Cardiff Garcia has a good rundown on the minimum wage debate. He’s looking for someone to persuade him either way, and I’ll try to explain my qualified support for a minimum wage. For many, the debate is about the relative value of a minimum wage, which is theoretically inefficient, against wage subsidies which are not. However, as Paul Krugman pointed out earlier this year (though this is nothing new) the minimum wage and Earned Income Tax Credit (EITC) are really compliments, at least to the extent your goal is ensuring workers and not employers capture the benefits.

Here’s the pith in just a few sentences. As far as welfare goes, the government should not really be concerned about the wage paid by employers as much as the wage received by workers. If we decide that everyone needs $15 dollars an hour to live a comfortable life, then the government should not require that employers pay at this level, but promise to cover the differential between the market clearing rate (for unskilled laborers). The problem is labor supply is not perfectly inelastic, so this becomes subsidy for employers who can pay less.

There’s another problem with the EITC – it’s somewhat procyclical. There’s some econometric evidence to this effect, but it’s pretty easy to see that a program dependent on employment is not very countercyclical. This is not a problem per se but the marginal value of government spending – not just in increasing the welfare of the poor, but in moderating business cycles – is much higher in recession.

We should institute a procyclical minimum wage – relatively high when growth is good, and low when growth is bad. Actually, at least in the short run, this will address Tyler Cowen’s problem as well:

What about when the wage profile for low-skilled workers is sloping downward over time?  One would expect the opposite result to hold, namely that employers are less likely to hold on to workers when confronted with a mandated wage increase.

For much of the 1990s, the labor market for less skilled workers was in decent shape.  Since 1999 or so often it has been in bad or declining shape, excepting the “bubbly” years of 2004-2006.  Therefore a minimum wage hike today would be more likely to boost unemployment than the minimum wage hikes of the past.  And that unemployment is more likely to be long-term, corrosive unemployment than in previous decades.

I do understand that a minimum wage hike, in the eyes of some, is more “needed” today, perhaps for distributional reasons.  But can we admit it is more likely than average to lead to additional unemployment?

There are many ways to make a minimum wage procyclical, but a simple heuristic might be keeping the portion of the workforce on minimum wage constant over time. That means when the labor market is tight the minimum needs to be raised to keep the level constant, and vice-versa in a loose market like today. There’s a pretty good argument that a minimum wage is like fiscal stimulus the government doesn’t have to pay for, advocated most vocally by billionaire Nick Hanauer. He thinks that’s a good thing, but huge cash piles or not, a recession is precisely the worst time to ask the private sector to pay more.

This would work in tandem with a wage subsidy guaranteeing some minimum income that is acyclical. In good times, the required employer pay rate increases, easing the government’s deficit. The disemployment effect during this time will be relatively negligible as per Cowen’s logic but also because inflation is higher during boom times allowing the employer to erode the real wage rate if the employee turns out to be bad.

When times are bad, the wage employees need to pay falls, which increases demand for labor, and the government picks up the tabs. Sure it’s partly a subsidy to employers, but one precisely when they need it.

This has the free benefit of making the EITC a lot more countercyclical. It also eases political constraints of efficient stimulus. The government can choose to make the minimum wage zero in slow times – something I’ve advocated before – which would in effect be providing free labor to employers. This sounds a lot better once you consider that at least today employers seem to think the long-term unemployed are approximately useless.

A procyclical minimum wage in tandem with a wage subsidy is in effect a countercyclical stimulus program. It also directly encourages hiring in a way the standard program does not. Here’s to the market determined 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 question, conclusively 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