Mr. Mankiw is reading the wrong paper on minimum wages
Greg Mankiw reviews a paper written trying to support minimum wages. Mr. Mankiw is not in favor of minimum wages and was not sold by the paper.
The best paper that I know of on minimum wages was written by Bruce Kaufman. His paper was titled, Institutional Economics and the Minimum Wage: Broadening the Theoretical and Policy Debate.
Highlights from the paper…
The 3 positive roles for a minimum wage…
“IE (Institutional economics) pinpoints 3 positive economic roles for a minimum wage: first, to boost employment by augmenting household income and aggregate demand; second, to prevent ruinous deflation and “destructive competition” in labor markets; and third, to maintain a better balance between spending and production both by counteracting greater inequality in income and by promoting a more broad-based sharing of the fruits of productivity growth.”
Here we see a rationale for the fall in labor force participation… the workers went “out of business”.
“A shifting of social labor cost is also facilitated by a second factor—a large supply of labor in the market. Even in a perfectly competitive labor market, the wage may not cover the subsistence cost of labor. A huge supply of firms, for example, floods the market with product, causing the price to fall until enough firms “die,” which constricts supply and restores profit to a normal (“subsistence”) level. The same process works in labor markets. Assume that the labor market is opened to unrestricted legal and illegal immigration. To balance supply and demand, the wage may have to fall so far that it does not cover the minimum subsistence costs of labor. The parallel market solution is for some workers to “go out of business” so that the labor supply shrinks until wages again cover minimum fixed and variable labor cost. This process may happen in a variety of ways: for example, workers may withdraw from the labor market and maintain themselves through crime or in the underground economy; they may become homeless and beg for food and live in community shelters; or they may die through sickness and starvation. If, however, workers had a recognized legal and human right to the social wage, the social cost problem would disappear. Commons (1898) proposed this solution (a right to work, or the minimum income therefrom) but was denounced as a radical (Kaufman 2003); it is, however, a logical step in making the competitive labor market even more “perfect” by filling in a missing human property right. Absent this step, a better-than-nothing solution is a minimum wage.”
Socially productive businesses are helped by the minimum wage…
“Minimum wage laws may enhance efficiency in another way as well, by protecting not only workers but also “high road” employers who make long-term investments in human capital, physical capital, and R&D.”
One problem with Neoclassical economics of which Greg Mankiw follows…
“NE (Neoclassical economics) typically brings externalities into the analysis as “exceptions” to the operation of competitive markets, but IE maintains that externalities are logically present in all labor market situations because, as earlier noted, the employment relationship always and everywhere involves an incomplete contract. An externality arises any time one or more dimensions of a good or service are not fully priced and covered in a complete contract, thus causing part of the benefits or costs to be omitted and shifted onto third parties. When this happens, there develops a divergence between the private benefit/cost realized by the buyer and seller and the social (or total) benefit/cost realized by the buyer, seller, and all affected third parties. Since buyers and sellers make decisions based on private benefits/costs, this divergence leads to incorrect decisions, false price signals in the market, and economic inefficiency from misallocated resources and inequity from misplaced or unanticipated gains/losses in exchange.”
The minimum wage leads to economic efficiency…
“The reason is that the minimum wage reduces or eliminates the externality-like gap between the private and social cost of labor
and thus improves economic efficiency. The effect is analogous to placing a tax on a paper mill that dumps pollutants into a river. The higher cost causes the firm to reduce production and cut employment, but economic welfare is improved—not hurt—because the tax corrects a market failure (a missing property right) that allows the firm to use a valuable social resource (the river) without paying the cost. A minimum wage is also, in effect, a tax on firms, but these firms—like the paper mill—are using a resource to make profit without paying the full social cost. The minimum wage, therefore, has exactly the desired effect: it ends (or reduces) the subsidy on low-wage labor and causes firms to cut back on production and employment to the efficient level that would prevail if the labor market were truly at a competitive equilibrium (for example, W2, L2). Society gains from this loss of jobs because the human capital can be transferred to alternative uses that yield a higher return.”
