonable approximation to reality. This is made difficult by the fact that there is no universally right assumption for how rents are shared in the labor market: there are different mechanisms in different labor markets, perhaps even co-existing in the same labor market. In spite of this, we focus on one mechanism for most of this book.

    In this book, it is assumed that employers set wages.

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