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Saturday, November 19, 2016

Exploring the minimum wage

With the basic economic theory of supply and demand, anyone can look at the price of a good or commodity and see that less of it will be demanded as the price rises. That eventually causes an oversupply so prices will have to fall. Think about what will happen when Nintendo finally increases the supply of NES Classics (but probably long after the holiday craze has worn off).  As of this post, the price on Amazon is $225, but the MSRP is just $60. As supply picks up and meets demand, prices will eventually adjust back to $60.

Taking it a step further, we can add a price control that artificially keeps prices high (or low). Think about farm subsidies (or rent control).  That basic economic theory states that if the market isn't able to clear because of some outside interference, then the market will be inefficient and is therefore unquestioningly a bad thing.

So what does economic theory say about the minimum wage? Following the basic theory, we can consider a minimum wage to be a price control that artificially sets wages above equilibrium. That means there will be fewer "buyers" of labor. So many point to that and say it clearly leads to job losses.

But how does that actually stack up in reality? We've raised the minimum wage dozens of times over the last century and there has not been a single time in which an increase in the Federal Minimum Wage has led to job losses. But this isn't anything new.  Back in the 1990s, two economists began working on a study that compared different minimum wages across state lines. What Card and Krueger (AER, 1994) found was that an increase in the NJ minimum wage had no significantly different shifts in employment relative to next-door PA which operated at the Federal minimum.

OK so what gives? As it turns out, minimum wage jobs are not desirable (imagine that!). Without getting into the more complicated monopsonistic economic theory, let's think about what would happen if there was a town that had only one employer. And if it was a pretty lousy employer offering a very low wage so nobody really wanted to work for them.  Some people would have to do it because they really needed the money. But many would decide it wasn't worth it and instead would start their own business or chose to make money Ubering or reselling NES Classics on eBay. If the wage increased, some of those people might now decide it would be worth while to actually apply for the job. That would be an increase in labor supply.  The people coming into the market now would be slightly better off (and more skilled) than those that were already in the market initially. And so with that increase in wage, the average level of productivity would begin to rise.  That means the company would actually end up doing a little better and, in turn, begin to hire more workers.

The lesson here is that the economy is not static -- it's always changing. And if the government can enact policy that increases worker productivity, that's almost always a good thing for economic growth. Let's hope we end up with some real economists advising the President on fiscal policy and not Meatloaf.

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