Minimum wage policies and redistribution

12/09/2013 01:45:00 PM
If you want to make Seattle affordable, Matt Yglesias has a book you should read.
I see that the minimum wage debate is heating up again, with a lot of people now calling for a $15 minimum wage, largely because they erroneously believe that's the minimum wage in Australia (actually, while Australia's labor market regulations are complex, their minimum wage is less than ours for many industries). David Newmark has a nice post pointing out, correctly, that more effective alternatives to the minimum wage policy do exist. Greg Mankiw thinks that the Council of Economic Advisors should have fact-checked the President's statement on raising the minimum wage, and I tend to agree--there is mixed evidence, sure, but still solid reasons for claiming that there exists a point above which a higher minimum wage will reduce employment. I have argued previously that the only reason the evidence has been so mixed is because (1) minimum wage changes have generally been very small, and (2) minimum wages have so low in our sample that hardly any workers were affected by it. These are problems of statistical power, not of soundness of the theory. Paul Krugman has argued that minimum wage laws are nice complements to a GBI policy (David Newmark rests his faith in EITC instead of GBI. I think that's misguided, as EITC is surprisingly hard to qualify for, and really quite stingy even if you do, regardless of your income level--it's only analogous to GBI if you ignore the G.), and I partially agree. I say partially because I don't think GBI and minimum wage policies do the same thing--GBI is a matter of redistribution from rich to poor according to income, whereas minimum wage laws are about redistributing from monopsonists to exploited workers, regardless of income. And finally, Ashok Rao argues for a minimum wage that is adjusted to combat the business cycle.

There are a lot of good and bad ideas here, but here are some things that should be uncontroversial:
  1. Australia's actual minimum wage is nowhere near $15 USD per hour.The $15 figure is, first of all, in australian dollars adjusted for neither the exchange rate nor purchasing power parity, and second of all, an exception rather than the rule. See, Australia's labor market regulations are extremely heavy-handed compared to the US. The government has tables upon tables detailing exactly what minimum wages and benefits and working conditions workers are entitled to, which depend on lots of factors including firm size, workers' ages, industry, right down to the specific job being performed. Australia micro-manages it's labor markets. The $15 per hour figure is a catch-all for any jobs and positions that through some freak accident aren't included in the tables. Oh, by the way, I waded through these tables for you--turns out that a 16 year old McDonalds worker in Sydney, Australia, can legally be paid as little as $4.92 USD, way less than he would be entitled to in the USA.
  2. At some point, raising the minimum wage will substantially reduce employment. I mentioned earlier that the evidence on this has so far been mixed, but that is only because the minimum wages of the past have been extremely low, affecting fairly few workers. We can debate where that threshold is, but my guess is when we start talking about minimum wages above $10 an hour, I think we will start seeing consistent, statistically significant effects where a minimum wage hike lowers aggregate employment.
  3. A minimum wage cannot achieve substantial amounts of redistribution. I say this because I think it is fairly uncontroversial that minimum wage workers are low-productivity workers. Theory says that no matter what minimum wage you impose, you will not induce firms to pay more than a worker's marginal product. Hence, there is an upperbound to the kind of redistribution that can be done with minimum wage policies, and it is quite low. What we can do is use minimum wage laws to make sure that workers are not being paid less than their marginal products--which happens in monopsonistic labor markets. The extent of monopsony, of course, is industry and locale-specific, so strictly speaking there should not be a minimum wage, but a bunch of job-dependent minimum wages, rather like what Australia tries to do.
  4. The income tax code is the best way to redistribute. As the Mirrleesian optimal tax literature says, we want to our redistributionary policy to be as close to lump-sum as possible, to minimize deadweight losses. However, we cannot directly observe worker productivity types so lump-sum transfers are impossible. That's ok because the government can observe something that is very highly correlated with worker types, namely their incomes. Hence, the best way to redistribute is through income taxation, with negative income taxes for the poor and very high tax rates on the very rich. A GBI that phases out gradually as income rises, and which is financed by progressive taxation on incomes above that, is very close to optimal tax policy.
  5. Unless you plan to implement state-contingent minimum wages (like Ashok Rao's proposal), aggregate demand considerations are irrelevant. I see a lot of left-wing commentary about how a higher minimum wage would improve the economy by giving people more money to spend. That would be great right now, while demand is too low, but in the long-run, prices will equilibrate demand with supply. Thus, while demand-side policies can be welfare-improving in the short periods where the economy is operating away from the long-run equilibrium, if made permanent they would become net-welfare-reducing by actually reducing long-run aggregate supply.
Max 12/11/2013 02:06:00 PM
"Theory says that no matter what minimum wage you impose, you will not induce firms to pay more than a worker's marginal product. Hence, there is an upperbound to the kind of redistribution that can be done with minimum wage policies, and it is quite low."

You mean, without increasing unemployment, right? Because if you're willing to tolerate some unemployment, then the potential redistribution - from consumers not employers - is large.