Saturday, February 04, 2012

Lower wages can be a good thing


Menzie Chinn points out that recovery in manufacturing and exports has been stronger than recovery as a whole. As an explanation, he cites America's falling unit labor costs. Unit labor cost is just the amount of wages you need to pay workers to produce one unit of output. Because America's unit labor costs are falling, it is becoming more economical for businesses to produce more tradable goods here, and so they are doing so.

This is a useful reminder of a economic principle often overlooked by progressives: There is sometimes a tradeoff between wages and employment levels (which is another way of saying that labor supply curves slope up and labor demand curves slope down). If economic "frictions" or the actions of policymakers hold wages up when economic forces are trying to push wages down, unemployment will often result. 

In the case of trade, what this means is that keeping American wages high can cause unemployment to rise. Starting around 2000, a huge massive glut of Chinese labor was dumped on the world market when China joined the global trade system; this created a tremendous natural downward pressure on American wages. Wages in America have stagnated since 2000, but it's difficult for wages to actually fall. This wage rigidity probably shrunk the size of America's tradable sector. 

But eventually, increases in American productivity have caught up and overtaken stagnant American wages. Here is Chinn's graph:


If you believe Chinn's story, the slow growth of U.S. wages is behind the mini-resurgence in American manufacturing and exports. This is the reality of "competitiveness."

Is this a good thing or a bad thing? Well, if what you care about is higher wages for the people who have jobs, then no. But if what you care about is increasing the total number of people with jobs, then yes. If you believe that our social safety net is good enough to provide for the unemployed by taxing the employed (ha), and that the efficiency losses from artificially high wages are small, then maybe you don't care.

Another example of a tradeoff between wages and employment is in sticky-wage models of the business cycle. In these models - which include many New Keynesian models - wage frictions can increase unemployment by preventing nominal wages from falling in response to a negative demand shock. (Of course, in these models, the optimal solution is for government to use policy to cancel out the demand shock, thus preventing wages from falling while preserving employment levels.)

Lots of people don't like the idea that there is a tradeoff between wages and employment levels. They point to the long run, in which (hopefully) wages rise without causing long-term unemployment. But the short-term is different than the long term. In the case of sticky-wage models, the "short term" may only be a few years. But in the case of trade, China, and "factor price equalization," the "short term" may last until China's wages catch up to ours. That could take decades. 

I believe that the mindset of some progressives - maximize wages at all costs - needs a rethink. When I look at the evidence, I see that higher wages do only a little to increase the happiness of workers, but unemployment is devastating for the unlucky few (and terrifying even for those who manage to keep their jobs). In Germany, labor unions often negotiate wage cuts in order to preserve long-term employment levels. I think we should look at doing something similar. After all, Germany is no blue-collar dystopia.

It seems weird, but lower wages can be a good thing.

Update: Note that if exchange rates were flexible, "competitiveness" would take care of itself through. The fact that unit labor costs matter for trade balances means that exchange rates must be sticky. For those of you who read Japanese, Himaginary analyzes this in the context of the Japanese economy.

67 comments:

  1. Oh no, there's nothing weird about it being a good thing for the market to determine wages...it's just weird to hear you acknowledge it.

    If you get a chance you should read my post on the Dialectic of Unintended Consequences.

    Having lived, worked and studied (globalization) in China...I thought it would take a gazillion years for China's demand for labor to outpace its supply...so it was kind of amazing when Obama said during his state of the union address that it is becoming more expensive to do business in China.

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  2. Anonymous6:28 PM

    Noah's opening his mind to anti-progressive sentiments? Well, let's see. Hey Noah, should we get rid of the minimum wage? Or possibly lower it? Afterall, just like your post states, it adds to wage rigidity and creates unemployment.

    Furthermore, since China has one of the lowest minimum wages in the world, and we do not, what are your thoughts on it in general?

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  3. Chinese exchange rate manipulation, export subsidies and lax health, safety and environmental standards increased the pressure on the wages of American workers.

