Tuesday, July 13, 2004

Much ado about nothing?

There is an ongoing debate in the blogosphere after this piece by Steven Landsburg on minimum wages appeared in Slate. For some reactions, look here, here and here.

Econ 101 tells you that if you set up a price floor, then the supply exceeds the demand which in the case of minimum wages means unemployment. There are some problems with this very simple text book analysis. First of all, as Tyler Cowen points out, the wages are not the expenses employers have that can be related to the employees. If you raise the minimum wage, the employers might lower other expenses at the same time which means that they don't necessarily have to lay people off.

The second problem I want to put forward is a problem that is very much related to the neoclassical analysis as such. This kind of analysis is what you will find in any standard Econ textbook. Beginning from the framework of a partial or general equilibrium, a price floor set above the equilibrium price will have the effect mentioned above. The problem is that in the real world, the market is not necessarily in equilibrium. In my view, it is even very unlikely that the market ever is in such a state (even though there are equilibrating forces).

Consider the following scenario. The related market have a equilibrium price P. The minimum wage is set at a price below P, at Pmw. Under normal circumstances there wouldn't be any problems, the market would offer a wage above the minimum wage. But the circumstances don't need to be normal. It might be the case that the minimum wage in one way or the other becomes "institutionalized". What I mean is that the wages are sticky, not just downwards, but also upwards due to an institution. An institution is in this context a rule behaviorour in society. This rule might have been created as a spontaneous order, by "human action but not by human design". The employers offer the minimum wage and the employees don't question this offer until they worked for quite a while (and if the minimum wage "spell" is short enough, they might never question it). The minimum wage thus becomes ceiling more than a floor,unforeseenseen negative effect.

This means also that the government can raise the minimum wage without creating unemployment. The tricky thing is to know the limit of the raise, and that might be "to wish impossible things". Is this scenario plausible? I don't know, but I wouldn't rule it out as entirely implausible.

Update: Some interesting thoughts from Steven Horwitz.