Welcome to week 12 of The Power of Markets course. What we're going to do in the sessions this week is focus on some applications of input market theory, particularly on labor markets. Again, because labor markets account for more a significant share of the income generated net economy. And then we'll look at conditions for promoting efficiency, why a competitive market satisfy those conditions, what can go wrong, what are the potential reasons for government intervention? And last, we'll focus on a few of those potential reasons, namely public goods and externalities. The applications we'll cover of input markets will include who pays the burden of the social security tax in the United States, how the NCAA cartel acts as a monopsonistic cartel and the impact on players and universities more generally. The impact of immigration on both domestic workers and the owners of capital. And in this session what we'll turn to is the minimum wage, which has been much in the news, there now have been calls in Congress for moving the minimum wage for the current level of $7.25 an hour to as much as 10 or $15 an hour. The minimum wage got started in 1938 at $0.25 cents an hour, it's moved up in several different steps. In 2009 it moved to its current level of $7.25. Certain states like New York and California actually legislate even higher minimum wages than the current federal level of $7.25. We'll look at the effects of the minimum wage on employment and why the designated beneficiaries or the intended beneficiaries of the minimum wage, may actually not end up being helped by this policy, and may end up being hurt. Let's see why, and we'll start in steps. First let's look at the disemployment effect of the minimum wage. And we'll do so through figure 18.1. Let's say the existing wage in the low skill market is $5, and that the minimum wage is imposed at a level of $7.25. The law of demand applies to this market, like any market. Higher price leads to less consumption of the good in question, here it's low-skill labor. The equilibrium employment level gets reduced from L1 to L2, and that decline in employment is the disemployment effect of the minimum wage. Now, some other considerations regarding the minimum wage. Well, the focus is typically on employment levels. We can't neglect that it may be the level of employment as well. So the same number of workers could be employed, but each for a fewer number of hours. With the legislated minimum wage, employers also have an incentive to cut back on fringe benefits. And it's probably no wonder that medical care provisions, on the job training tend to be at minimal levels in the low skill market when minimum wages are employed. There are also issues of what portion of the unskilled labor market is covered by the minimum wage versus not covered. For example, tipped jobs aren't covered. Seasonal workers aren't covered. Workers in the charitable organizations aren't covered. In the agricultural sector, this migrant farm work isn't covered. So to the extent that the minimum wage leads individuals that can't get jobs in the covered sector to work in the uncovered sectors of the economy. That'll depress wages in the uncovered components. And then, a fourth consideration is the minimum wage also gives employers an ability to discriminate, because you get to pick at the higher wage which of the workers to keep. As we saw in figure 18.1, you reduce overall employment from L1 to L2. So employers have the ability to choose which of the L2 will end up retaining their jobs. To the extent that employers have discriminatory preferences against gender, race, ethnicity, those can enter the picture and their hiring decisions. It's likely too that workers prior to the minimum wage that were earning the least per hour are the most likely to get squeezed out of the labor market. For example, if you were earning $5 an hour versus $7 an hour, you're more likely to get squeezed out because the wage increase proportionally and total absolute magnitude will be larger than for an individual that was making $7 an hour. Now, does the minimum wage harm the poor? A number of economists believe that the minimum wage is a very blunt instrument if the intention is to harm individuals that are below the poverty line. Because the minimum wage ends up being applied to all workers that work in the low skill market. And of the workers that fall below the poverty line, which roughly is about $23,000 for a family of four currently in the United States, 60% plus are there because they don't have a job, so raising the minimum wage won't really impact them. And 80 plus percent of the individuals that earn a minimum wage are in families that are above the poverty line. A significant percentage, roughly 45% are in families that are 3 to 4 times the poverty line in their category. So it's a very blunt instrument if you're trying to target individuals that are below the poverty line. There was a recent study done by two economists for the Economic Policy Institute that actually has argued to looking at the increase in the minimum wage to $7.25, that of individuals below the poverty line, the increase actually ended up hurting them. And the way their analysis goes, and we'll look on that in Figure 18.2. Of the individuals that are below the poverty line, that are affected by the minimum wage, they only