John Moser
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179 votesJohn Moser
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The hidden cost of a low minimum wage is an excellent example of broken window fallacy.
When minimum wage is low, high-productivity firms can't compete with low-productivity firms: the gap between wages becomes large, and labor-saving technology has to save MUCH more labor for a productive firm to be cost-effective, and thus competitive with a low-productivity firm.
Many say, well, but if minimum wage were higher, wouldn't firms reduce employment? And the answer is yes, an individual firm would; but what does that mean?
Broken window fallacy: well these workers do need work, after all.
If you go about smashing windows, you make work for the glazier. This is a loss because it's unproductive, as if the glazier weren't replacing broken windows, they could be making new windows, and retiring glaziers could be replaced by shoemakers or carpenters.
The same is true of a low minimum wage: if the hours invested by the low-wage glazier hand-producing flat glass were replaced by fewer hours invested by the high-wage, skilled glazier using advanced processes and tools, then more glass could be made with fewer glaziers. An increased minimum wage—relative to per-captia GDP—causes this efficiency gain.
Just like with the broken window, the reduction in demand for glaziers—even with an increase in demand for glass—leaves us with labor we can apply to other uses. These workers may now make shoes, table, medical supplies, or all other manner of things. Retiring glaziers are replaced with skilled glaziers, with college-educated engineers, with computer programmers, with doctors and nurses, all manner of people more-productive than glaziers using the old methods.
The broken window fallacy drives an unfortunate tendency for countries to think of minimum wage as a "balance between equity and competitiveness," when it's really a balance between equity and the limits of economic flexibility. At a substantially high minimum wage, the economy is still flexible and perhaps even optimal; but above an exceedingly high point—which may even be as much as 100% of per-capita GDP, although 67% is a known-stable level—wage compression accelerates.
That is to say: wages get closer together as you raise minimum wage because market forces increase other wages, but higher wages increase less than lower wages. As minimum wage increases, the rates of increases across the wage structure become more-similar, until a 10% increase in minimum wage causes a 10% increase in mean average wage. Raise minimum wage too much beyond this and the wage distribution requires more money than there is spending—mathematically. That means wages squeeze closer together once again because the market cannot find the money to pay for the effects minimum wage has on other wages, and the market starts to fall apart.
Everything has its limits, after all. You can't just set minimum wage to $10,000 an hour and expect good things to happen; you can, so it seems, set it to $21/hr in mid-2020 and expect pretty much only good things to happen, certainly only good things after 14 quarters with the wage indexed to per-capita GDP (this has been measured).
So long as you don't do something egregious, a higher minimum wage simply redistributes, rather than reducing, demand for labor. Higher minimum wage increases competitiveness for productive businesses, rather than unproductive businesses: rather than "even the least-productive need work," many less-productive workers end up in more-productive jobs, while others simply have higher pay (yeah, we're not replacing retail shelf stockers any time soon on current technology, and they're not getting more productive; but their pay is a small part of the total wage bill anyway, so increasing it has effects on prices so small our monetary policy is TRYING to make greater inflation, and would simply back down a little to compensate).
This is all, of course, non-obvious, because the micro view that Firm A will replace labor with capital is both correct, natural, and naturally expanded to the incorrect conclusion that firms in aggregate will use less labor. Such reasoning begs the question of how and why people have any jobs at all.
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327 votesJohn Moser
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That's wage compression: Wages came closer together, and the productive method became more cost-effective.
But what about the workers? If Firm B needs only 1 hour to do the work of 5 hours, then isn't that 1 worker doing the work of 5, leaving 4 workers unemployed?
Well not so fast. The empirical evidence has shown this not to be true…but why?
Imagine if everybody on the whole planet were infinitely rich. This can only be true if all things appear with zero human labor, and so the government sets up all the things to make all the things, and everything is free. That's not actually possible.
So people always face scarcity: they want more than they have. They have limited means to achieve their ends, and have to face trade-offs. They can't have everything they want.
So you have 4 workers now no longer needed to make the table. Well, they still have two working hands, right? They would like jobs because they really, really don't want to be unemployed and destitute.
You also have people who don't have everything they want. They would like things, and somebody has to make those things, ship those things, sell those things. You have a market: a meeting of buyers and sellers.
But what if no buying and selling is happening?
