Economics textbooks and minimum wages

8 March, 2016 at 17:35 | Posted in Economics | 2 Comments

Suppose worker productivity rises so that workers can produce more per hour, and this causes the value of production to rise … According to the textbooks, worker pay should rise to reflect this increase, but that is not what has happened in recent decades. Instead, the lion’s share of the additional revenue has gone to the owners and managers of firms instead of to workers. The working class has not been able to bargain effectively and capture its share of the gains when productivity increases, and this has contributed to the rise in inequality.

Minimum_Wage_IncreaseHow can this be changed? One answer is the return of unions … Another way to increase worker bargaining power, what I want to focus on here, is increases in the minimum wage. Minimum wage workers have very little ability to effectively negotiate over wages, and an increase in the minimum wage can serve as a substitute for their lack of bargaining power. When the minimum wage is increased, firms do not have the option of threatening to replace workers with other workers who, due to their circumstances, would be willing to work for less than they are worth to the firm. In addition, when the minimum wage is increased at the federal level, firms cannot relocate to take advantage of lower minimum wages elsewhere.

But doesn’t an increase in the minimum wage reduce employment? The answer appears to be no, at least not to any significant degree. It’s possible to find evidence on both sides of this question, but the preponderance of the evidence suggests that the employment effects are minimal.

This is just what you would expect if minimum wage workers are paid less than the value of their marginal products, i.e. less than their value to the firm. In such a case, an increase in the minimum wage does not push workers’ compensation beyond the point where they remain valuable to the firm. The main effect is to redistribute income from managers and owners to workers in a way that better reflects the contribution of each to the production of goods and services.

Mark Thoma

Back in 1992, New Jersey raised the minimum wage by 18 per cent while its neighbour state, Pennsylvania, left its minimum wage unchanged. Unemployment in New Jersey should — according to mainstream economics textbooks — have increased relative to Pennsylvania. However, when economists Alan Krueger and David Card gathered information on fast food restaurants in the two states, it turned out that unemployment had actually decreased in New Jersey relative to that in Pennsylvania. Counter to neoclassical demand theory we had an anomalous case of a backward-sloping supply curve.

Lo and behold!

But of course — when facts and theory don’t agree, it’s the facts that have to be wrong …

copy-Reality-bats-last-final-blk-ledge

buchC6The inverse relationship between quantity demanded and price is the core proposition in economic science, which embodies the pre-supposition that human choice behavior is sufficiently rational to allow predictions to be made. Just as no physicist would claim that “water runs uphill,” no self-respecting economist would claim that increases in the minimum wage increase employment. Such a claim, if seriously advanced, becomes equivalent to a denial that there is even minimal scientific content in economics, and that, in consequence, economists can do nothing but write as advocates for ideological interests. Fortunately, only a handful of economists are willing to throw over the teaching of two centuries; we have not yet become a bevy of camp-following whores.

James M. Buchanan in Wall Street Journal (April 25, 1996)

2 Comments »

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  1. I am pretty sure Mark Thoma is agreeing with you here. And that you are both right.

  2. I take it that the point you are trying to make is that (mainstream) economists are, in fact, “a bevy of camp-following whores” (with tongue firmly planted in cheek)🙂


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