    The fact that China is seriously corrupt also biased Chinese manufacturers towards an export orientation. Exporters are less vulnerable to domestic corruption and fraud than are manufacturers supplying the domestic Chinese market. It is no accident that the largest private employer in China, Foxconn, is a foreign company doing contract manufacturing for export.

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  4. Wow, this post is clueless on so many levels. I have a (fairly irritated) response here.

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  5. There are some levels of complexity you left out. Like, whose wages? For assembly line workers making $50/hr, I can see some downside potential. For assembly line workers making a subsistence level wage - not so much.

    Plus all of what Absalon said, and none of what anon @ 6:28 said.

    The other thing about your post is that, taken to an extreme, isn't it the exact reasoning of Hayek's Great Vacation theory of unemployment during the Great Depression?

    JzB

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  6. The other thing about your post is that, taken to an extreme, isn't it the exact reasoning of Hayek's Great Vacation theory of unemployment during the Great Depression?

    Not taken to extreme, it's just the same argument. Noah is saying there is no such thing as involuntary employment, just an unwillingness of US workers to accept the market-clearing wage. Of course, he doesn't say anything specifically about what mechanism are supposed to be keeping wages artificially high, or why the demand for US labor fell so much between 2007 and 2009. Sure, American wages are higher than many of our trade partners, but that's been true for *all of US history*. As an explanation for why unemployment is so much higher now than five years ago, it's nonsensical.

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  7. Anonymous12:07 AM

    @Jazzbomba I believe I'm the only anon, so you really didn't have to note the time I posted. But anyways, how are those people who are forced into unemployment via minimum wage increases? How is surviving working for them? If your concern is subsistence wages, then why take jobs away from people who can't afford to be unemployed? Furthermore, have you even looked into the studies considering the other negative effects of minimum wage increases? Such as increased inflationary pressure? (you know, like an inflation tax that effectively steals MORE money from those who really can't survive with any less than they already have?) How about the studies showing that minimum wage increases lead to higher drop out rates? As to my statement of wage rigidities, what exactly do you take issue with? I would think most people would agree with that. If you want some evidence (I really don't know of any directly studying the effects of the minimum wage as far as wage rigidities is concerned, so I'm just going to wing it.) you can look at the fact that the minimum wage unfairly discriminates against Blacks and Hispanics, and how these are also the groups that face the largest unemployment losses in times of economic crises. If anything, that agrees with me. When a recession hits, and firms want to cut costs, they can decrease the wages of those at higher pay rates (whites), but must disproportionately lay off those near the minimum wage (considering they can't decrease their price to below the minimum wage). Is it really ME who is leaving out the complexities? I would recommend looking at mattski's link. Why can't we have that Krugman back? You know, the more reasonable one?

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  8. Yes, wages can be too high, but wages are not the only factor in price. Workers in higher wage countries generally produce better quality goods and can operate more complicated machinery. Japan can produce certain kinds of kitchen tchotchkes more cheaply than any other country because of good machinery and workers well educated to operate those machines.

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  9. andrew3:09 AM

    I think comparing voluntary wage cuts by German workers and those of American workers is kind of a bad comparison. For one thing, management-labor relations in Germany are totally different. Another thing (but related) is that labor unions are looked at a bit differently over there than over here - it seems that labor unions behave differently in Europe because they aren't paranoid about being crushed all the time.

    American workers' wage cuts were totally different - in order for American workers to accept the types of wage cuts that German workers did in order to preserve employment, they would need stronger unions and decent relations between the unions and managers. We know that as of now any hint of more unionization will be met with hysteria by the Glenn Becks

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  10. Noah is saying there is no such thing as involuntary employment, just an unwillingness of US workers to accept the market-clearing wage.

    No, I am not saying that.

    But that is what sticky-wage models say.

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  11. Oh, my.

    This post was just painful to read -- so much errant and confused nonsense.

    Menzie Chinn managed to get through the linked post without making these errors. What went wrong?

    When did you start thinking in terms of "natural pressure" and impersonal "economic forces" contending against "policymakers"? What makes a wage "artificially" high?

    If economic "frictions" or the actions of policymakers push wages down when economic forces are trying to push wages up, unemployment will often result. Like now. Or, during the Great Depression.

