The Dangers of Econ 101 in the Minimum Wage Debate

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Because the well-meaning but economically illiterate majority supports the minimum wage law, opponents must adhere to a high standard of argumentation if they are to make progress towards the repeal of this harmful law.

By Garrett Petersen @ Mises Daily

Minimum wage opponents often illustrate its effects with the standard, econ 101 treatment of price controls: They draw a supply-and-demand graph for low-skilled labour with a price floor set above the market-clearing wage creating a surplus of low-skilled labour. I caution against such argumentation on two grounds: First, it fails to capture many of the effects of the law. Second, failing to present these effects up front unnecessarily opens the anti-minimum-wage side of the debate to criticism.

Problems with Basic Supply-and-Demand Analysis

The assumptions underlying every supply-and-demand graph are far too strong to apply to something as heterogeneous as the many diverse markets for low-skilled labour. These graphs can only apply to markets where all buyers and sellers regard all units of the good as identical. It makes no sense to draw supply and demand curves for “fruit” because bananas, apples, pears, and peaches are all recognized as different by buyers and sellers. Similarly, to draw a single demand curve for the vast class of services that fall under the category of “low-skilled labour” is to misrepresent economic reality.

Labour services are heterogeneous. For instance, labourers are heterogeneous with respect to their skills and natural abilities. Even those labelled “low-skilled” have many skills. One cannot deal well with customers without language skills, one cannot deliver pizzas quickly without the ability to drive, and one cannot move heavy boxes without physical strength. Thus, although all of these tasks are basic and command relatively low wages, employers must value different workers differently based on their possession of the relevant skills and abilities.

This comes into the analysis of the minimum wage in the substitution between different sorts of workers. While employers must economize on all labour services affected by the price floor, this affects different sorts of workers differently. Suppose one sort of labourer would earn $8 while another would earn $4 without a minimum wage law. Suppose also that these labourers provide substitutable services.

A minimum wage set at $10 changes their relative prices from 2:1 to 1:1, thus inducing a substitution from the latter, less productive labourers, to the former, more productive labourers. Thus, while the effect on the less productive labourers is unambiguously negative, substitution towards the more productive labourers could potentially offset other factors. Delivering gains to relatively more productive labourers at the expense of relatively less productive ones flies in the face of the law’s ostensibly egalitarian goals.

A second element of heterogeneity in labour markets comes from the heterogeneity of labour contracts. Contra econ 101, there is far more to contracting in labour markets than simply agreeing on a quantity and price for something called “labour” or “low-skilled labour.” Employers and employees agree (implicitly or explicitly) on various employment conditions, including employee benefits. A benefit can be anything from employer-provided health insurance, to various workplace amenities, to general job training, to anything else that is costly to the employer and valued by the worker. An employer can consistently provide a benefit if and only if workers prefer the benefit to the wages they must forego so that their employer can profitably employ them while bearing the cost of the benefit. The provision of benefits is another element of exchange between employers and workers, but since the exchange occurs through an implicit subtraction of wages from what they otherwise would be, a price floor on wages can act more like a price ceiling on the implicit price paid for benefits. Thus, if some set of employers and workers would choose to contract at an hourly wage of $8 with benefits rather than $12 without, a minimum wage set at $10 induces both parties to contract in such a way as to cut the least-preferred $2 of benefits. The loss to both employer and employee comes from the foregone gains from the implicit exchange of $2 in lower wages for benefits worth at least $2 to the employee.

Relevance to the Minimum Wage Debate 

These arguments should be familiar to veterans of the minimum wage debate. My further argument is that by presenting the econ 101 argument as the first introduction for the uninitiated, minimum wage opponents make a tactical error. If the arguments presented above are not at the front and center alongside the standard argument that the minimum wage causes disemployment among the less skilled, they can appear as desperate attempts at regaining a losing position.

Imagine observing a debate on a topic you know little about. If one debater makes a bold claim, the other points out problems with the claim, and then the first debater falls back to various other arguments, who would you judge to be more likely to be correct? It would seem that the first debater is in retreat, that he must think of various weaker arguments to save himself from his initial failure. He may turn out to be correct, but most observers would bet on the other debater given the initial exchange.

When the standard argument against the minimum wage is simply that it causes unemployment, supporters of the law can plausibly point to various examples and statistical studies that appear to show a small or even slightly negative relation between the minimum wage and unemployment; all else is not equal, after all. The takeaway, for someone who is only aware of the standard argument, is that demand for “low-skilled labour” is particularly inelastic, so the trade-off between unemployment and higher pay to low earners appears favourable. For opponents to fall back to various other arguments against the minimum wage gives the appearance that their case is weak.

Pundits give the minimum-wage-causes-unemployment argument precedence only because it is the easiest to illustrate with basic, neoclassical principles.[1] General reductions in employment among labourers affected by the wage, substitutions from some types of labourers to other ones, or cuts to employee benefits could each be large and important or small and insignificant in any given historical context. Theory yields no constant, quantitative relations, so it would be impossible to conclude that one effect is necessarily more important than the others are. By giving one particular effect of the law a more prominent place in the debate, we undermine our position should other effects dominate in any given set of historical circumstances.

Because the well-meaning but economically illiterate majority supports the minimum wage law, opponents must adhere to a high standard of argumentation if they are to make progress towards the repeal of this harmful law.

[1] The other arguments could be illustrated within neoclassical models; it would just require more equations and graphs.

This article originally appeared at Mises Daily