Well, to buy and sell, you need money. Without money, you have a money shortage: people looking to buy, people looking to sell, no buying or selling because there is no money to trade.
Now, if everybody is working and there is no way to make more tables, then adding twice as much money so people can buy twice as many tables won't work. There won't be twice as many tables, and people willing to spend more can get two tables. People will be willing to spend more if it means they can get a table, so prices go up: you have inflation.
But what if you want to buy more tables and you have all these unemployed?
In that case, creating money—and thus spending—activates labor. These unemployed are used to make tables, as the demand for tables has increased, the table market is hot, and sellers want to cash in on that. Jobs are created, and sellers compete for business by keeping low prices, wage permitting.
At this point we see a number of things: the increase in minimum wage caused technical progress, i.e. a change in process to become more productive. More productive means less labor is used to do the same thing, and the additional labor can be used to do something else. Unemployment doesn't change, but the amount available to purchase for each person does.
And there's the rub: the dollars go further. Minimum wages got closer together, prices may have gone up a little, and yet the people whose wages increased more slowly than minimum wage are still able to buy more. That last bit happens for a lot of complex reasons, such as that low wages are a small part of the total wage bill—higher wages affect price much more—and of course, because wages closest to the minimum wage move the most, while wages farther up move the least. 10% of $5 is only 50 cents, which is only about 3.3% of $15, and about 1.7% of $30. So put it all together: $5 wages increase faster than $15 wages; and $15 wages increase faster than $30 wages; and a small increase in a $30 wage is equivalent to a much larger increase in minimum wage; AND this compression causes replacement of larger amounts of unproductive labor with smaller amounts of productive labor, so there is a ceiling on the cost increase somewhere for various products.
That's right: all real wages go up. Buying power goes up.
It's tied to the relationship between minimum wage and per-capita GDP, technically, but that's another matter that gets into optimal policy and indexation. Research on that is here: https://arxiv.org/abs/2010.14669
And that's what happens when you step back from the micro perspective of "Firm A replaces labor with capital" and consider the macro perspective of "we have available labor to be applied to more productive work, but Firm B can't cost-compete with low-productivity Firm A if minimum wage is too low." Carrying this out further gets into things like trade—if productivity growth from moving Firm A to Firm B is much less than the growth in producing another product, then we import whatever Firms A and B were making, and alter the composition of industries by producing more of the other, more-productive thing. That, however, is another topic.
An error occurred while saving the comment John Moser
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Yes, it is; it would also be good to cover how minimum wages interface with productivity, and the difference between the microeconomic and macroeconomic impacts of minimum wage.
In a microeconomic perspective, a minimum wage—in theoretical terms—reduces a firm's demand for labor. Notice the exact wording: "a firm's demand." That's an important distinction from the aggregate demand, i.e. the demand for labor in total across the economy.
To expand upon the microeconomic view—and I urge you to take this information in carefully, as studying microeconomics before macro is harmful to a student's understanding of either—one might consider two firms able to produce the same good, but using different processes. In Firm A, five hours of worker wage at $5/hr is used; in Firm B, one hour of worker wage in aggregate at $30/hr is used.
By "in aggregate," I mean that both these processes take in the same inputs, and both produce the same outputs; but in Firm B, they might use different tools, machines, and so forth. Human labor hours go into making those tools, maintaining them, fueling them, and operating them. Amortizing all those activities to get the average total wage paid for 1 hour of work, where 1 hour produces the same output as 5 hours by Firm A, gets you the aggregate hourly wage for 1 hour of aggregate work.
So that's a lot of words.
To simplify the model, just accept that Firm B uses a worker who's five times as productive. This wraps up all the above explanation and puts it into a black box which we understand logically, but no longer have to think about.
Well look closely: Firm A uses five hours, or $25 of labor, to produce what Firm B produces in one hour but at a cost of $30. Firm B will not be able to compete with the prices of Firm A, and so productivity will not grow, and the economy remains poorer than it would be if Firm B were more cost-effective.
We might ask questions like: what if Firm B became even more efficient and could produce in 1 hour the output of 7 labor-hours of work at Firm A? Then we could say well, without minimum wage, Firm A workers would lose their jobs unless they took a pay cut, and so wages will go down.
We can do even better.