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  12. I believe that the mindset of some progressives - maximize wages at all costs - needs a rethink.

    I think what you're getting at is the need to stay flexible in our thinking, which is a valid and important point.

    On the other side though, falling wages leads to falling demand which is not a desirable feedback loop. So as a general statement I think a willingness to accept lower wages should tend to be associated with a willingness to accept higher taxes on the very rich.

    What (I believe) progressives ought to be fighting against is cultural/economic mitosis. Under some conditions a market economy will undergo extreme stratification. That's what we don't want, that's what we all (whether we know it or not) have an interest in avoiding.

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  13. Noah,
    Sticky-wage models do not say there is no such thing as involuntary employment. Maybe you're using a definition of your own here, but if so you should say what it is. The best-known definition is Keynes's:

    "Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment."

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  14. If the central bank is (say) targeting inflation, then Noah is right.

    Take a standard New Keynesian model with some degree of monopoly power (like monopolistic competition) in both output and labour markets. Assume that the central bank is targeting inflation.

    Suppose that inflation is on target, and output is at the natural rate, but there is an excess supply of labour, and unemployment. An exogenous lowering of nominal wages (or wage inflation) will put downward pressure on the price level (or rate of inflation) to which the central bank will respond by loosening monetary policy, increasing the demand for output, and increasing the demand for labour, and reducing unemployment, in order to offset that downward pressure on the price level (or inflation).

    It is even possible that real wages might rise as a result, depending on the parameters of the model.

    But an increase in the target rate of inflation will have no (long run) effect on unemployment.

    On the other hand, if the central bank is doing something stupid, like targeting real or nominal interest rates, and has a vertical (or even upward-sloping) AD curve, then wage cuts won't (generally) help. At best they reduce the unemployment of labour and increase the unemployment of some other factor of production.

    It all depends on monetary policy.

    And yes, "progressives" do need to start being intellectually honest about this. If wage cuts always help employment, why don't we just increase wages one hundred-fold?

    My old related post:
    http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/02/we-are-all-paid-too-much.html

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  15. Thought experiment: how many workers would a given business or industry hire if they could get them for free? Would they double their workforces? Hardly. A business is a machine made of people, and no machine needs extra parts. Perhaps a 10% increase would be reasonable, hardly more.

    Further, for many types of work it would be harder, not easier, to fill jobs if the pay for all comparable jobs (or for local jobs in the aggregate) fell below a certain level -- say, to zero.

    The only way business can escape paying a living wage is if the workers are getting some or all of their sustenance elsewhere.

    This is assumed and accepted to be the case for many minimum wage jobs -- the kids are subsidized by their parents (a net subsidy to low wage businesses.)

    In other cases, the subsidy is less direct, like groundwater seeping in.

    Examples: Currently, in my city, about a third of food bank clients are working, many or most in dual wage-earner families. Compassionate people are underwriting low wages.

    Utility companies and landlords can end up subsidizing businesses, when their underpaid workers can't pay their bills.

    Victims of some sorts of crimes can underwrite businesses when underpaid workers end up embezzling, stealing, not keeping up automobile liability insurance, etc.

    And of course the health system pays up front for uninsured health care, which in underpaid workers can often not be repaid.

    Now, all these groundwater subsidies are a small part of the worker's sustenance - can we guess 15% or so?

    What happens if salaries drop further, say to zero? For some jobs, amazingly, this won't effect if they are filled. People like doing things, there are lots of volunteers doing work they believe in o enjoy for the cost of coffee and donuts. Police, nursing, child care, farming, clergy -- lots of varieties of work are done for the passion of it.

    But other jobs would dry up and blow away. Who, really, is going to clean office buildings till midnight for nothing? or scrape a grill for 8 hours, flipping burgers?

    It is evident to me that the secret of keeping wages low (i.e. the minimum recompense for effort delivered) is to make sure they are not too low, and that the groundwater subsidies don't become too large, streamlined or efficient, but are still present.

    Noni

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  16. Cursed typo: penultimate line should read:

    If wage cuts always hurt employment, why don't we just increase wages one hundred-fold?

