The Economics Behind Minimum Wage Laws, It's Just Monopsonistic Labor Market
"It's simple supply & demand. If you impose a minimum wage, you artificially raise the price of labor. With a higher price, businesses will demand less labor. Therefore, minimum wage causes more unemployment."
Many people use this argument to combat minimum wage laws. I can almost picture them smugly thumbing through an Econ 101 textbook for 10 minutes, then using this simplistic supply & demand argument to oppose something they already didn't like.
It takes more than superficial supply and demand knowledge to explain something as complex as minimum wage laws. I read the Econ textbook for 11 or 12 minutes, so I can tell you there is little to no basis for this economic argument against minimum wage. (To please the CSO requirements, I should tell you that I've really taken 5 economics classes, most graduate level. That's what "makes me an authority on the subject". I may even have read each textbook for more than 12 minutes.)
In the front of that Econ book, there are some important assumptions to be made before describing basic supply & demand. These are:
1) There are many buyers & sellers
2) There is perfect mobility (both buyers and sellers can freely enter and exit)
3) There is perfect information (everybody knows everyone else's prices)
In a market with these conditions, a minimum wage (or any minimum price) will indeed lower labor demand and increasing unemployment.
But does the labor market fit these conditions? I argue that the labor market doesn't meet ANY of these conditions.
1) I can attest that there are very few buyers of my particular labor.
2) There is almost no mobility. If I find that Google would offer me $100 more salary, I can't join Google and then later return to my original job when they offer me $200 more. Mobility is very low.
3) Information is nowhere near to perfect. Often, I don't know much a company is paying for labor until AFTER I've interviewed.
The Supply & Demand model does not describe the labor market very well. So we have to delve a little deeper, maybe even into the Econ 102 book.
We can describe minimum wage laws better with a monopsony model. The word monopsony might sound foreign to you, but it's just like a monopoly, which shouldn't be foreign at all.
In a monopoly there is only one seller. Since the monopolist doesn't face competition, it can set the price. Buyers then choose whether to purchase or not. Buyers can't choose to shop around for a better price. In most monopolistic markets, the seller will set an artificially high price to maximize its profit.
In a monopsony, there is only one buyer. That buyer sets the price, and then sellers can choose to sell or not. In a monopsonistic market, the buyer will set an artificially low price to maximize its utility (in other words, get more stuff for less money).
The labor market displays something closer to monopsonistic competition. This means there are multiple buyers who set their own prices. When was the last time you went to a job interview and said "I'm selling my labor for $50,000. Would you like to purchase?" In reality, the buyer sets the price (Executive Assistant needed, $35,000 salary). There is a little room to negotiate, but for the most part the seller can choose to take the job at the price offered, or not. The business (the buyer) sets the price of labor.
Monopsonistic labor buyers set artificially low prices, which is economically inefficient. Essentially there is waste which makes society as a whole worse off. A minimum wage will bring the supply and demand equilibrium closer to its most efficient levels. In a monopsonistic market, a minimum wage will often actually INCREASE employment (or reduce unemployment). So if the labor market is monopsonistic, then rejecting a minimum wage law will increase unemployment.
Is the labor market monopsonistic? Economists are divided on the issue. However, there is little question that the monopsony argument better explains labor markets than the simple supply & demand argument.
So next time someone uses superficial economic reasoning, you will know better. It's not nearly that simple. At some point, we'll have to stop trying to logicize our way through the issue. The only way we'll get a clear answer is by testing minimum wage laws empirically, and then observing what truly happens.
Published by Scott Schlimmer
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- The labor market may resemble a monopsony, which is similar a monopoly.
- If that's the case, then minimum wage laws do not increase unemployment.
- Maybe we should stop trying to logicize our way through complex issues. We should test empirically.
18 Comments
Post a Commenthttp://www.youtube.com/watch?v=02n9SIllNcM#t=284
"Now, many people who argue for a minimum wage law will cite the theory of monopsony labor markets. They will point out that many labor markets are monopsonistic, and as a consequence it's possible to raise the wage rate and increase the number of workers that are hired. But you must also realize that there are many competitive labor markets, and the net effect of the minimum wage will be the difference between the negative employment effects in the competitive labor markets versus the potential positive employment effects in monopsony labor markets."
Ah - no links. Well, the Mises detail is at http://blog.mises.org/archives/010337.asp#comment-571544 and my submission is at http://blog.libertarian.org.au/2009/05/05/pml-on-tax-reform (with links to the other stuff).
Somebody just brought out these issues at a Mises blog thread, and I've provided some detail there.
People might also be interested in what I found when I researched the area for a submission to the (Australian) Henry Tax Review. It turns out that some economists, e.g. Professor Kim Swales of the University of Strathclyde and his colleagues, and Nobel winner Professor Edmund S. Phelps, McVickar Professor of Political Economy at Columbia University, have found another approach to implementing a minimum wage that raises employment (see here and here).
Scott-- Seems that by saying "Monopsonistic labor buyers set artificially low prices, which is economically inefficient", you are describing a cartel-- members of which, as you are well aware, are still competing with each other and have incentives to bid the best labor away. And cartels rarely, especially in a large non-collusive environment such as your average city, keep their act together. So it looks like you're assuming that the buyers (i.e. firms) will all keep their prices artificially low-- but this isn't the case, because they're competing and thus will pay the least possible to get the best labor possible at the given pay scale, leading to that equilibrium you mentioned. Then raising that minimum legal wage will remove an entire class of people (say, the folks' whose productivity does not equal the minimum wage) from employment, because while you can raise the minimum wage, you cannot force firms to retain people that cost more than they produce. Now-- this won't affect s
Care to tell us how or why you say? Truth and reasoning are much more convincing than credentials.
Increasing minimum wage absolutely increases unemployment. First hand experience here, as well as a degree in Economics, taught by Nobel Prize winning professors!
Orpher - You make good points that there's more to the minimum wage issue than economics. You're right - we're talking about real people here and ethics do matter. But I think your capitalist/communist comparison, although true, does not apply here. I'm making a pure economics point. A capitalist market and it's "invisible hands" should bring a market to optimum efficiency, as you point out. The problem with the labor market is that it's not at optimum efficiency. In your example, the current market is more like communism, since each company essentially runs a mini monopoly, which is not efficient. I say a higher minimum wages break up the mini monopolies and push the labor market closer to it's competitive capitalist perfection.
The people who dissent, you're right that the business makes less profit when minimum wage increases (yes, even Bryan is right on that point despite the childish tone). But that's not the point of this article . The point is that increasing minimum wage does NOT increase unemployment.
Finishing the cut off sentence: Failure to do this is both ethically wrong, and leads to societal unrest, costing us all more in the long run.
In the most general terms, capitalism works better than any other economic system we know because it works along rather than counter to the way most humans think. If a worker can work less and still get the same compensation (as in communism) most workers will work less, and both the economy and society suffer. If a worker in a capitalistic society does not perform to a minimum standard, s/he gets fired or at least does not get a raise, motivating workers to be productive. Having said all that, capital markets don't self-police well unless forced to. If the FDA did not force food safety standards on businesses, most would go the more profitable route and sell untested products (think China). Similarly, lacking minimum wage, most businesses would pay less for unskilled labor, leaving the poorest workers no recourse. Minimum wage is not solely an economic consideration. Society must ensure a person working full time can live at a reasonable minimum standard. Failure to do this is both et