The Law of Demand: We Ain't Singapore

W.W. goes on a bit of a screed against a minimum wage increase on Democracy in America.

While it's certainly true that the law of demand means that less labor will be demanded at a higher wage, ceteris paribus, things are not ceteris paribus with regards to a minimum wage increase in the United State.

W.W. does acknowledge that there are significant disputes in the literature, but the very presence of these disputes should tell us that the disemployment impact of a minimum wage increase are rather small.

Furthermore, there are a significant number of things being ignored by W.W.'s preference for " no minimum wage, wage subsidies, and transfers to low-income households that phase out in a way that does not tax small increases in income at absurdly punitive rates."

The first is that the United States is not a small, open economy like Singapore where demand is exogenous. Since demand is endogenous in a large economy like the United State an increase in the minimum wage will impact the resources available to low income neighborhoods providing increased business opportunities and increased economic growth in these areas. Related to this, evidence shows that a significant portion of wage subsidies (about a quarter) are captured by business owners rather than workers (this is the main factor that led me to favor a minimum wage increase relative to direct wage subsidies). The minimum wage and wage subsidies like the EITC have complementary strengths and weaknesses and should be linked together as an anti-poverty strategy. As a result of a minimum wage increase, income will shift towards lower wage individuals who have a higher propensity to spend, so on net, aggregate demand will be not just shifted, but increased.


The second issue is that minimum wage increases have a wage compression effect. While businesses often look at minimum wage workers as a cost center, they frequently look at higher wage workers as a profit center; think bankers being called producers and given multi-million dollar bonuses. While lower wage workers are often compensated based on replacement costs, without businesses paying little if any attention to their marginal product, higher wage workers are often compensated based on the success of their business unit. Wage compression serves to lessen the impact of these class attitudes,* low level workers see their wages rise in relation to the minimum wage while higher expenses force businesses to cut back on compensation near the top. This is heavy handed; but since it seems next to impossible to shift attitudes among management in favor of lower level workers it's a necessary evil to prevent increased inequality as well as to prevent the authoritarian tendencies in most corporate management from exploiting productive lower wage workers.

It also needs to be noted that historically the United States is a very high wage economy. In fact, I'd go so far as to say that all successful, rapidly growing non-catch-up growth economies are high wage economies. The early industrial revolution was marked by its ability to pay higher wages than both competing countries and other sectors; not by undercutting wages so that employers got a larger cut. While a lot of business people, and economists who like to listen to them rather than pay attention to empirics, believe that what is good for their bottom line is good for the economy as a whole this doesn't seem to match up with historical experience. Since the US began to pursue lower wages as a "competitive" (scare quotes because I believe this was misconceived and has made us less competitive) measure we seem to have been falling behind. I think it's time to rethink this whole low wages lead to a more competitive economy thing; it just doesn't look like it's working.

Then there's a grab bag of other more minor reasons. Higher minimum wages mean that businesses have an incentive to invest more in their workers and seek to raise retention; with a fair amount of evidence of the deskilling of the workforce this may be not a so minor concern. Given evidence of profit hoarding a raised minimum wage may give an incentive for businesses to use some of those idle assets to invest in new equipment to replace higher wage workers. Increased wages may provide incentives for businesses to shift compensation back towards cash and away from benefits, a rebalancing we're badly in need of. An increased minimum wage may also help to motivate discouraged workers, many people have an implicit reservation wage below which they won't work; instead getting assistance from friends or family or being a one instead of two income household (given how stingy welfare programs are I doubt anyone is not working because of them, everyone I have ever been acquainted with which chose not to work did so because of family support and some availability of under-the-table work; what research I've read on the subject backs up these anecdotal cases).

In short, the evidence of the negative impacts of a minimum wage increase are contested and these effects are likely to be rather small. The minimum wage complements, not displaces, other anti-poverty measures. Given other widely reported problems in the economy, like badly unbalanced incomes and cash-hoarding, this seems like a natural time to raise wages.

*As I've said before I don't really like the concept of class. However, it does seem to be an apt description of a certain social attitude that develops when a culture begins to believe the wealthy and powerful deserve their high incomes and that lower people deserve the treatment they get. This doesn't seem to me to be an inevitable product of capitalism but rather a product of inequality and power structures.

In the workplace, I see this all the time and read about it more. We hear of "talent" getting multi-million dollar bonuses while the secretary or mail-room clerk is paid at the replacement wage. In my experience few managers, or any other successful business people, would seriously consider the marginal product of their secretary even as they focus obsessively on the marginal product of their "talent." They would never think to even ask the question about whether a business unit is doing particularly well because they have a great secretary who manages to put potential clients in such a great mood that they are predisposed to buy.

This is just one element of class-bias. While partially the product of the economic system, the market system and the clarity of the price system seems to favor linear thinkers; business geniuses are the chess-master type not the kind of people who do well with high levels of randomness and apply non-linear thinking and multiple-perspectives to a problem. This tends towards assigning responsibility where it is clearest rather than trying to understand what is happening holistically, it also seems to predispose them against academic arguments that focus on systems, nonlinear functions, and indirect causes generally. Business tends to reward this, but it is able to do so because of highly stylized rules and conventions not because business is an accurate reflection of social reality.