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  17. What IS the "real compensation per hour" shown in Chinn's graph? There's a big difference between an average wage and a median wage. Over the past few decades, haven't median wages lagged productivity? I mean, the real median wage now is about where it was in the early 70s, and surely productivity has gone up--so what is that graph all about?! If it shows average compensation, then it ignores the way compensation is distributed and I think we can safely ignore your whole post as a bunch of hot air. I often learn from your posts, so please let me know why I should not ignore this one.

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  18. "labor supply curves slope up and labor demand curves slope down"

    But even if households are still massively indebted? Gross consumer and mortgage debt still exceeds total disposable income in the economy. Krugman's claim is that, given this, the labor demand curve is upward sloping. What are your thoughts?

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  19. David Pearson10:16 AM

    Its hard to argue with the "competitiveness" thesis; however, it leaves a lot out. Middle-income households borrowed to smooth consumption as a response to a "temporary" stagnation in real wages. At the end of this period, we have a financial crisis that tightens financial conditions and forces household delevering. At this point, the MM/Keynesian prescription is: "depress real wages at a steeper rate over a few years." The question they seem to ignore is, "are household future real wage expectations robust or fragile?" Further: "what would be the effect of a real wage shock on the rate of household delevering?" How about: "would the distribution of household living costs and income gains from inflation be even, or would the costs accrue to levered households and the gains to (low consumption propensity) high net worth households?"

    If one assumes success, all the above questions go away: robust real growth cures all ills. However, it typically pays not to the assume success of a policy when arguing for the success of a policy.

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  20. Anonymous10:51 AM

    There is only one way to restore our growth rate and improvement in our standard of living and that is by becoming more efficient. We must make more goods, either for our own consumption or for export. Failure to do so will move our dollar lower and that will reduce our standard of living further. We need more flexibility in wages and benefits as a part of becoming more efficient, especially for industries that are being hurt by foreign competition. We have structural unemployment and it is very much evident in youth unemployment. The minimum wage tends to hurt our youth and minorities. At the very least, the minimum wage should not apply to those under 18 and also the handicapped. The handicapped tend to get laid off when minimum wages rise because they are lack productivity--they are not competitive enough. Our youth need job training as teenagers to prepare them for the real world. Unemployment for 16 to 24 year olds is at record levels.

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  21. Anonymous10:56 AM

    Just how many generations of banana republic/3rd world wages would you recommend American working people endure at the very same time that economic inequality has never been greater?

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  22. Nick Rowe-

    If wage cuts always hurt employment, why don't we just increase wages one hundred-fold?

    I'm astounded and deeply disappointed that a smart guy like you would throw out such a ridiculous straw man.

    Seriously.

    anon @ 12:07 -

    I believe this is the first time I've ever been criticized for excess specificity.

    Noni has given my answer, and better than I could have. I'll just add that you have to believe that paying a worker $7.50 instead of, frex, $6.50 is enough to skew the hiring decision to "no."

    Sometimes, maybe. It depends on what the labor input is relative to total cost, and what the productivity is. (Hint - a better paid worker tends to be more productive.)

    I once read that paying lettuce pickers $30.00 per hour would raise the price of a head of lettuce about 10 cents. Just an anecdote at this point, but worth pondering.

    And to eric's point, productivity growth has averaged 2.24 percent annually since WW II. (BLS data series PRS85006092.)

    Plus there is this study showing how minimum wage increases have been compatible with falling unemployment in the UK.

    http://econ.economicshelp.org/2008/04/why-has-higher-minimum-wage-increased.html

    When there are conflicting studies, as is always the case in economics, positions come down to ideology.

    JzB

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  23. "a huge massive glut of Chinese labor was dumped on the world market when China joined the global trade system"

    Which is why the full-employment wage equilibrium is falling. And will continue to fall for as far as the eye can see.

    So, yes, lower wages are a good thing. But only if you care more about China than the American people.

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  24. "So, yes, lower wages are a good thing. But only if you care more about China than the American people."

    Which is exactly why people who haven't lived outside the US shouldn't be allowed to vote. Or conversely...which is exactly why even children should be allowed to vote.

