Tuesday, April 29, 2014

Removing money from the minimum wage debate

Many people think that economics has a lot to do with money. But in reality economics is so much more than money. There are certainly areas within economics that focus on money; monetary policy, money and banking, the role of the Federal Reserve system, etc. There is also an overlap between economics and finance when it comes to things like the stock market and investments.

But many fields within economics do not focus on money. In fact, money often obscures what is really going on. To demonstrate how money can cloud an issue, I am going to give an example in the context of a minimum wage.

Suppose Henry owns a small diner. To keep things simple let's assume that this diner only serves hamburgers. Henry has 4 workers; Tom, Hank, Fred and Carl. Each worker produces 9 hamburgers per hour. This is a world without money, so each worker is paid in hamburgers.

(One of the benefits of having a universal medium of exchange such as money is that it solves the coincidence of wants problem. In order for Tom, Hank, Fred or Carl to consume something other than a hamburger they have to find someone who has what they want and is willing to take some amount of hamburgers in exchange for that good or service. Money, as opposed to barter, makes it easier for people to find willing trade partners.)

Since each of the workers is being paid in hamburgers I will further simplify the example and assume that there is only one other good in this economy, apples. The exchange rate is 1 hamburger equals 3 apples, or 1H = 3A. Out of the 9 hamburgers that each one of the workers produces, they get to keep 7 as their pay. The other 2 hamburgers go to Henry. This is the return on his capital. Henry provides the grill, the knives, the counter space, the restaurant itself, and all of the things other than workers that go into making hamburgers. So Henry pays each worker 7 hamburgers, he keeps 2 hamburgers from each of the 4 workers, and thus he earns 8 hamburgers per hour.

Now suppose the government doesn't think that 7 hamburgers per hour is a fair amount of burgers for the workers and they increase the amount to 8 hamburgers per hour. Henry now only keeps 1 hamburger from each worker instead of 2 and his earnings are now 4 hamburgers per hour instead of 8. All of the workers are now getting 8 hamburgers per hour.

Note that there is no more output than before. There are still only 36 hamburger being created per hour. The minimum wage just moved hamburgers from Henry to the workers. Before the minimum wage Henry could trade his 8 hamburgers for 24 apples. After the minimum wage he only has enough hamburgers to get 12 apples. Henry could try to increase his apple consumption by raising the price of his burgers. That is, he could unilaterally increase the price of a hamburger from 3 apples to 5 apples. If he did that then he would be able to get 20 apples after the minimum wage increase. This is still not as many apples as he was getting before but it is closer.

Note however that the apple producer, let's call him Johnny, now has to pay more for a hamburger than he did before. Johnny is worse off if Henry raises the price of a hamburger from 3 apples to 5 apples in response to the minimum wage increase. Because Johnny will be worse off, he might not agree to Henry raising the price and avoid buying hamburgers from Henry. If that is the case Henry might just have to accept that he can only get 12 apples after the minimum wage instead of 24. With no price increase the workers: Tom, Hank, Fred, and Carl, are better off, Henry is worse off, and Johnny is not affected. If Henry is able to pass on some of the cost to Johnny by raising his price, then both Johnny and Henry are worse off but the workers are still better off than before the minimum wage. There is no way to make everyone better off with a minimum wage though, since the minimum wage only moves hamburgers around between Henry and the 4 workers. It does not make the 4 workers more productive.

Suppose instead of setting the minimum wage at 8 hamburgers per hour, congress increases it to 9. Since the workers only produce 9 hamburgers per hour, Henry either has to accept 0 hamburgers for himself, shut down, or find workers who are more productive and can produce more than 9 hamburgers per hour. This is another important point; a minimum wage often changes the type of worker that is employed. Henry will have to find more productive workers in order to stay in business and so the 4 workers he currently has will be out of a job since they only produce 9 hamburgers per hour. No other hamburger diner will hire them since they cannot produce more than the amount an employer is required to pay them. Any employer who tries to hire them will get no return on his capital. The least skilled workers are the people who suffer the job losses when a minimum wage is imposed.

Removing money allows us to see what is really going on . People only care about money because they can trade it for the stuff they really want: hamburgers, apples, cars, books, etc. No one values money for money's sake. When people talk about increasing the minimum wage and only think about dollars, it muddles what is really going on. People are paid based on what they produce, and in the long run it is impossible for any business to pay somebody more than what they produce. Minimum wages do not create any more stuff, they simply shuffle production around. Also, it is the least productive worker that is harmed the most when a minimum wage is imposed.

Societies only get richer when they create more output. A minimum wage does not further that goal and anyone who tells you otherwise is either ignorant or lying.

4 comments:

  1. Advocates of the minimum wage almost always argue for it for the purpose of lowering inequality, not raising output.

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    1. I disagree. See:

      http://www.businessinsider.com/raising-minimum-wage-small-businesses-retail-2013-2

      http://www.usnews.com/opinion/blogs/economic-intelligence/2013/08/09/a-fair-minimum-wage-helps-workers-and-businesses

      http://www.desmoinesregister.com/story/opinion/columnists/iowa-view/2014/04/08/iowa-view-minimum-wage-hike-good-businesses-communities/7446811/

      These were the first 3 articles from a Google search "min wage helps businesses". The basic argument is that the min. wage increases demand which is good for business. Also it leads to more loyal/productive workers, which is true if the least productive workers are forced out like in my example.

      But to your point, I don't see how making the least productive workers unemployed reduces inequality. $0/hr is lower than $7.25/hr.

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  2. I didn't say no one argues that point ever. It's just not the most common.

    More importantly, your post is generally baseless all together regardless of how you feel minimum wage affects growth. Basically you're just saying if you create a model that has no money, there will be no monetary effects on output of a minimum wage increase. Not sure what that brings to the table.

    To your last sentence, see Card and Kruger. Even if you think it's a BS study, the opposing side of the argument has never presented anything more difinitive.

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    Replies
    1. I still disagree that it is not the most common. Robert Reich, one of the most vocal proponents of a higher minimum wage, makes that argument all of the time. But we can agree to disagree there.

      I don't know what you mean about monetary effects on output. Are you talking about a multiplier? Or perhaps something like the Lucas surprise model only instead of unexpected inflation there is a min. wage shock?

      Card and Krueger's paper concluded that the a higher min. wage caused no decreases in employment and could in fact raise employment if unskilled labor was bought in a monopsony market. I disagree with their theoretical monopsony story and their empirical findings are also suspect. Neumark and Washer (2006) reviews the empirical studies and they conclude that the preponderance of evidence points to lower employment among younger, unskilled workers.

      Also, as far as I am aware, Card and Krueger never address the change in the type of worker that occurs when a higher min. wage is imposed. Employment, as in the number of jobs, could remain relatively unaffected but the type of worker filling the jobs could still change. This is still an adverse effect for the lowest skilled workers.

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