account for 13% of the beneficiaries. And these economists estimate that the increase in wage, let's say it's from W to W1 when we're looking at the analysis of the increase to $7.25 per hour for the minimum wage. That'll generate an overall benefit to workers of $18.3 billion of higher wages. Since people below the poverty line only account for 13% of the beneficiaries, that means there are of the $18.3 billion, only $2.3 billion goes to individuals below the poverty line. So, let us focus on them in particular in this figure 18.2. And let's also assume that the law of demand applies that there's a decrease in employment and so while the workers that retain the jobs get paid more. There are also individuals that lose jobs. Rectangular area FBL1L2. And this gain for people below the poverty line, with these two economists Burkhauser and Sabia for the Employment Policies Institute, estimated to be roughly $2.3 billion per year. If you assume a reduction of 5% and employment that's associated with the minimum wage rising at the time from $5.15 to $7.25, the elasticity of demand that they assumed was roughly 0.25. So fairly inelastic, but still greater than zero. And they estimate that the loss of jobs per year. Resulted in a $0.7 billion decrease to individuals below the poverty line. So when you net out those two areas, there is a benefit of $1.6 billion to individuals below the poverty line from the then increase in the minimum wage. But then what these two economists also point out is that as you earn more, your tax also increases, and any benefits that the government provides are diminished as you move further up the income scale. And when you take those factors into account, the net gain gets reduced to $0.8 billion. And then the final factor is as labor cost rise, those end up being translated into the higher costs of goods and services. If you assume as these economists do, that people below the poverty line consume 6% of the US economy's overall goods and services, that means that the net gain of $0.8 billion actually ends up being erased and reversed from the higher prices of goods and services that the poor pay. And the net loss factoring in all components amounts to $0.3 billion a year. So again, well intentioned policy but when you look carefully at where it's targeted, who ends up benefitting, and then the other impacts from lost jobs and higher costs of goods and services, you end up with an unintended consequence. Now certain economists have argued that the minimum wage is an example of an efficiency wage. And an efficiency wage this is a concept that was first tied to Henry Ford, who in the early 1900s doubled wages at his factory so as to lower turnover and to lower absenteeism. And what Ford Motor found was there was a fairly dramatic increase in productivity, on the order of 50% and the company became more profitable as a result. So individuals that are now advocating a higher minimum wage also argue it could be an example of an efficiency wage, lower turnover, lower absenteeism, increased productivity. In general though economists that have looked at this carefully have argued that you really don't need a government spur if there truly is an efficiency wage component. Firms have an incentive to pay those higher wages to capitalize on the greater productivity, and the greater profitability. So that should be motivation enough, and it's highly unlikely that in the low skill market that you could argue a minimum wage as an efficiency wage. And there are also ongoing arguments, it's a very hot bone of contention right now in economic circles. How large is the disemployment effect of the minimum wage? And to give you some sense of why there are some issues around this argument to economists, Larry Katz from Harvard University and Alan Krueger from Princeton, for example look into the 1990s how much of a disemployment effect when the minimum wage then went from $3.35 to $4.25 an hour. They took an unorthodox approach, they telephoned franchise food operators in the state of Texas and found that only 11% intended to decrease their employment of low skilled workers. As people have looked at the analysis, a key thing that has been going on is to what extent were other factors held constant? At the time Texas was doing relatively better than other states. Its unemployment rate was falling from 6.9% to 5.8%, so in a sense there was also an increase in demand for goods and services in that economy relative to the rest of the United States. Texas's proximity to Mexico and greater trade played a role in that more positive performance. Other economists from Texas A&M, Welch, Deere and Murphy, who have looked also carefully statistically, and tried to hold other things constant will argue that the disemployment effect was much larger than Katz and Krueger estimated. And on the order of a 12 to 18% decline in teenage male and teenage female unemployment rates on account of the minimum wage increase. Analyses of the more recent increase to $7.25 lead to similar controversies are really holding other things constant. And then to what extent are we just looking at employment levels versus hours worked, fringe benefits and the impact of the higher wage, and also discrimination. And to what extent, as we saw, do people that we hope to benefit from the policy, we end up making worse off?