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  25. Why are we building up a communist state that financially represses its own people?

    For profit and because we are fools. That's why.

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  26. Jazzbumpa: OK, if I'm attacking a straw man, can you tell me when (under what conditions, or what magnitude) wage cuts or increases would help or hurt employment?

    Because I did answer that question.

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  27. But an increase in the target rate of inflation will have no (long run) effect on unemployment

    If an increase in targeted inflation erodes the burden of private debt over time why can't that boost demand and thus employment?

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  28. A lot of the comments, including this rant, have focused on my comment on sticky wage models. I'll leave that discussion to Nick Rowe, Jazzbumpa, etc. And I'll just say that I don't necessarily believe that sticky wages are the reason for recessions.

    Because this post is really more about trade and factor price equalization. You dump a kabillion Chinese workers on the global markets, and you're going to get downward pressure on wages (and upward pressure on the return to capital). I don't like it, but don't blame me, blame Mao, who kept those workers capital-poor and isolated from global markets in the first place. My point is that frictions that prevent wages from falling will tend to preserve wage levels but hurt employment levels.

    This can be true even if labor markets don't clear.

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  29. Anonymous1:00 PM

    There is a political dimension (actually many!) to this that some wish to ignore: Low wages, especially over an extended period, keep labor politically weak. And when excessive inequality and low wages keep labor very weak, those with substantial resources use those resources in an effort to make permanent their social and economic power. The conceit is that eventually everyone will benefit and that labor will gain strength as the number of available workers shrinks. Don't hold your breath.

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  30. Low wages, especially over an extended period, keep labor politically weak.

    Ah, but low and lower are not the same thing!

    Look at Germany. Wages are high. But when foreign competition threatens German industry, Germany's strong unions voluntarily negotiate - even insist on! - temporarily lower wages, and Germany's industrial clusters of small manufacturers are preserved, along with high unionized manufacturing employment.

    And in the long run, despite having the same macro problems as everyone else (and the same or worse responses to those macro problems!), Germany has high blue-collar wages, low inequality, strong labor unions, and strong social safety nets.

    I think we should just think about that example, and consider whether something like it would work for us.

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  31. You dump a kabillion Chinese workers on the global markets, and you're going to get downward pressure on wages

    The argument that the integration of China into the world trading system has contributed to the long--term stagnation in US wages is worthy of serious debate. The argument that it explains short-term variation in US employment -- the argument you actually made -- is not.

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  32. "factor price equalization"?

    Really? Now, you are making my head hurt again.

    Nick Rowe tried to rescue your macro, but you are going to refuse that life preserver and go jump into the quicksand of "factor price equalization" applied to wages, globally? All "natural" and inevitable -- blame Mao, you say. Jeebus.

    Factor price equalization would predict that the highest, relative price in the economy -- the wages of top corporate executives -- would become cheaper. Funny how your theory doesn't work out. Shocking, in fact.

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  33. Noah - your argument boils down to the postulation that if everyone took a 10 percent pay-cut then those savings could be used to employ the currently unemployed people so there is full employment. There is so much wrong with that scenario I don't know where to begin. What I think I am saying (and I am not an economist) is that the Labor Demand curve does not "slope down" and that thinking of the issue in those terms is just plain wrong.

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  34. Anonymous3:30 PM

    @Jazzbumpa I read Noni's post just once, but from a superficial glance it's hard to think he was directly contradicting my post. If anything, he said that a lot of people won't work for zero dollars an hour, and he seemed to mention the fact that laborers have their own power to raise their wages. No argument there, perfectly reasonable.

    Now, onto yours.

    "I believe this is the first time I've ever been criticized for excess specificity."

    I didn't blame you for excess specificity, but lack thereof.

    'I'll just add that you have to believe that paying a worker $7.50 instead of, frex, $6.50 is enough to skew the hiring decision to "no."'

    In nearly every study I've seen that looks at labor intensive jobs that have pay-rates that oscillate near the minimum wage there have been negative effects on employment after an increase. Some are not always statistically significant, but all are negative. But this is also something I like to call the stair step fallacy. Sure, a one dollar increase might have modest effects on employment, but how about a large jump, say, from $0.00 to $7.25?

