Workplace reform: unions lie about minimum wages and unemployment
Gerard Jackson
Union apologists are still citing Card and Krueger’s study, falsely claiming that it found that raising the minimum wage actually raised the demand for labour. Ignoring for the moment the important fact that the study has been discredited, it needs to be pointed out that what Card and Krueger really argued is that under certain circumstances an increase in the minimum wage will not reduce employment and might even increase it.
They were only half right. There is a situation where increases in the minimum will not add to unemployment. Economics carefully explains why raising the price of a good reduces the demand for its services. So how can the minimum wage be the exception? It cannot. What is missing from this argument is the adjective effective.
So long as the minimum wage does not exceed the market rate it will not cause unemployment. Let us take as an example the fast food sector. Now assume that politicians, ever eager to do good and get re-elected, raise the minimum wage in this sector without any apparent effect on the demand for labour. It now appears that economic theory has been refuted, or at least an exception discovered.
To encourage this idea along come a couple of economists who survey the sector to try and determine the employment effects of the minimum wage increase. To the delight of our politicians they find that employment actually increased, leaving market economists who warned that the increase would kill jobs with egg on their faces.
Our two economists’ discovery immediately leads other do-gooding politicians and union activists to demand even more increases in the minimum wage, even though our avant-garde economists issue a warning that the alleged positive effect of minimum wages only holds for small increases in the wage rate beyond which unemployment will emerge.
The first thing to remember about economics is that nothing is constant. This is something critics of minimum wages tend to overlook, perhaps because of the undue influence of static analysis.
As labour, along with every other factor, tends to receive the full value of its marginal product in a free market raising its cost above its market clearing rate will cause unemployment. But value productivity is always changing. In a booming economy where the demand for labour is rising, a minimum wage that would have destroyed jobs even a couple of years ago might now be totally ineffective, giving the impression that minimum wages are harmless.
In this situation even a significant increase in the minimum wage might have no effect on the demand for labour. However, it could give the unfortunate impression, supported by an impressive array of statistical research, that raising the minimum wage will actually increase employment.
Some argue that monopsony requires minimum wage laws if labour is to receive the full value of its product. But the notion that labour markets are dominated by monopsony is so patently absurd that the subject is rarely raised.
In fact, the monopsony argument is usually confined to a one-factory town situation. Even here I find the concept strained and highly artificial. But it does have the theoretical advantage of showing that if such a situation existed attempts to equalise wage rates with marginal revenue would fail because the increase in marginal costs would exceed the wage rate. Any standard economics textbook should provide a diagrammatic explanation.
Of course, if you subscribe to the absurd view that there can simultaneously exist “more than one equilibrium wage” rate if we sum up “individual supply curves” (Debunking Economics by Steve Keen) you will happily cause mass unemployment.
Some comments on monopsony:
I admit to being somewhat amused when a union operator like Grant Belchamber, the ACTU’s chief research officer, attacks marginal productivity theory while still arguing that wage rates are indeterminate. This is a contradictory line to take because indeterminacy means the demand curve must be vertical. In mathematical terms it is undefined, i.e., it has no slope.
It is very important that this fact is borne in mind because the monopsony approach argues that because the supply curve for labour is slopes upwards marginal labour costs exceed wage rates and therefore unnecessarily restrict the demand for labour.
This is supposed to happen because the monopsonist is not facing a demand curve where the quantity of labour demanded is determined by the wage rate. But the underlying assumption here is that labour has no alternative line of employment, hence the absence of a demand curve. This is nonsense.
Demand for labour is a downward sloping curve consisting of descending values of its marginal product. These are, in fact, its opportunity costs. In a free market labour services, like all factors of production, are determined by total entrepreneurial demand which gives us labour’s general demand curve.
Moreover, it is contradictory to attack marginal productivity theory while employing the marginal cost concept. This is what I meant when I said that “The economic case against monopsony rests on marginal productivity theory” (Liberal Government labour market reform: unions attack economics).
Now if indeterminacy was the general case so-called collective bargaining would still not be necessary. Because the demand curve for labour would contain an indeterminate zone it would pay firms to bid up the price of labour services until they reached the maximum point of zone, beyond which the demand for labour would become price sensitive: what economists call elastic.
Therefore in a free labour market wage rates are determined by firms competing for labour while the capital-labour ratio determines the height of real wages.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 24 October 2005