A guest post from Harry Winters

David Roberts argues that carbon taxes are incapable of driving the industrial transformation necessary for a low carbon world. We are delighted to learn that no carbon tax can reduce consumption by a sufficient margin. Our only concern with the master plan to fund government with land and carbon pricing was that it might accidentally encourage efficient consumption and innovation [1]. Observing that the carbon tax may be immune to this bug, we should move forward with our proposal. The worst case scenario is a carbon free world at which point we may even have to consider taxing good things.

[1] See Laffer, Arthur. Annals of Applied Napkin Studies (1974).

Don’t miss Harry’s upcoming post on whether the California water crisis might be a source of infinite revenue for the state.

On the rather simple question of whether banning low-wage employment would increase overall employment, Paul Krugman has offered an answer that refers to the real money supply, liquidity trap, short-run interest rates, Federal Reserve, monetary base, outside money, among other economic concepts we can barely define, let alone measure.

First and foremost, Krugman’s premise that a decrease in minimum wage results in lower wages assumes his conclusion that a reduction in the minimum wage does not increase employment.  A lower minimum wage results in lower wages only if it does not increase employment.  To the extent it increases employment, many wages w = 0, become positive.  The mistake he makes is clear in one of the introductory paragraphs.

Here’s how the fallacy works: if some subset of the work force accepts lower wages, it can gain jobs. If workers in the widget industry take a pay cut, this will lead to lower prices of widgets relative to other things, so people will buy more widgets, hence more employment.

The first and second sentences are not consistent.  Those arguing the minimum wage will increase employment are, by definition, not referring to workers in the widget industry that take a pay cut.  As I’ve explained in this post,  to the extent the employer has a lot of bargaining power to siphon surplus from labor, it should be able to pay heterogeneous wages.  To the extent the employer operates in a very competitive labor market, it is difficult to imagine many workers taking a pay cut only because the minimum wage was reduced.

There are ways to contrive an effect where the increase in employment is offset by decrease in the wages of those already working.  Typically this assumes the desired conclusion, as above.  Additionally, even if this were to be the case, Krugman’s conclusion is channeled through complicated monetary mechanisms that are not well-defined, hard to measure, and embedded with lots of uncertainty.

(It is true that one day someone will write a paper demonstrating how newly employed workers have a high marginal propensity to save because their employment means the price level of goods will fall increasing expected deflation and the present value of debt, which furthers the liquidity trap, resulting in even greater unemployment.  The paper might conclude with the “paradox of employment”, where banning employment actually increases employment.)

Krugman also relies upon a conflation between general wage levels and the minimum wage.

But if everyone takes a pay cut, that logic no longer applies. The only way a general cut in wages can increase employment is if it leads people to buy more across the board. And why should it do that?

Most people are not employed at the minimum wage, and therefore it seems unlikely that a decrease would somehow trigger a “paradox of toil”, wherein the increase in labor reduces the price level, thereby increasing the real value of debt at any meaningful threshold.  By definition the minimum wage is not a general change in wages.

The minimum wage is a 100% tax on all wages wk.  Perhaps instead of increasing k we should reduce the tax rate.  Does Krugman believe a decrease in the low-wage tax rate would have contractionary effects in a liquidity trap?

Say there is a rich country without a minimum wage.  Some people rightfully dislike challenging labor.  For example, in a remote college town, some people fold student laundry at $4/hr for 40 hours a week, and work at the local library for $6/hr for another 20 hours a week, yielding a weekly salary of $280.  The federal government determines that $280/week is necessary, and therefore requires a $7/hr minimum wage based on a 40 hour work week.  Some time later an economist uses regression analysis to show that neither employment nor output fell, how could this be?

Though wages at existing jobs probably increased without reducing net employment to some extent, through some third-order mechanism, a simpler and more tangible answer is available.  Suppose individuals in the above example had a target wage of $250, without which they would die.  The available hours for employment doing laundry or working at the library are no longer high enough to meet the target.  Therefore, some such individuals started working as low-end construction workers earning $11/hr part-time, a job which they never wanted given its physical rigor.

