Friday, November 22, 2013

Minimum Wages and Macroeconomic Silliness

Mark Perry has a silly argument against raising the minimum wage, which thankfully David Cooper has ably addressed. The gist of Perry’s argument is captured by his title:
In Western Europe, the average jobless rate is twice as high in countries with a minimum wage vs. those with no minimum
Cooper replies:
First of all, as we learned in Statistics 101, there’s a difference between correlation and causation. Even if there appeared to be some pattern between minimum wages and unemployment, that wouldn’t mean that one is in any way causing the other. The only way to try to identify causality is to isolate as many—ideally all—other factors that might play a role in the suspected relationship through statistical regression methods … take a look at the countries that do have minimum wages. If minimum wage laws do lead to higher joblessness, as Perry suggests, one would expect that the higher the minimum wage, the higher the jobless rate. According to this table, that’s not the case in Western Europe. The figure below is a simple scatterplot of the minimum wage rates and the jobless rates from the table. As you can see, under the superficial approach that Dr. Perry is viewing these data, higher minimum wages actually imply lower jobless rates.
Note that Greece’s minimum wage is quite low and it has a 27.2% unemployment rate. On the other hand, Luxembourg has a very high minimum wage but its unemployment is quite modest. If we are playing this game, we could also look at the real minimum wage in the U.S. over time comparing it to our unemployment rate. After all – the real minimum wage peaked in 1968, which was also a year where the unemployment rate dropped to 3.4%. David Cooper is not suggesting that higher minimum wages tend to lower unemployment rate, but we are saying that Dr. Perry’s little exercise is silly.


Tax Attorney said...

Also, in statistics you learn about the outlier effect. The truth is that Spain, Portugal, Greece, and Ireland have very high unemployment rates because of the austerity measures Germany and the EU forced them to adopt. I have never heard a persuasive argument that their economic problems were caused by a minimum wage.

Also, what about the fact that states with a higher minimum wage than the federal tend to have a lower unemployment rate than those that do not have a higher minimum wage?

For a number of reasons, an increase in the minium wage does not lead to the unemployment effects that the overly simplistic demand and supply curve model predicts.

First, not all labor market are purely competitive (which the above model implies), especially in rural regions where there may be only a few employers. Where you only have one or two local employer of low wage labor, those employers have tremndous power to set their own price for labor (they don't have to compete with other employers in attracting workers).

Second, many employers will comply with the minimum wage by reducing their profit levels, which classical economic theory incorrectly states is always zero.
Soaring corporate profits show there is room for lower profit margins.

Thirdly, an increased wage does not mean that the employer's costs increase by the amount of the increased wage. That's because studies show that paying a higher wage results in less turnover and higher productivity from workers.

Fourthly, consumers may see a rise in prices from the minimum wage, though historically the minimum wage has not resulted in much inflation.

Jazzbumpa said...

Your David Cooper link is broken.