Thursday, May 22, 2014

Can a minimum wage increase employment?

One of the ideas proposed by Card and Krueger (1993) to explain their finding that an increase in the min. wage increased employment at fast food restaurants is that those restaurants had monopsony power. A monopsony is analogous to a monopoly but instead of only one seller there is only one buyer. This creates a theoretical scenario in which a min. wage could increase employment rather than decrease it as in the usual theoretical supply and demand model. Ultimately Card and Krueger dismiss this idea in their paper because it didn't match some of their other findings but pundits in the media still bring it up from time to time.

So how does this work? Like a monopolist which has to lower their price to sell more, because a monopsonist is the only buyer of a good, in this case low skilled workers, if they want another one they have to increase the wage offered. For example, suppose Wendy's is offering a wage of $5/hr and this induces one worker to go work for them. If Wendy's needs two workers they need to pay the next worker $6/hr to get her to come work for them. But if wages are set at the margin, that is there is no way for Wendy's to pay the first worker $5/hr and the second $6/hr, then if they want two workers they will have to pay each of them $6/hr. There are several reasons why price discrimination i.e. paying one worker $5 and another $6 might not be feasible, such as bad employee morale due to perceived unfairness, the high time costs of posting two different wages and then interviewing workers one at a time, labor laws about equal work, equal pay etc.

So if Wendy's wants two workers and has to pay each worker $6 their total costs do not go up by $6 per hr when they hire another worker, but by $7 per hour. $6 per hour goes to the second worker and then an extra dollar per hour must be paid to the first worker, who would have only earned $5 per hour if the second worker was not hired. Below is a chart that with some hypothetical numbers.


The quantity of workers is in the first column, the wage (marginal cost of the next worker) is in the second, the total cost of workers is in the third, and then the change in the total cost of workers is in the fourth column. Notice that the change in the total cost, MTC, is always greater than the wage after 1 worker. This is because like in the example above, if Wendy's wants to hire one more worker it increases the wage for all of the previous workers. So when Wendy's goes from 2 workers to 3 workers, the wage goes from 4 to 6 and the total cost goes from 8 to 18, a change of $10/hr, greater than the $6/hr that would be paid to the next worker if they could just pay him $6 and keep the previous workers wages the same. This is because they pay the third worker $6/hr and have to increase the pay of worker 1 and 2 by $2/hr each (6+2+2 = 10)

So how can a min. wage increase employment in this scenario? Let's put this information in a diagram.


Here we have a demand curve for workers (the downward sloping black line), a marginal cost of the next worker curve (the upward sloping blue line), and a marginal total cost curve (the upward sloping red line). If Wendy's could pay each worker their own marginal cost, they would hire workers where the blue line (MC) intersects the black line (their demand for workers). This leads to an equilibrium quantity of 5 workers and a wage of $10 paid to the 5th worker. 

But for the reasons given above, if they have to pay each worker the exact same amount as the last worker hired, Wendy's will care about the change in their total cost, and instead will hire workers up to the point where the red line (MTC), intersects the black line. This leads to an equilibrium quantity of 3.4 workers and a wage of $6.80/hr. The wage at an amount of 3.4 is the wage that comes from the blue line, not the red line. Remember the red line represents how much total costs are changing and the blue line represents how much the workers actually get paid. The reason they don't line up is because of the monopsony power of Wendy's. Because Wendy's has to pay more for an additional worker they create a wedge between the wage and how much their total costs increase with each worker.

Now let's talk about the min. wage. Without monopsony power the last worker, in this case the 5th, would have been making $10/hr. But suppose the govt institutes a min. wage of $11/hour. This is represented by the orange horizontal line in the diagram. So if Wendy's is forced by law to pay each worker at least $11/hr, they will hire the amount of workers that corresponds to where the min. wage line intersects their demand line for workers. This is at a quantity of 4 workers. So the min. wage amount of workers is 4 and the monosopny amount of workers is 3.4. This is how, in theory, a min. wage can actually increase employment. Under this scenario there are more workers (4 > 3.4) and they are all earning a higher wage ($11 > $6.80) than under the monopsony scenario.

