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Bryan Caplan is wrong about the minimum wage

Bryan Caplan has a pretty interesting argument for the orthodox interpretation of the minimum wage (that is causes unemployment). It really, almost works – but it doesn’t. Caplan argues that even if data ‘officially about the minimum wage’ doesn’t support his case, all plenty of other highly relevant data does:

1. The literature on the effect of low-skilled immigration on native wages.  A strong consensus finds that large increases in low-skilled immigration have little effect on low-skilled native wages.  […] These results imply a highly elastic demand curve for low-skilled labor, which in turn implies a large disemployment effect of the minimum wage.

2. The literature on the effect of European labor market regulation. Most economists who study European labor markets admit that strict labor market regulations are an important cause of high long-term unemployment […] European governments are afraid to embrace the deregulation they know they need to restore full employment.  To be fair, high minimum wages are only one facet of European labor market regulation.  But if you find that one kind of regulation that raises labor costs reduces employment, the reasonable inference to draw is that any regulation that raises labor costs has similar effects – including, of course, the minimum wage.

3. The literature on the effects of price controls in general.  There are vast empirical literatures studying the effects of price controls of housing (rent control), agriculture (price supports), energy (oil and gas price controls), banking (Regulation Q) etc.

If you object, “Evidence on rent control is only relevant for housing markets, not labor markets,” I’ll retort, “In that case, evidence on the minimum wage in New Jersey and Pennsylvania in the 1990s is only relevant for those two states during that decade.”  My point: If you can’t generalize empirical results from one market to another, you can’t generalize empirical results from one state to another, or one era to another.

4. The literature on Keynesian macroeconomics.  If you’re even mildly Keynesian, you know that downward nominal wage rigidity occasionally leads to lots of involuntary unemployment.  If, like most Keynesians, you think that your view is backed by overwhelming empirical evidence, I have a challenge for you: Explain why market-driven downward nominal wage rigidity leads to unemployment without implying that a government-imposed minimum wage leads to unemployment.  The challenge is tough because the whole point of the minimum wage is to intensify what Keynesians correctly see as the fundamental cause of unemployment: The failure of nominal wages to fall until the market clears.

If the data that actually tests the phenomenon in questionconclusively notes that minimum wage does not have employment effects, it doesn’t make sense to appeal to second-order, but relevant, data. Here’s why this argument begs the question:

  • The null hypothesis was that economic theory is right which implies that wage controls cause unemployment.
  • David Card and Alan Krueger disprove the null, showing that wage controls contradict economic theory.
  • Caplan argues that if theory holds, elsewhere, it must hold for minimum wage as well.

In other words, the original argument against a minimum wage was based on textbook economics, Caplan argues that textbook economics holds elsewhere too, and therefore must be applicable to wage controls.

Caplan further argues that we can extrapolate empirical data in one market to every other market. Is Caplan really suggesting that because the market for apples gives rise to a downward-sloping demand curve wherein price floors cause surpluses that the same must apply for human labor? Why, then, can I not extrapolate the labor market from rice in the Hunan Provence (ostensibly a Giffen good). I would agree with Caplan that we ought to stick with standard economics had the null not been conclusively disproven.

For that “relevant” empirical evidence to mean anything, standard theory has to be true. You can’t explain why standard theory applies to wage controls and simultaneously use evidence which is predicated on standard theory being true.

I’m also curious about the extent to which European regulations increase the unit-cost of labor. I was under the impression that most of the inflexibility in Europe came from unions that made it impossible to fire workers. The argument comparing minimum wage effects to immigration is similarly flawed: immigration has demand-side effects, as well, which make the process worthwhile.

