Some thoughts on arguments in favor of the minimum wage.
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 w < k. 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?
This is Ashok. 
Your concluding question is a great way to frame the minimum wage vs. wage subsidy debate. “Should governments tax low wage workers at 100% of their income or some negative %?” To answer differently based on a penny difference between two wages seems absurd. Taxing the lower wage higher is regressive on its face. A minwage advocate might respond, “This question falls outside the ambit of tax progressivity. Work below a certain wage is fundamentally abusive. The tax system should not be an enabler of worker abuse. Hard cutoffs send a clearer message, and we want to nudge that line over time towards living wages.”
I notice another reason wage subsidies aren’t as popular: unemployment is seen as a problem of markets, or something even more general and inchoate about the structure of society; low wages are a bargain with a specific devil. So the thing wage subsidies appear to subsidize isn’t poor people but corporate thrift. I saw a Facebook ad for $15/hour in my province that said something like, “nobody who works all week should be on food stamps.” Government assistance in this conceit is like a buck of shame that’s been passed from employers to workers. The shame disappears, leaving only the buck, when you’re talking about unemployed people. Which in turn quiets any cognitive dissonance brought on by the risk of minwage-created unemployment.
The problem is that we know that raising the minimum wage increases employment. That’s a simple fact that gets confirmed again and again. We see it in time series and we see it in border studies. We also know that when the minimum wage rises more slowly, we see slower economic growth. The cause isn’t all that important. The phenomenon is.
There was a time that US business magazines published regional income statistics so that businesses could plan their expansion. Wages were rising during that period, so businesses could benefit from expanding in areas where there were more customers, that is, people with money. That led to an upward cycle with rising living standards.
Those statistics haven’t been published in years, in magazines or on business news websites. There was a phase shift in the late 70s and early 80s where businesses started looking for cheaper workers by shifting production to low wage regions. This led to our current downward spiral of weak wage growth, weak spending growth and weak economic growth. It has also discouraged investment as labor is now cheaper.
If you lower the minimum wage, you do create an incentive for employers to lower wages. They aren’t going to hire more people unless demand grows. Suppose a company reduces its wage payments by hiring new workers at lower rates or cutting wages. Their profits will rise in the short run, but there is now that much less money pursuing goods and services including the goods and services of that particular company.
What would induce them to add an employee? Most companies increase their staff as revenues rise, not when revenues are stagnant or falling. It’s the area under the pay curve that determines demand. Slide down-wage and demand falls. Decreasing prices might counter this, but it will hurt revenues. At best the firm will break even. As we see repeatedly, decreasing the minimum wage just isn’t a formula for a vibrant economy.