Small increases in the minimum wage at non-random times over a long history may not demonstrate this effect.  But there are lots of people who may be working jobs that are mentally, emotionally, or physically strenuous because easier labor has been criminalized. Hence, demonstrating that there is not a significant decline in employment after the minimum wage, by itself, does not show anything.

Lots of people could be truck drivers or natural gas workers in North Dakota, probably earning way more than they do today.  They choose not to because they don’t want to drive around the country all day or leave their families as modern-day migrant workers.  People have the right to make this choice.  If it is offensive for whatever reason that some people are not rich enough, we should give them cash instead of criminalizing their choices.

A friend pointed me towards a description of a labor market where a minimum wage would increase employment and output from two economists at the Cleveland Fed.  I’m not sure whether the model they propose is novel, or from the literature.  I wanted to explore this claim in more detail, since I am told that the presence of monopsony employers is an important feature of arguments in favor of the minimum wage.

Consider a local labor market in which a large coal mine is the community’s dominant employer (a monopsony). Because the mine has negligible competition from other firms, it can set a wage that maximizes its profits. Unlike a competitive firm, however, a monopsony cannot hire as many workers as it wants at a constant wage. If the mine wants to add workers, it must offer a higher wage to attract new labor-force entrants. Suppose, for instance, that 10 potential hires have reservation wages below $5 and another candidate has a $6 reservation wage. If the mine wants to hire 11 workers, it must raise its wage from $5 to $6 across the board. Thus the mine’s cost of adding one worker, the marginal cost of labor, has two elements: the $6 hourly wage it pays one person plus a $1 hourly increase for each of the other 10. In this case, the marginal cost of labor is $16 ($6 + $10).

The firm maximizes its profits when the cost of having an additional worker equals the value of that person’s output. Thus, in the right-hand panel of figure 2, the point where the marginal product of labor intersects with the marginal cost of labor is the employment level for a monopsonistic firm. Notice that the employment level is lower than it would be in a competitive labor market. The wage, which can be read on the labor supply curve for the monopsonistic employment level (denoted wM in figure 2), is lower than the competitive wage. So a monopsonistic firm employs fewer workers and pays them less than their marginal product.

Suppose that Congress sets a federal minimum wage that is higher than the monopsony’s wage but still below the competitive one. In that case, the curve representing the marginal cost of labor (right-hand panel of figure 2) flattens until it intersects with the labor supply curve. This happens because the cost of an additional worker is now simply the minimum wage (as long as the firm does not want to hire more workers than the number willing to work at or below this minimum wage). In this case, a minimum wage increases employment by mitigating the negative effects of a monopsony’s power. All workers gain: More of them have jobs, and those who do receive a higher wage. The employer loses because the minimum wage policy reduces its profits. In fact, the optimal level for the minimum wage is the competitive wage that maximizes employment (right-hand panel of figure 2).

I think this model fails to accurately portray the economics of a monopsony employer.

