Matt Yglesias and the Minimum Wage

8/09/2013 09:25:00 AM
Matt Yglesias seems to take a similar view of the minimum wage as I do: the arguments for it are suspect. We both want to see lower and middle class incomes rise (who doesn't?), even if at the expense of upper-class and investment income. A typical argument against redistributing income through taxes on investment income is that such a tax would also harm the lower and middle classes, whose wages rise and fall with their employer's capital stock--if you tax capital income you get less capital, and therefore lower wages.

Moreover, it is not clear exactly what the minimum wage does. Conventional wisdom outside the economics profession seems to feel that raising the minimum wage simply raise real wages for everyone, with no impact on employment. But in the long run, that makes very little economic sense: if production costs rise, companies will simply cut production, reducing the amount of labor they hire. That's also bad for the middle and lower classes. Lots of empirical papers attempt to measure the impact of minimum wage hikes on employment, with mixed results. A prominent article by Card and Kruger, for example, actually found no-to-slight-positive effects, though a slim majority of the research has found that such hikes do lower employment, especially among the lowest earners. Moreover, as Yglesias mentions, there's a huge difference between the very low minimum wages in those studies and the \$15 per hour figure being proposed now--none of the previous results are generalizeable.

Yglesias doesn't have much of a solution to offer. He notes that corporate profits are at extraordinary highs, but that there's no guarantee that a minimum wage law will merely redistribute this money without harming lower and middle class workers. He theorizes that perhaps the sky-high corporate profits are the result, not of a profit-maximizing strategy, but of mere social convention and herding behavior. So he's left with an extremely mediocre suggestion: lets just politely ask corporations to pay their workers more.

At first glance, Yglesias's suggestion that the profit-maximizing strategy is actually one that involves smaller corporate profits is prima facie absurd. But, recall that there is a difference between "accounting profits" and "economic profit." Conventional use of the term "profit" outside the economics profession refers to accounting profits--the amount left over on the annual ledger of a legally defined entity (ie, corporation) after all payments are made to any entities not part of that legal definition (ie, to workers, suppliers, etc). Economic models, on the otherhand, take the same scenario and applies slightly different labels to things. For example, in the models, we treat firms as separate entities from the owners of the capital that the firm uses--investors play two, completely separate roles as both owners of the firm and owners of the firm's capital. The returns that these investors make in their role as owners of the firm is true economic profit, and is usually small or zero due to competition, whereas the returns these investors make in their role as owners of capital is not considered profit--as it accrues to individuals not firms--but rather just considered a stream of personal income (the analogy here is that firms "rent" capital from investors, in the same way you rent an apartment from a landlord). In the real world, by contrast, the law makes no distinction whatsoever between the shareholder's roles as owners of firms and their role as owner of firms' capital--the "profit" of these combined legal entities therefore is the sum of the economic profit earned by the firm plus the rent that investors demand on their capital.

In some respects, this looks like a conflict of interest: if investors, in their role as owners of firms, are supposed to maximize economic profits, that requires minimizing costs (aha! you can prove this using the Separating Hyperplane Theorem!), including the cost of renting capital from investors. But in their role as owners of capital, investors also want to maximize the "cost" of renting capital, which is also their income. However, happily for the repose of neoclassical economists every where, this distinction between the real world and the modelling environment makes no difference. You can amend the model to assign ownership of capital to inter-temporal firms, and then assign ownership of firms to investors, and derive the exact same equilibrium results--the apparent conflict of interest has no effects. The reason for this is competition: in perfectly competitive markets, firms have to compete for investors either way, which guarantees that they will end up maximizing returns on capital, even though they are also minimizing capital costs (oh, what a splendid beauty is the separating hyperplane theorem!). The same argument also applies to labor, actually: even though firms are squeezing wages, they are also inherently maximizing them, at least in the model, due to competition for workers.

So given the model, is there room for Yglesias theory that firms are irrationally increasing accounting profits at the expense of workers? It's hard to see how. In the model, anything that hurts workers relative to equilibrium also hurts accounting profits relative to equilibrium. Of course, there's no guarantee that we aren't off the equilibrium path and that firms could both pay workers more and earn higher profits as a result, but that invalidates Yglesias's key piece of evidence that the profits are already too darn high. Now, its easy to amend this model in a way that increases profits by hurting workers: for example, if workers have firm-specific skills then perhaps firms are monopsonistically competitive in the labor market, allowing them to pay workers less than their marginal product and increase economic profits. But, if that's the case then we invalidate Yglesias's premise about herding behavior or irrationality--in this case, underpaying workers really does maximize economic, not just accounting, profits. Moreover, in this situation a minimum wage hike would boost wages without harming employment (though, once we add in heterogeneity, the one-size-fits-all minimum wage might not work well).

I don't really have a point here, other than that Yglesias's suggestion makes no more or less sense than any of the arguments for the minimum wage. Getting firms to unload corporate profits onto workers is a puzzler. But, if we care only about getting firms to part with their hoards of cash without theoretically harming GDP or workers--well, here's a way we can do that:
  1. Lower the dividends tax, and
  2. Raise the corporate profits and capital gains taxes.
These changes would basically force companies to unload all their cash on hand in the form of cash payments to investors. Hopefully, investors could then turn around and invest that wealth in some job-creating wage-boosting startups.
Max 8/09/2013 11:28:00 AM
It seems like most discussions of the minimum wage assume a closed economy. But it's pretty clear that the minimum wage suppresses immigration, and by the same token, promotes trade with poor countries. In other words, capital can either move jobs to poor countries, or attract workers from poor countries.
Matthew Martin 8/09/2013 02:11:00 PM
Well if you think about a two-country, two-good model where workers move to (frictionlessly) find employment, then a minimum wage law in country A would still reduce employment in country A, but also reduce labor supply in country A, increase labor supply in country B, decrease wages in country B, and increase employment in country B, while the effect on net imports is ambiguous.

In the context where there is extrinsic net immigration to country A, then indeed we might expect fewer immigrants, rather than more emigrants per se.
Lord 8/09/2013 05:05:00 PM
There really doesn't seem to be any reason to prefer more lower wage jobs to fewer higher wage jobs though. Two reasons one might prefer the latter are to separate work from welfare and to promote the time dynamic of increased technological investment. The work from welfare argument is that it becomes difficult to say whether welfare flows to those on it or to their employers when the working qualify for welfare. It is also an argument there are better uses for those that might be so employed than work, like school. The technological argument is stronger as it can induce productivity enhancing investment with spill over effects.
Obuj balok 5/22/2015 05:33:00 AM