This doesn't seem to be the case in the real world though. There are a lot of different buyers of low skilled labor. Fast food restaurants, car washes, bar security, retailers, etc. In a world of so many different buyers it is more likely that the wage for low skilled labor is set by the market demand, that is the demand of all firms who hire low skilled workers, and then each individual firm takes this price as given. That is, each firm knows that if they want a worker of a given skill level they can pay the market wage and get as many workers at that wage as they want. So if Wendy's wanted a new cashier and they are paying the current one $9/hr they can go hire another one for $9/hr if they wanted to, not $9.50 or $10.

Hopefully this wasn't too difficult to follow. Now if you hear anyone talk about monopsony power and how a higher min. wage can lead to more employment you will have an idea of how it works.

Tuesday, May 20, 2014

The catch 22 of revitalizing a struggling city

In Enrico Moretti's book, The New Geography of Jobs, he discusses two methods of encouraging job and population growth in a city; attract employers and skilled workers will follow or attract skilled workers and employers will follow. He talks about this being a catch 22 in the sense that employers are reluctant to locate in a struggling, low cost area for fear that workers won't show up and workers are similarly reluctant to locate in the same area for fear that jobs won't show up. Neither wants to be the first mover.

This situation can be modeled in a normal form game where the strategies are to locate in a struggling city or not.


In the game above there are two players, firms and labor. Labor is the column player and Firms are the row player. If both workers and firms decide to locate in the same area they each get a positive payoff of 2 (2 has no quantitative significance. It can be any positive number to signify that they both gain if they both locate in the same area.). This is because the struggling area has lower property costs. If you are a firm and you sell a tradeable good i.e. a product that is bought both inside and outside of your area (think cars, computers, consulting services etc.) then the lower property costs mean more profit since you sell your product at a nationally (or even internationally) set price. If you are a worker and you earn a wage based on the national/international price of the good/service your company sells then the lower housing prices mean you have more money to spend on other goods and services or even a larger house.

If only one of the players chooses to locate in an area they get a payoff of -2 while the other gets a payoff of 0. This is because there are costs to choosing a struggling area without the other player being present. Not only are you located in a city that is down e.g. Detroit when you could have located in an area that is doing better e.g. Columbus, OH, Atlanta, GA or even the suburbs of Detroit but there are additional costs as well. For the firm, these include training workers, higher search costs for workers, relocation packages for attracting workers, or potentially relocation costs for the firm if they decide to relocate to an area with better workers. For workers these include taking a job that doesn't match your skill set, longer search costs for a job, being more susceptible to labor shocks and, like firms, potential relocation costs to an area with more employers. The other player, the one who does not locate, gets a payoff of 0 because they presumably remain where they are and thus are no better or worse off than before.

The two equilibria in this game are {locate; locate} or {don't locate; don't locate}. So like Dr. Moretti says, it is possible that struggling cities will stay struggling even though both workers and firms could be better off if they both decided to locate in one. How can struggling cities make it more likely that firms and labor will decide to choose {locate; locate} over {don't locate; don't locate}?

On the one hand, city leaders can try to signal to workers that they are going to attract employers. They do this by giving tax breaks and other perks to firms if they locate in their area. On the other hand, city leaders can try to signal to firms that they are going to attract employees. They do this by redeveloping downtown and adding high price amenities that skilled workers are attracted to.

Both of these have costs in actual dollars and opportunity costs. If firms/labor are not convinced that labor/firms will locate there based on the incentives the city decides to provide then the city ends up at the {don't locate; don't locate} equilibrium and has spent a bunch of money for little or no benefit. Dr. Moretti mentions Cleveland, Santa Fe, and New Orleans as U.S. cities that have failed using the attract workers approach. He mentions St. Louis and Fremont, CA as cities that have failed using the attract employers approach.

