Minimum Wage 101

Kevin Drum and Karl Smith are having a go-around about the effect of minimum wages on employment. There is the famous Card/Krueger study (and others) showing that increases in the minimum wage do not adversely affect employment rates, and a bunch of other studies plus basic economic reasoning suggesting that they do. Drum weights the former more heavily, Smith weights the latter more heavily, but they can both be right. The effect of a price floor of any kind depends on where the floor is set relative to the competitive equilibrium. In the graph above (originally used to depict a basic relationship between capital ratio regulations and bank behavior, but the same principle works here), a floor below the equilibrium has no effect on behavior. Think of this as a minimum wage below the market wage, or (perhaps) the Card/Krueger finding. In the graph below, the floor is above the market equilibrium, so behavior is altered.



The point is that the effect of a minimum wage change will depend on many factors besides the minimum wage itself. In a depressed labor market, with many potential low (or zero) marginal product workers, the demand curve for labor shifts left, the equilibrium price falls, and a minimum wage increase is more likely to retard employment rates than it would in a robust labor market where the demand curve shifts right and equilibrium price rises.

Many people argue that a relaxation of payroll taxes would help boost employment. If that is true, then a minimum wage increase would decrease employment, at least for workers at the margin where any of this is relevant. That may not be many workers (as Drum claims), but given the depressed labor market today it is probably a lot more than it would have been in 2005.

Also keep this in mind: if a minimum wage is successful it must set a floor above the competitive equilibrium, and therefore must reduce employment. Maybe that shows up in hours worked or price increases rather than crude employment rates but it has to be there somewhere. A wage floor below the equilibrium doesn't change anything, and is therefore unsuccessful.