The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.
- BLS Handbook of Methods
- Bureau of Economic Analysis
- Bureau of Labor Statistics
- Congressional Budget Office
- Economic Data - FRED® II, St. Louis Fed
- Office of Management and Budget
- Statistics: Releases and Historical Data, Board of Governors
- U.S. Census Bureau Economic Programs
- White House Economic Statistics Briefing Room
December 10, 2006
Modern Labor Economics And The Minimum Wage
As I continue in my futile quest to catch up with all the blog reading that I have let slip, this post from early last week at Angry Bear caught my eye (I added the link to the Atrios site):
Duncan [Black] also recommends Monopsony in Motion: Imperfect Competition in Labor Markets by Alan Manning:
Much of labor economics is built on the assumption that all the workers will quit immediately. Here, Alan Manning mounts a systematic challenge to the standard model of perfect competition.
Simply because my aim here is to inform as best I can -- at least about the things I think I am qualified to be informative about -- I think it worthwhile to point out that this doesn't really describe the state of modern labor theory. For a description of that, I'll turn to Rob Shimer, one of the guys at the top of the list of people actively creating modern labor theory:
I begin by describing the simplest version of the Mortensen-Pissarides matching model...
A central feature of this model is that the matched worker and firm are in a bilateral monopoly situation. That is, an employed worker could always leave her job and find another employer; however, because search is time-consuming, workers are impatient, and all jobs are identical, she prefers to work for her current employer. Likewise, a firm could fire an employee and attempt to hire another one, but this will take time and will not yield a better match. There are many wages consistent with the pair agreeing to match, and so the model provides little guidance as to how wages are determined...
Rob's article -- which is quite accessible -- is must reading for anyone with even a passing interest in what labor theory is all about these days. My point in highlighting this passage is, of course, that the challenge to the perfectly-competitive spot market view is already well under way (even in macroeconomic models). And as you can see, that theory is not built on the assumption that "workers will quit immediately." Nor is it built on the assumption that employers will fire immediately.
What, then, does modern labor economics have to say about the minimum wage? A complicated question that. Here is a sampling of abstracts, generated by my highly scientific method of typing "minimum wage matching model" into Google --
From Adrian Masters (in a paper published in a good peer-reviewed journal), the argument that wages may indeed be too low:
This article focuses on wage formation in an equilibrium (two-sided) model of search with match-specific heterogeneity. Despite a large number (a continuum) of employers, search provides sufficient isolation to generate market power. By posting wages, employers, without collusion, capture most of the surplus that accrues to any match. The equilibrium wage is below that which maximizes employment...
But be careful. From Michael Pries and Richard Rogerson:
So what happens when a policy, such as a minimum wage, interferes with that equilibrium wage rate? If the imposed minimum wage is higher than what the equilibrium wage would be, says Rogerson, there will be cases in which firms no longer want to enter the match to test it out.
The reason, says Rogerson, is that raising the minimum wage raises the minimal level of match quality that a firm will accept to test out the relationship. The firm will still enter into some matches at above-minimum wage, but only those that show a higher potential of being good matches.
Rogerson explains the phenomenon through a car-buying analogy. "Imagine that a law was passed that said you could no longer test-drive a car," Rogerson says. "That deprives you of an important source of information. Although you can get some information from looking at a car, you have a much better idea after test-driving it than before." So what would the outcome of a test-driving prohibition be? "People would be less likely to find the car that best suits their needs, implying a loss in economic welfare."
Policies like the ones Pries and Rogerson analyze -- minimum wages, unemployment insurance, dismissal costs, and taxes -- are not the same as imposing a ban on test-driving automobiles. But their effect is to make test-driving an employee (hiring him to see through experience if he will be a good match) more costly, which means that firms will do it less often.
...The effects of other policies by themselves, including dismissal costs, unemployment insurance, and taxes, are minimal, write Pries and Rogerson. But the effects of those policies combined (as they often are in the real world) are quite large.
In fact, we should probably be thinking about labor market policies as a collection of interventions, rather than taking the piecemeal approach that characterizes how many of our policies are actually implemented. From Pierre Cahuc and Andre Zylberberg:
We analyze how wage setting institutions and job-security provisions interact on unemployment. The assumption that wages are renegotiated by mutual agreement only is introduced in a matching model with endogenous job destruction à la Mortensen and Pissarides (1994) in order to get wage profiles with proper microfoundations... the assumption of renegotiation by mutual agreement allows us to introduce a minimum wage in a coherent way, and to study its interactions with job protection policies. Our computational exercises suggest that redundancy transfers and administrative dismissal restrictions have negligible unemployment effects when wages are flexible or when the minimum wage is low, but a dramatic positive impact on unemployment when there is a high minimum wage.
Just to make things more difficult, observing outcomes that we generally interpret as negative -- such as rising unemployment -- need not mean that a policy is misguided. From Christopher Flinn...
... we analyze the effect of changes in minimum wages on labor market outcomes and welfare. While minimum wage increases invariably lead to employment losses in our model, they may be welfare-improving to labor market participants using any one of a number of welfare criteria... Direct estimates of the welfare impact of the minimum wage increase from $4.25 to $4.75 in 1996 provide limited evidence of a small improvement. Using estimates of the primitive parameters we show that more substantial welfare gains for labor market participants could have been obtained by doubling the minimum wage rate in 1996, though at the cost of a perhaps unacceptably high unemployment rate.
... and from a related paper (published in a very, very highly regarded journal):
Although minimum wage increases may or may not lead to increases in unemployment in our model, they can be welfare-improving to labor market participants on both the supply and demand sides of the labor market... We show that the optimal minimum wage in 1996 depends critically on whether or not contact rates can be considered to be exogenous and we note that the limited variation in minimum wages makes testing this assumption problematic.
So, is the minimum wage a good idea or not. Our theories, and attempts to quantify them, speak clearly: It depends.
UPDATE: More links on the topic, at Economic Investigations.
TrackBack URL for this entry:
Listed below are links to blogs that reference Modern Labor Economics And The Minimum Wage:
- Payroll Employment Growth: Strong Enough?
- Forecasting Loan Losses for Stress Tests
- Men at Work: Are We Seeing a Turnaround in Male Labor Force Participation?
- What’s Moving the Market’s Views on the Path of Short-Term Rates?
- Lockhart Casts a Line into the Murky Waters of Uncertainty
- How Will Employers Respond to New Overtime Regulations?
- How Good Is The Employment Trend? Decide for Yourself
- Is the Labor Market Tossing a Fair Coin?
- When It Rains, It Pours
- Pay As You Go: Yes or No?
- August 2016
- July 2016
- June 2016
- May 2016
- April 2016
- March 2016
- February 2016
- January 2016
- November 2015
- October 2015
- Business Cycles
- Business Inflation Expectations
- Capital and Investment
- Capital Markets
- Data Releases
- Economic conditions
- Economic Growth and Development
- Exchange Rates and the Dollar
- Fed Funds Futures
- Federal Debt and Deficits
- Federal Reserve and Monetary Policy
- Financial System
- Fiscal Policy
- Health Care
- Inflation Expectations
- Interest Rates
- Labor Markets
- Latin America/South America
- Monetary Policy
- Money Markets
- Real Estate
- Saving, Capital, and Investment
- Small Business
- Social Security
- This, That, and the Other
- Trade Deficit
- Wage Growth