There is likely no fail-proof, one size fits all solution for revitalizing struggling cities. I will have some more thoughts on this in later posts.

Sunday, May 18, 2014

The Washington D.C. taxi cartel

A recent reasonTV video talks about new companies like uber and lyft battling the DC taxi cartel. The video is good and I recommend the whole thing. The DC taxi cab commission is crony capitalism at its worst.

In this post I want to focus on one part of the video. At about the one minute mark the video mentions how the supply of taxi medallions in DC has been fixed for years. It also mentions that taxi drivers need permits and that the city has recently begun issuing new permits for drivers again even though the amount of medallions has not changed.

When I heard that it got me thinking about the wages of taxi drivers. Taxis are produced in a fixed inputs production process. In economic jargon it is called a Leontief production function. In other words, each functioning taxi needs 1 driver and 1 car. Adding more cars/drivers without adding more drivers/cars does not produce any more functioning taxis (although Google is trying to change that and I am looking forward to it). So what do more driving permits mean for drivers?

We can think about this using the supply and demand framework.


In the above diagram, the demand for taxi drivers by the companies who own the medallions is represented by the vertical demand curve and is fixed at the number of medallions allowed by the D.C. taxi cab commission. The supply of drivers is initially the supply curve S1. When D.C. starts issuing new driver permits, the supply curve shits out to the red curve, S2. As can be seen in the diagram, this supply shift means that the equilibrium price of a driver, i.e. the wage paid by the cab companies, falls from W1 to W2. Because the amount of medallions is fixed no new taxis result from the increase in the number of drivers with permits.

A quick Google search did not lead to any articles about what caused D.C. to begin issuing driver permits again, but looking at this diagram it wouldn't surprise me if the medallion owners wanted the number of driver permits to increase. After all, more divers competing for the same amount of cabs means that the price of their labor will be lower all else equal. This is what is predicted by the diagram.

The Bureau of Labor Statistics website has wage data for occupations by metropolitan area. I pulled the data for D.C. cab drivers. A graph of annual earnings from 2007 - 2013 (most recent year available) is below.


As shown in the graph, the mean and median salary of taxi drivers/chauffeurs fell from 2011 to 2013 after rising for the previous 5 years. This evidence should be taken with a grain of salt though, since it does not isolate cab drivers only, nor does it hold everything else constant. There was likely a lot more going on in D.C. from 2011 to 2013 other than more driving permits being issued. That being said these wage numbers do support the theory.

Capping the amount of cars allowed while issuing more driving permits should lower the wage of taxi drivers all else equal. An initial look at the data supports this theory. Politicians often talk about helping the working class but in the case of the D.C. taxi commission their policies are lowering wages for the drivers, costs for the medallion owners. and not producing any more taxis for the consumers. And since taxi rates are fixed by law, if the wage paid to drivers decreases and the rates are not changed to reflect this wage drop the medallion owners will make more money. This is why I wouldn't be surprised if the medallion owners supported the issuing of new driver permits.

Friday, May 16, 2014

Free speech on college campuses

Several high profile commencement speakers have been dis-invited or have decided not to speak this graduation season, including former Secretary of State Condoleezza Rice.

I am not sure if this is an entirely new phenomenon but it does seem to be more of a news item this year than in years past. I have been on college campuses, first at Miami University and now at Clemson, for almost a decade and I do not remember commencement speakers being such a hot issue.

There does seem to be some truth to the idea that young people today would rather shout down their opponents than engage in thoughtful debate. I try to encourage my students to listen to proponents on all the sides of an issue, do their own research, and come to their own conclusions. Dismissing something out of hand is not a good way to learn about anything. You can't know if you are for or against something until you have information about it and that involves being open minded and listening.

