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)