What if there are two firms like Firm A, both unproductive?
Well supply and demand, that graph that shows the equilibrium point? It shows where quantity supplied equals quantity demanded. It also shows that below a certain wage price, some lower quantity is demanded.
That means workers are available at a lower price.
So imagine you buy tables. If the same table is available at $200, but also one for $175, which would you buy? The one for $175, of course. Now, will you buy two tables, spending $350 in total? No, of course not; or at least the vast majority of the market won't. In aggregate, the quantity demanded doesn't increase by as many tables as are sold at $175; instead, much of the purchase of $175 would have been $200 purchases, and there is a $25 consumer surplus—the consumer got the table for $25 less than they'd be willing to pay.
Well this is a problem.
The firm producing $175 tables hires 100 workers at $4/hr. The firm producing $200 tables loses customers, and experiences a reduction in sales equivalent to what is produced by 100 of their workers—who are paid $5/hr. Those $5/hr jobs go away.
This tightens the job market. Workers have trouble finding jobs because the demand for labor has fallen: the quantity demanded at $5 has decreased, as has the quantity demanded at $4. The workers, desperately in need of work, become more willing to take jobs at $4/hr, and the quantity supplied at $4/hr increases—supply increases, meaning wages decrease. Note that if the workers stubbornly refuse to take jobs below $5/hr, they will not find jobs, and they will remain unemployed, so unemployment will increase; but this is unlikely.
So without a wage floor, wages move downward and downward. Consumers have less money, and demand for products falls; but price also falls. There are a lot of reasons why prices don't fall as much, which have to do with wage compression.
So what is wage compression?
Consider again Firm A and Firm B. Firm A can produce a table for $25 using five worker hours at $5/hr; Firm B can produce a table for $30 using one hour of $30/hr labor. What if we raise the minimum wage to $5.50/hr?
Firm A can now produce a table for $27.5, but Firm B can't produce for less than $30. The wages at Firm A went up by 10%, but the wages at Firm B didn't.
At $6.50/hr minimum wage, however, Firm A has to pay $32.50 of wage to produce a table. Now Firm B can produce a table for $2.50 cheaper, right? Not so fast: the demand for more-productive workers increases because less-productive workers are expensive; and more-productive workers remain more cost-effective until an aggregate wage of $32.50. Wages at Firm A increased by a full 30%, but at Firm B they only increased by a maximum of 8.3%.
Intellectual property laws allow creators to obtain returns on their labor investment, thus creates not only an incentive, but a method to self-sustain.
Unfortunately, copyright terms are so long as to stifle creative pursuits and thus harm the economy.
A trademark is identity, and an indefinite trademark is wholly-appropriate: nobody can say their creation is YOUR creation.
A patent lasts about 20 years. The rapid pace of technological advancement creates an enormous incentive to license patented processes or to put your own into practice for a competitive advantage. A higher minimum wage would of course increase this incentive.
Copyright is death of the author plus 99 years.
With copyright, you need to be popular and interesting. Your book, your movie, your video game, who really wants to consume it? By and large, people aren't waiting years and years for your stuff to be suddenly free.
This creates an odd effect wherein you either make lots of money in the first year or three, or you make nothing and you're never going to. You might make more later, capitalizing on your long-term royalties and long-held interest; but that only really happens sustainably if your work had economic value (i.e. was popular) anyway.
Many would consider the release of copyrighted works in the public domain to carry high social value; but there's also an economic consideration: new works are built on old. King Kong, Cinderella, Snow White, built on old stories. Many bands started as cover bands. Old video games are constantly modified to create new works—illegally.
A 7 year copyright term, with one 7-year renewal, would be reasonably long. Your childhood, your identity, who you are, is defined by the media you consume. Think about yourself. Can you do so without the kinds of music you like, the movies you've watched, books you've read, games you played…before you were 20? These things shaped your social life and your identity.
So it's also a human rights issue: right to cultural heritage, a third-generation human right.
A 7-year term is significant: creative works are capitalized on much more rapidly than patented inventions. A 14-year term is generous. A person's childhood is free to them in their adulthood under such terms, and their creativity—which will be primarily built on the creative works they consumed—can run free with such copyright terms.
Multi-generation copyright terms restrict every generation from the source of their creativity, destroying the economic and social value produced by the arts.