I will say that I think politically correct speech has gotten out of hand. People are afraid to talk about sensitive subjects because there is always someone ready to accuse them of being a racist, or sexist, or homophobic, or whatever else might be en vogue. Speech can be a clumsy way of expressing oneself and sometimes things don't come out exactly the way we mean them too. But people need to be given the benefit of the doubt so that they can fully explain themselves before others accuse them of being something that they are not.

Open minds along with public discourse is how rational, thinking beings like humans should solve problems; not name calling and sometimes an outright suppression of ideas. This should be especially true on college campuses, a place where academic freedom is supposed to reign supreme. If current events are indeed part of a new trend I hope we can reverse it.

Wednesday, May 14, 2014

Infrastructure spending and waste

Sen. Sherrod Brown, a man I often criticize for his populist economics, is at it again. In his most recent newsletter he laments that the Federal Highway Trust Fund is running out of money.

"Unfortunately, the Highway Trust Fund, the major source of funding for these programs, is projected to run out of money by late August unless Congress acts. As the 2012 highway bill is set to expire on September, 30th it is critical that Congress, once again, passes a Federal Highway Bill."

He makes the typical democrat remarks about infrastructure spending; it creates construction jobs and encourages economic development. But at what cost? The money for the fund has to come from somewhere, in this case taxes on gas. Driving does create some trace amounts of pollution so there is an externality there and thus some level of tax is efficient, but if the tax is too high it creates an inefficiency (dead-weight loss) and if the tax is too low it doesn't fix the initial externality. I doubt the government gets the tax right, but suppose they do. There are other problems.

The bill raises money from the drivers of each state and then distributes the money to the states. In order for this program to make any sense for at least some states they must think that they are going to get more back than they put in. Otherwise states would be sending X dollars to an inefficient bureaucracy, funneling it through that wasteful system, and then get X - B back, where B is the money spent on transmitting and handling the money by the federal bureaucracy. Those federal workers in DC don't work for free.

When roads in some states are subsidized by money from other states we get too many roads in the subsidized states and this creates a dead-weight loss. And this happens. The money in the Highway Fund is not only spent on highways according to Sen. Brown:

"Every region of the state has large-scale projects—the Brent Spence in Cincinnati, the Portsmouth bypass, Route 8 in Akron—but a reduction in highway funding would also slowdown the replacement of smaller roads and bridges." (my emphasis)

If the local communities do not want to maintain their smaller roads and bridges, maybe they should not exist. It is a marginal benefit, marginal cost decision and the local Ohio communities know the benefits and costs, not the taxpayers in Wyoming. Using money on bridges and roads where the marginal benefit of them existing is less than the marginal cost of maintaining them is wasteful. Resources are scarce, we should not be misusing them. Unfortunately the further away the people who bear the cost are from the people who receive the benefits, the more waste is going to occur.


Monday, May 12, 2014

Signaling with luxury goods

My friend and I have been thinking about a research project; do marginalized cultural, racial, or ethnic groups use luxury goods to signal to the market that they are different from the "average" member of the group that they are typically identified with?

The luxury goods could be used to signal intelligence, wealth, reliability, or any other trait that people think is good that is typically not associated with other members of their group due to discrimination, stereotypes, racism, etc.

We initially started thinking about this in the context of modern Chinese and black people in America. A Chinese friend of mine alerted me to the fact that many people in China buy flashy cars, clothes, and accessories like jewelry and watches in large amounts relative to their income. That is they choose to spend relatively more money on the things that other people will see than they spend on private items such as housing, house furnishings, and food. This same kind of behavior can be seen in America in urban areas inhabited by relatively poor people. In these areas many of the residents, who are often disproportionately black, choose to spend their money on clothes, jewelry, and cars rather than housing or food.

But really it doesn't even have to be relatively poor people. Middle class blacks or Hispanics in America may find it worthwhile to dress nicer or drive a better car than similarly wealthy whites.