Here are some reasons why human labor is different:

  • Not to sound Marxist or anything, but there is a sense in which the decision to work isn’t really a choice in the classical sense, but a natural force. Those earning at minimum wage are very unlikely to have any wealth to wait for a job, and must accept the most immediate opening to make end’s meet. This is not a choice. In this position, employers clearly have the power considering a captive demand to work. If we’re making market analogies, this is somewhat akin to a central bank increasing capital reserve ratios, thereby creating a captive demand for government debt and hence forcing prices down.
  • Unlike an apple uneaten or machine unused, labor unemployment has external social costs. My point is, it’s better to let a man work and pay him nothing (in an economic sense) to prevent skill atrophy. This thinking may convince employees to work for far less than optimal wages to remain connected with our social fabric.

The point is, for whatever reason, economic theory can’t explain wage controls. Caplan saves his argument by noting his strong priors:

Part of the reason is admittedly my strong prior.  In the absence of any specific empirical evidence, I am 99%+ sure that a randomly selected demand curve will have a negative slope.  I hew to this prior even in cases – like demand for illegal drugs or illegal immigration – where a downward-sloping demand curve is ideologically inconvenient for me.  What makes me so sure?  Every purchase I’ve ever made or considered – and every conversation I’ve had with other people about every purchase they’ve ever made or considered.

But his argument was intended for those of us like me who don’t have strong priors, and don’t deeply distrust empirical data. In that sense, his premises assume his conclusion, and the argument fails to have logical validity.

h/t: Scott Sumner and Tyler Cowen

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8 comments
  1. originalsandwichman said:

    I just posted the following comment at Caplan’s blog:

    “Part of the reason is admittedly my strong prior.”

    Come to think of it, Bryan Caplan’s “prior” is actually “priors”, one of which is the notorious lump of labor! Caplan is “99%+ sure that a randomly selected demand curve will have a negative slope.” But a demand curve for WHAT? For hours of work or for workers?

    Caplan assumes that a negative sloping demand curve for hours of work transforms automatically into more jobs rather than, say, into more hours — at lower pay — for fewer workers. What’s the empirical evidence for that assumption?

    As Maurice Dobb pointed out long ago, even if the elimination of the minimum wage led to higher aggregate earnings for low wage workers, “It is not aggregate earnings which are the measure of the benefit obtained by the worker, but his earnings in relation to the work he does.”

  2. Not to sound Marxist or anything, but there is a sense in which the decision to work isn’t really a choice in the classical sense, but a natural force. Those earning at minimum wage are very unlikely to have any wealth to wait for a job, and must accept the most immediate opening to make end’s meet. This is not a choice. In this position, employers clearly have the power considering a captive demand to work. If we’re making market analogies, this is somewhat akin to a central bank increasing capital reserve ratios, thereby creating a captive demand for government debt and hence forcing prices down.

    What if the employer really needs the help? Is that not a choice for him?

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  6. Hey man! Michael from UPenn, founder of down to chill (we met once). I tend to be more on the libertarian end and think minimum wage at the point currently in the united states is comparatively low, to have that much of a negative effect on employment. Also, standardization of unit cost of labor for a place like mcdonalds lowers the marginal cost of labor for them, hence nullifying the disemployment effect (for that type of employer). I would argue though the size of the united states, as comparable to the EU in terms of regional variations in income and the like, it would make more sense that state minimum wages would be more effective than federal ones. I think you want to also have enough room in the minimum wage not price the low skilled out of the market. I think Milton was really right here that a minimum wage prices out the lowest skilled workers, and I think you’ll find the data is quite convincing that, all though all things equal it has no massive negative effect at the low range on unemployment, it still has disproportionate demographic/geographic effects. Considering the state of education, it might be better for many poor youths (maybe not ideal, but the best choice available to them) to take a job at say 4-5$ an hour, and build up skills and responsibility the schools don’t teach as they go from 15 to 16 to 17 etc. Many exemptions are pre built in for this sort of thing, so no problem for a major corporation to take advantage of it, but the small business owner faces a very real cost of employment. If minimum wages are to exist, they should be more local in enforcement and price setting. all things considered, 50 minimum wages would be more economically effective and more politically potent if they were decided in each state. If you make the cost of a low skilled unit of labor “sticky” the only way to correct that labor market is either with discretionary monetary policy or a change in that nationwide price floor.

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