Sunday, 15 April 2018

Economic Myths - imposing a minimum wage will always lead to falls in employment and output

Opponents (broadly, "right wingers") say that wage levels are set in a competitive market, so if the minimum wage is higher than this, this will cost jobs and reduce output. Defenders of minimum wages (broadly, "left wingers") say that it levels the playing field between exploitative employers and exploited workers and insist that any small fall in employment is a price worth paying.

Each side puts out their studies which purport to prove their theory. I'm not really convinced by either set of 'facts' as people are highly selective and tend to find what they are looking for.

(I personally am heartily indifferent about the National Minimum Wage, my view being that the best guarantee of workers' rights is a growing economy and full employment - i.e. get rid of VAT and supertaxes on employment income such as National Insurance Contributions. We can back this up with a Citizen's Income, which strengthens the bargaining position of potential workers slightly, especially when it comes to low-wage jobs.)

I have recently stumbled across a theory that says, evidence shows that the negative impact on employment and output was not only nowhere as bad as the doom-sayers predicted, but that in some situations, imposing a minimum wage can actually increase employment and output.

Sounds very counter-intuitive, but actually it makes sense. This is because most businesses have some monopoly/monopsony power (they are two sides of the same coin).

Let's start at the very beginning with a business in a perfectly competitive market where labour is the only variable cost with a given supply curve and a given demand curve. The level of output of the business in question would be 9 units, wages £10.40 and selling price £11, being the highest level of output before the business tips into losses:

The columns for marginal cost and revenue are the total cost/revenue at that level of output, minus the total cost/revenue if one unit less were produced and sold. The relevance of this will be explained further down.

(I am perfectly aware that no business knows exactly what its marginal costs per unit are, let alone what its marginal revenue per unit it, and that most businesses do some sales at a loss, whether by accident (budget overrun or customer doesn't pay) or by design (loss leaders). Nonetheless, businesses must have some collective intuitive grasp of this or they'd all be bankrupt. 'Home builders' are the crassest example of this, in the short term, more supply depresses prices and costs would increase rapidly).

So if a minimum wage of £12 is imposed, the business in a perfectly competitive market has to reduce output to 8 units, wages £12 and selling price £13, being the highest level of output before the business tips into losses. This is bad, and what the opponents predict:

As we well know, most businesses have some monopoly power (can restrict supply) and, especially if there is permanent un- or under-employment, a stronger bargaining position than potential employees, which we shall consider monopsony power for the purposes of this debate.

Such businesses (or industries) do not end up setting prices at just above costs, which is the optimum position for the economy as a whole. They choose the level of output which maximises profits, and you can't fault them for that. Some interpret this to mean that businesses (should) set output at the level at which any further increase in output means that marginal costs would exceed marginal revenue.

So this business restricts output and employment to 5 units sold for £16 each, total profits £44, wages of £7.20 per hour. There's no point going to 6 units - marginal costs £12 exceed marginal revenue £10 and profits would fall.

What happens if the minimum wage is set at £8 per hour? While average wages go up, the marginal cost goes down to a flat £8 for the first six units of labour. The new profit-maximising level of output is now 6 units sold for £15 each, total profits £42, wages of £8 per hour.

Higher wages, more jobs, more output, lower prices and monopoly profits (rent) shaved back a bit. What's not to like?

Yes, I know this is all hypothetical, but there are simply too many studies showing that there is no measurable negative impact of minimum wages on employment levels to simply be dismissed out of hand, however biased the authors. So I think that there is something in it, however difficult it is to explain.

Or maybe both sides (left wingers and right ringers) are half-right and the extra jobs in monopoly businesses cancel out (or outweigh) job losses in competitive businesses. This would still be a good thing, if those competitive businesses are only competitive because wages are depressed.


Derek said...

Looks good to me, Mark. It's a neoclassical Capital/Labour analysis but as such it will make sense to most economists, not just Georgist ones. I have previously defended Minimum Wage legislation on Quora using a classical Land/Capital/Labour analysis which you can see the gist of in this answer. That predicts a couple of additional "unintended consequences" of MWL including the possibility of rural depopulation if the MWL is national rather than local.

Mark Wadsworth said...

D, that's another good explanation. But every now and then I try to do a post without mentioning land values :-)

Sackerson said...

I'm not terribly technical but I take the view that paying workers more means they'll have more to spend and so the velocity of money and the level of economic activity will increase, whereas funnelling wealth to the richest is more likely to result in investment (ownership of land and businesses) and savings.

I suppose it's complicated by the fact that a lot of what we might buy more of, is now from abroad.

Mark Wadsworth said...

S, that's the basic argument. Does the NMW increase or decrease wages? If it does = good, if not = bad.

jack ketch said...

Whenever people talk about the NMW I recall those victorian mill owners who grizzled about whichever Act meant they could no longer demand their workers work extremely long hours (can't recall the exact details, been 30+ years since I took "Social & Economic History" at O level).

Those mill owners claimed "their greatest profit was made in the very last hour of the day". The arguments from both sides in the NMW equation seem to me to be similar to those of those Owners of Dark Satanic Mills ie based on a misconception but I'm not clever enough to understand what that misconception is....something to do with the markets being self adjusting, perhaps?

Lola said...

Interesting analysis.

Min wages are a 'price control'. Generally considered mostly not good.

Maybe the effect of a statutory MW (no, not our host...the mind boggles were 'MW@ to be statutory...) is self cancelling. That is it simply universally increases costs throughout an 'economy'? And no-one really ends up benefitting. That is (2) that no redistribution actually takes place from exploiter to exploitee?

To my mind the greatest wages problem in the UK are that about four fifths of NMW pay goes out on taxes and rents. Solve that and you solve 'low wages'.