Consumers and firms have an incentive through lower prices to favor lower labor costs…
“Consumers have dual interests to the degree they not only buy goods but also sell labor. Nonetheless, IE surmises that their self-interest on balance tilts toward lower-priced goods, given that lower prices of consumer goods in the economy improve every consumer’s welfare but most forms of higher labor standards improve welfare for only a subgroup. If we look at a minimum wage, for example, most people work at companies that pay considerably above this level, so voting for political candidates who favor a minimum wage increase is likely to reduce the voters’ real income (via higher prices) without any compensating gain in wages. Examined this way, consumers and firms have a shared preference for laws, regulations, and
an institutional infrastructure that promote lower labor cost (Freeman 1996).”
Consumers and firms are parasitic upon low wage workers…
“The idea is that the wage paid to workers must cover not only the opportunity cost of leisure but also the maintenance and depreciation of their human capital, or otherwise private production cost understates social production cost. This means that the wage must cover all items that define the long-run subsistence cost of labor, such as minimal necessary health expenditure, minimal retirement income, minimal income support during periods of unemployment, and minimal income for dependent children (so the nation has a future work force). Firms, however, may be able because of market imperfections and incomplete contracts to partially or completely avoid paying these costs, which in effect also shields consumers from these costs in the form of higher product prices. Instead, the costs are shifted to the workers themselves, their families, local communities, or the nation at large. For example, a firm may be able to obtain employees at a low wage and not pay health insurance; or it may opportunistically renege on pension payments by firing workers when they get closer to retirement age; or it may routinely continue to pay the maintenance cost of capital during slow periods but shift the maintenance cost of labor to third parties through layoffs. Consumers and firms are, in Webb’s term, “parasitic” in that they enjoy lower prices and more material abundance at workers’ expense—particularly low-wage workers who often work in unsafe jobs, have the least financial ability to withstand ill health, and have the least income for and access to alternative suppliers of health care.”
There are good economic reasons to have a minimum wage… Mr. Mankiw.
I’m sure Prof Mankiw has no trouble with applying the Uniform Commercial Code to transactions in goods — even with its provision on unconscionable contracts or clauses, analysis of which should include consideration of the relative bargaining power of the parties, and the section requiring contracts to be for a reasonable duration and termination be subject to reasonable advance notice. Both are to be interpreted according to the flexible and ever-evolving standard of reasonableness.
So Mankiw is perfectly willing to see such concepts — to be construed “liberally,” by the way — applied to transactions between businesses, but when it is individuals selling their services, suddenly, in the interest of “labor flexibility,” we need to throw these ideas away. So, Mr Mankiw, is it perfectly conscionable to hire someone for $4.00 an hour because there are so many unemployed workers that someone can always be found who needs to at least keep from starving? Shall we assume that, since workers at very low wages have no bargaining power in relation to the employer, it is conscionable for the law to allow employment at will, instead of expecting that once hired, the employee is entitled to reasonable supervision to help him or her do the job adequately, and, since the employee will starve if he or she cannot find at least this kind of job, notice of termination must be early enough to make it very likely that a new job will be found? (And wouldn’t the reasonableness of that notice be affected by the level of unemployment the employee will face? Oh, God forbid, such socialism!)
Perhaps Prof Mankiw will concede that laws to prevent employers from allowing machines that routinely cut off workers’ arms is a legitimate intervention of government. So it would be interesting to see how he thinks this differs from society saying, through its government, that paying someone below a certain level that is at or near to a poverty level is unconscionable and will simply be impermissible, period. Why is applying concepts of fairness like those in the UCC OK for businesses but not for workers?
Ah, but employers are different. They are the job creators, because if the laws are constructed to allow them to keep more of the money generated by both capital and labor, they will use it out of the goodness of their hearts to hire more workers. Or something like that.
This is what Harvard has to offer?
Minimum wages is in it’s simplest form bad public and private policy…
It makes sense only for those whom are economical challenged…
One big advantage of a minimum wage law is that it raises overall economic efficiency. When labor is expensive, employers use it wisely, redesigning, automated and capitalizing to replace labor, or at least get the most out of it. If English wages hadn’t been so high in the 18th century, there is no way the Industrial Revolution would have taken hold. In fact, most economic progress has been the result of labor shortages, de facto or de jur.
I agree with the other reasons in your post, but efficiency drives societal wealth and well being, but the positive impact of high labor costs are often downplayed.