Our contention is that this is done to signal to the market that they are superior to how the "average" member of their group is typically viewed. This is done in the hopes of getting better employment opportunities, a better social network, or perhaps a better mate. The marginal benefit of buying luxury goods as a signal is larger for individuals in groups that are stigmatized than for those that are not. So for a black male who makes $50K / year it may be rational to spend a larger portion of his money on a Lexus or nice suits than a similar white male would spend. The black male is more concerned with how society at large perceives him. The marginal cost of a suit or a Lexus is the same for everyone, but the marginal benefit is higher for members of marginalized cultural, racial, or ethnic groups who are trying to differentiate themselves from the "average" member of their group. Since a higher marginal benefit on average means that the marginal benefit is going to be greater than the marginal cost more often for certain groups, those groups will have a larger amount of luxury goods relative to their income.

This theory applies to the American Irish in the late 19th century and to the American Italians in the early 20th century. I am sure it can be applied to Jews at various points in time as well.

One anecdotal example is from the Tom Cruise movie Far and Away. In that movie Tom Cruise is an Irish immigrant who ends up making some money bare knuckle boxing. How does he spend that money? On a bunch of nice hats. Instead of saving the money or investing it in something more durable, he spends it on a fashionable signaling device of the time period, presumably to show people that he is not just another lowly Irishman fresh off the boat; he is cultured, he has skills, he has wealth. I know this is a movie but that scene can be explained by the theory presented here.

To test this we would need data on wages/income and purchases. I am not sure how we could get that data for enough groups over time to make the results convincing, but I think the theory has merit.

Sunday, May 11, 2014

Homburg on Piketty's Capital in the 21st Century

Here is a link to a paper by economist Stefan Homburg that critiques Thomas Piketty's Capital in the 21st Century. 

http://diskussionspapiere.wiwi.uni-hannover.de/pdf_bib/dp-530.pdf

It is an academic paper so it is a little wonky but there are some parts in there that are free of economic jargon and will make sense to many readers.

To summarize it strongly criticizes Piketty's claim that a rate of return on capital that is greater than the growth rate of output (r > g) will lead to a rising wealth - income ratio and perpetuate inequality. It also calls out Piketty's implicit assumption that savings are never consumed and criticizes Piketty's definition of capital.

Tuesday, May 6, 2014

Policy proposals and utilitarianism

I was recently having a debate with some of my economist friends about  French economist Thomas Piketty's book Capitalism in the 21st Century. Over the course of the debate I started thinking about how we judge policy proposals. For example, when it comes to the minimum wage economists who are for a higher minimum wage often argue that the wage gains experienced by those who keep their jobs more than offset the impact that a higher minimum wage has on those who lose their jobs. Often this is demonstrated by pointing to evidence such as that provided by the CBO in their minimum wage report.

In this report, the CBO claims that approximately 500K people would lose their job if a $10.10 minimum wage was implemented and 16.5MM people would have higher weekly earnings. Minimum wage proponents conclude that the benefit of 16.5MM people making more money outweighs the cost of the 500K people who lose their job. But this calculus is subjective. There is no direct way to compare the benefits that accrue to the people who earn more money to the costs that accrue to the people who lose their jobs.

Utilitarianism is a branch of normative ethics that argues that a good policy is one that maximizes utility or total benefit. But calculating total benefit implies that the utility of individuals can be summed together. This is nonsense. Utility, as economists use it, is ordinal and does not have magnitude. It cannot be added together across individuals. People prefer things, but only in relation to the options that they have. Preferences are relative and do not have numeric values that can be easily calculated, added, or subtracted.

As I was thinking about this I realized that public policy compels us to become utilitarians. In order to make "good" policy we are forced to engage in the ridiculousness that is adding up utility across individuals. That is why implementing any policy that alters the free decisions that others have made is dangerous and should be done with care. There is no way to ensure that the correct policy is done because there is no way to correctly calculate the costs and benefits. It is better to leave people be whenever possible rather than engage in meaningless utility calculations. The outcomes that result from voluntary exchange do not require any action from a third party who intervenes based on some utility (mis)calculation.