  1. Suppose the firm knows the reservation wage of each worker.  If it were truly a monopsony it would just pay that amount, since it has all the bargaining power it would not be constrained by a constant wage rate.
  2. Suppose the firm does not know the reservation wage of each worker.  It would just announce how much it would be willing to pay the nth worker for n = 1 to n = population and accept bids for employment.  Without unionization or collusion this handles heterogeneity in reservation wage.  This obviously would not happen in reality, but nor would total monopsonies, if that’s our metric.  The firm probably also has reasonably good heuristics about reservation wages based on easily observable factors.  (Additionally, in the above case it is almost certainly true that the government in charge of a minimum wage has substantially less information about reservation wages, preventing a reasoned ability to set policy.)
  3. Suppose a monopsony initially hires 5 workers at $1 and another 3 workers at $2.  The imposition of a minimum wage at $2, assuming the premise about equal productivity and everything else is correct, would increase wages for low-reservation workers and reduce profits by $5.  This effect remain true even if all workers had a reservation wage of $1.  This suggests the premise is unnecessarily complex and noisy; or relies on odd assumptions about ability to pay heterogenous wages for a supposed monopsony.
  4. Furthermore the reduction in profits from the minimum wage is realized as an increase in the cost of capital.  This increases the required rate of return from workers on new projects, which unfairly hurts those whose necessary value to firms falls below the minimum wage as required rate of return increases.  The minimum wage is not statically imposed but affects future periods, cost of capital, etc.
  5. The example in (3) provides a distributional effect.  However this could just be accomplished through tax and transfer.  There is the concern that this would let the monopsony underpay the higher reservation wage worker since the government pays some or all of the difference.  To the extent that is the case, the government can just increase the tax rate.  This doesn’t matter as it normally would since the only taxable entity is a monopsony.
  6. It seems unrealistic that there is no correlation between reservation wage and quality of labor.  For example, the higher reservation may reflect greater talent in normal economies.  In a monopsony it just reflects a higher labor preference.  However, that means the increase in employment is not welfare increasing per se.  Even in the contrived example of constant wages, imposing a minimum wage at the higher reservation only results in surplus for the lower wage employees, as the new entrants sacrifice equally-valuable leisure.
  7.  In reality there are probably not monopsonies like the ones described above.  Congress should not set a federal minimum wage on that basis.

Let me briefly address the idea that minimum wage addresses the problem of market wages being far lower than return to each worker.  Surplus has to be distributed between two parties in some way.  If workers receive less because they have lower bargaining power, it might be a good idea to encourage union formation.

It’s unclear why the minimum wage would increase bargaining power – especially since it prohibits threat of competition for those who have a preference for easier jobs.  Some unskilled workers that like peace and quiet might have worked for $5/hr folding clothes for college students in a remote suburb.  The imposition of a $15/hr minimum wage might force such workers into low-end construction or other harder jobs.  Employment does not fall and wages increase but happiness and freedom does.

In any case, the normative claim should not be “workers should deserve x percent of surplus” but rather “workers should be rich enough to buy y“.  A tax and transfer looks like a better solution here, even in the face of contrived examples.

I also don’t understand the following claim from the article.

If the market wage is too low and workers lack bargaining power, the introduction of a binding minimum wage strengthens labor force participation, even though the duration of unemployment increases. In contrast, if the market wage is high, a minimum wage reduces the supply of vacancies and increases unemployment duration, which discourages workers from entering in the labor force.

  1. Market wages may be low relative to productivity if reservation wages are also low for some reason.  Meaningful lack of labor force participation occurs when market < reservation < value.  For one, this is unlikely to occur with heterogenous wages which would be attempted in any number of creative ways were such a situation to ever exist.
  2. The existence of low participation could just as easily reflect value < reservation as it does market < reservation.  In normal economies, increasing the minimum wage will result in mandatory productivity that may be greater than some people can reasonably muster, reducing participation.

Finally let’s just observe that we aren’t capable of measuring productivity, marginal revenue product, reservation wage, competitive equilibrium wage, bargaining power in at the conceptual and statistical resolution necessary to advance a policy that can change the lives of many individuals.

Edited to remove accusations that everyone might be a joker and emphasize the more substantive point that there are liberties more deserving of our undivided attention and relentless defense than the right not to live next to a guy with a rifle.

Not long ago, activists protested war and sat-in against racial oppression. Recently they protested consumption of foreign food and today they sat-in for the pyrrhic passage of useless policy. We should be more than a little embarrassed by politicians sitting in for gun control when they could be defending genuine Constitutional liberties. What if we fought for the 1st, 4th, 5th, 6th, or 8th amendments as vigorously as Republicans fight for the 2nd?

Here’s a quick summary of a few of the other original amendments.

