Thursday, September 18, 2003

When might minimum wage make low-productivity workers better off?

Minimum wage, like rent control and protectionism, is one of those things that people are convinced will help the less fortunate, but in reality it makes the poorest of us even poorer. No one will hire someone for more than the value of their output, so a minimum wage of $5/hour prices out anyone whose output is lower than $5/hour. Given that $5/hour isn't much, such a person is not very productive and it seems perverse and cruel to deny them the opportunity to build the skills they need to become more productive, and command a higher wage. Arnold and Jane (via Marc) have covered the usual case where higher minimum wages hurt workers, as well as why this is separate from executive pay, so I'll deal with the outlier: when might minimum wage help low-productivity workers?

There's really only case in which this could be true. It's rare, but instructive, so here goes: If you have a monopsony, that is, a market where there is a single, monopoly buyer of labor, you will have an upward sloping supply curve where labor supplied is not very sensitive to price (wage). The monopsony employer might be selling into a perfectly competitive market, but it's the only employer (buyer of labor) in town.

In this case, the monopsony can maximize its profits by restricting the amount of labor it buys and lowering the price. This is the mirror image of the more common monopoly seller raising it's price, selling less, and maximizing profit. In a monopsonist market for labor, raising the price of labor through a minimum wage will increase employment and benefit the economy as a whole (the employer will be slightly worse off, but its loss will be smaller than the overall gain). In such a situation, a minimum wage will make both the employees, and society as a whole, better off. Note that if the market is not a monopsonist market for labor, a minimum wage will price low productivity labor out and hurt both them, and society as a whole.

The nice thing about this analysis is that it reduces an emotional "raising minimum wage will help/hurt labor" to an empirical test: how many similar employers are competing for labor in this market (or, how elastic is the supply of labor for a particular employer)? In a remote town with just one employer, labor supply will be pretty inelastic (there aren't many substitutes) so you could expect a minimum wage to be less harmful, maybe even beneficial, there. But in the areas we most closely associate with minimum wage labor: fast food, entry level retail, low level services, there are lots of similar jobs around so the labor supply should be pretty sensitive to price. It isn't hard for a fast food worked to flip burgers somewhere else.

So if anyone claims raising minimum wage will not hurt low productivity workers, ask them to demonstrate a monopsony market for labor. But don't expect to change any minds.


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