  • The 4th amendment gives you the right to be secure in your house and against unreasonable searches and seizures and requires probable cause supported by oath or affirmation describing the place to be searched, and the persons or things to be seized. You’d think that’s a pretty important thing to defend when it was only yesterday that the Supreme Court decided to change “the right of the people” to “the right of the people who remembered to pay their parking ticket”.
  • The 5th amendment gives you the famous right to remain silent. More importantly it gives you the right not to be deprived of life, liberty, or property, without due process of law; [or  have your] private property be taken for public use, without just compensation. What if we wrote about the many people forced to sit in jail only because they can’t post bail as much as about gun control abroad? What if we spoke as much about the perpetual and tragic expropriation of private property under the auspices of civic forfeiture to fund margarita Fridays at the local precinct?
  • The 6th amendment gives everyone a right to a speedy and public trial. Wouldn’t it be a pretty honorable to defend this right to the very end when a 16 year old convicted of stealing a backpack commits suicide after waiting in Rikers Island for 3 years instead of writing again about the gun show loophole?
  • The pesky 8th amendment says that excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted. Half a million Americans sit in pretrial detention. The idea that “pretrial detention” can even exist is appalling enough. Apparently protecting this right isn’t as fun as childish shouting matches, lie-downs, or sit-ins.

Joke we may about how founding fathers couldn’t possibly know about how powerful guns would one day become. But why not also acknowledge how immensely foresightful the they were about things that matter ten times more. That gun control might work is not a sufficient or even relevant metric. Getting rid of a right to fair trial might also save lives. What is fair and reasonable may not always be Constitutional, and what is Constitutional may not always be fair and reasonable. Unfortunately the right to life, liberty, and the pursuit of happiness that we ought to cherish is sacrificed on the altar of a political theater that caters more to the unfiltered emotion residual after tragedy than the extreme liberty and freedom that made his country great.

It isn’t enough that many writers acknowledge the ailing judicial defense of constitutional liberty. If an article was written about a “mass seizure of liberty” every time 3 guys get put in jail on bail they can’t afford, every time a guy gets two weeks of solitary for sneaking in a pillow, every time the police raids a random house either without a warrant or without a justified warrant, or every time the government kills and assassinates someone at home or abroad without declaring and waging war we would be a better country.

Today those on the political extremes defended our liberties with more life and animation than the too many others who applauded politicians sitting down and shouting mean things at Paul Ryan.

It’s frustrating to see that people who should know better are still saying this. That the government bought for 80 something it could have bought for 50 that went to 100 does not mean it earned a profit. In other words, the government could have made just as much cash for a lower upfront investment if it bought its equity stake in Citigroup on the market. You might say that the government overpaying to capitalize a systematically important yet insolvent institution was a good idea, and you would very plausibly be right. But in that case you would be happy about the outcome even if the government lost some of its TARP money. Citigroup did not accept public capital at a high price because it wanted to be charitable to the government. It accepted public capital at a low price because no one else would make an offer nearly as good. No economist, journalist, or politician would have been happy with the terms of TARP if they were lending their own money. The government didn’t proft from TARP any more than I did from the game of Russian roullette I survived that I was paid to play the other day. 

Indicators that compare the outstanding balance of debt to a measure of repayment capacity are frequently used to estimate debt sustainability. There are many cases in which such ratios elevate the conversation, but it is helpful to highlight the pathological, indeed obvious, cases where they do not.

If the US suspended all tax collection for 3 years, the debt-GDP ratio may roughly double from 100% to 200%. Other things equal, I would guess rates would not move much. At least not without a presumption that individuals will use their rebate to dig holes. Even if we tried this over 30 years, instead of 3 years, future uncertainty in US earning potential might increase rate volatility and risk premia, but it isn’t obvious interest rates would increase much. This seems pretty clear at large magnitudes, but is equally valid for small changes in the ratio governing daily commentary on debt commentary and credit risk. Notably things about distribution over time is not necessarily important. A huge tax cut today means more cash provided in inheritance to future generations. (This doesn’t apply to spending because it doesn’t always in a form that can be sold and saved).

The level of debt-to-GDP is on the first order not much more than a choice about where we store future income, with some distributional effects thrown in at large magnitudes. And while countries are not perpetual entities, large debt-GDP ratios do not obviously change interest rates for credible institutions, even over large periods of time. Sometimes conversations such as these evolve into discussions on the properties of money, which I do not know much about. That said while it is true a large increase in US debt would be associated with certain “money-like” features, this observation is not necessarily limited to rich countries.

Obviously too much debt will increase interest rates and decrease expectation of repayment. Many times “too much debt” is associated with high debt-GDP ratios. But the underlying mechanism emerges from something else entirely. It may be that the increase in the ratio reflected large spending programs that were not expected to generate economic value. Or maybe it reflected the decline in expected future productive capacity of a country. (This isn’t a reflection of only stock and flow concerns as it would apply to flow/flow or stock/stock ratios as well.)

But without that information, understanding what debt ratios mean is hard. For example, it is sometimes claimed that we may not consider a large emerging market deficit to be problematic since we expect repayment from a growing economy. This is true in the same sense that we may not consider a deficit doubly big, other things equal, to be a problem outside of the way it modifies quality of projects funded. Since this ratio is a choice within reasonable bounds, understanding the motivation for this choice, the underlying economic truth it modifies, and the way it will affect and be affected by another country’s choice in the future are important to know.

Cases for the progressive carbon tax:

  1. Some people are concerned that carbon taxes might discourage innovation since it is a critical ingredient to the existing economy. However people emit carbon not because they care about the output, but because they like to emit carbon as an end in and of itself. More importantly, the most efficient emitters produce so much carbon that they wouldn’t even notice a large tax. It’s unlikely that a progressive carbon tax is going to force billionaires to stop flying in private jets, so the substitution effect is not large.
  2. Carbon offers a lot less utility to those who emit a lot of carbon, like a traveling doctor, than it does to those who do not, like a monk.
  3. Carbon inequality in the United States has reached levels not observed since the Carboniferous Age. The meat hipster renaissance means grass-fed beef connoisseurs can emit an unprecedented amount of carbon, but we’re concerned less fortunate Americans may be left out on the carbon binge.
  4. While we understand steeply progressive carbon taxes might reduce the incentive to emit at the highest levels, we can encourage emissions in other ways, including a middle school curriculum with slogans such as “If you keep your lights on frequently enough, even you can emit as much carbon as Richard Branson ” or “The American Dream: Emit a lot, save coal, and maybe your kids can drive a Hummer”.
  5. Still we should not get carried away. Equality of emission is less important than equality of the opportunity to emit. In this regard, we support targeted spending mechanisms such as business class upgrade subsidies and carefully crafted Pigouvian taxes such as a vegetarian penalty.
  6. We’re skeptical of our opponents who want to tax capital and labor. For one carbon is a necessary byproduct of employment and innovation, so an income or wealth tax would indirectly raise carbon prices as well. Additionally, a lot of people benefit from labor and capital favoring a carbon tax. We understand that not all labor is good, and can institute restrictive occupational licensing instead.

Cases against the progressive carbon tax:

  1. A carbon tax, if it exists at all, should be very regressive because you didn’t emit that. Even though it may appear as though your private jet produced a lot of carbon, you wouldn’t have been able to fly that jet without the workers who built it. It is only fair that they share some of your burden.
  2. A carbon tax cut could actually increase revenues. If the carbon tax is high, people might inadvertently emit less or develop non-carbon alternatives, reducing our tax base.
  3. It might appear that carbon inequality has increased a lot over the past 30 years, but this doesn’t properly adjust for carbon surplus. Mass consumer items, like cars and heating, have become a lot more carbon efficient. The apparent inequality only reflects the fact that the largest carbon emitters haven’t seen a substantial drop in their carbon needs. In fact the trend may have even reversed, as grass-fed beef requires more water and energy than its factory-farmed counterpart. While electric bikes exist today, private jets will remain gasoline-fueled for some time to come.
  4. We understand that carbon inequality still exists, however that is a private issue. You can always donate gasoline and coal to your frugal neighbor or the Treasury.
  5. A little envy is always good. Watching your friend eat a burger while you eat lettuce will encourage you to find the desire to emit more carbon, creating a virtuous cycle of carbon creation.