    "Sometimes, maybe. It depends on what the labor input is relative to total cost, and what the productivity is. (Hint - a better paid worker tends to be more productive.)"

    Agreed.

    "I once read that paying lettuce pickers $30.00 per hour would raise the price of a head of lettuce about 10 cents. Just an anecdote at this point, but worth pondering."

    As much as I think anecdotal evidence is completely and utterly useless, I'd like to see where you got that. Anyways, this is what happens when you limit your scope on the effects of minimum wage. If you were to, say, ignore the employment effects, then yes, you might see a modest increase in price. But that's the problem, you're limiting your scope, and that doesn't even bring up the other effects I mentioned. Besides, I would be inclined to think that a market such as lettuce would be extremely skewed. It 1) seems perfectly competitive, and therefore unlikely to accept price increases, 2) probably subsidized, 3) filled with many works illegally working under the minimum wage, therefore skewing the actual employment effects. (although you obviously didn't cover employment effects, this is the hypothetical situation in which a study would be done.)

    "Plus there is this study showing how minimum wage increases have been compatible with falling unemployment in the UK."

    Is that right? Well, here's fifteen combined years of research on the effects of minimum wage increases and employment by two of the leading economists in the area:
    http://ftp.iza.org/dp2570.pdf

    Nearly all of them are negative, and a large majority of them are statistically significant. To say "When there are conflicting studies, as is always the case in economics, positions come down to ideology." You are being completely disingenuous. It sort of reminds me of religious people saying there isn't an overwhelming amount of evidence against the existence of God. Or perhaps Republicans claiming that there isn't an overwhelming amount of evidence that Climate Change is man-made. More of this whole "teach the controversy" nonsense. I wouldn't say there is actually a controversy in this regard, and even if there was, it wouldn't be "minimum wage increases employment", but rather "minimum wage might have modest effects on employment, without taking into considering the other effects."

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  35. In nearly every study I've seen that looks at labor intensive jobs that have pay-rates that oscillate near the minimum wage there have been negative effects on employment after an increase. Some are not always statistically significant, but all are negative.

    Bullshit.

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  36. Anonymous3:38 PM

    I'm the Anon who just posted, and I want to say that this new Noah (You know, the one who just linked to a bunch of sources who don't agree with his political ideology, and made a post with very anti-progressive sentiments) is pretty reasonable. I'm liking it.

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  37. I'm not sure you're aware of this but, lower unit labor costs can coincide with higher wages. In fact, in some cases they likely do. Watch high unemployment continue, and i think you'll also watch unit labor costs grow even more.

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  38. Anonymous3:56 PM

    @JW Mason First, I'll be pedantic and argue I said "nearly" every study, because I've certainly heard of a couple that have contradictory conclusions. However, these aren't exactly among them, considering half of these studies show no statistically significant changes, as opposed to the "positive" effects Jazzbumpa claimed.

    It also appears some of those are studies that measure outside effects that are irrelevant to minimum wage and employment, such as "The Hidden Public Costs of Low-Wage Jobs in California", "Do Businesses Flee Citywide Minimum Wages", and "Do Frictions Matter in the Labor Market? Accessions, Separations and Minimum Wage Effects" looks at labor flows and concedes a negative effect on employment in the short run, but perhaps not a permanent one.

    But anyways, I'll look through them. Thanks for the link!

    P.S. Why am I not surprised this came from Berkeley? ;)

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  39. Anonymous4:24 PM

    Noah, wages have already been stagnant and, worse, lower. For some time. So, lower still more - that is, even lower for a more extended period - is low. We are already at lower. The political realities remain.

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  40. If you have capital in your home then are you shooting unemployed people in the foot by not using that capital to start a business that can employ them?

    Here's the context of that question...Rachel Maddow vs Rand Paul

    "I don't like it, but don't blame me, blame Mao, who kept those workers capital-poor and isolated from global markets in the first place." - In case you didn't get a chance to read my blog entry...that's pretty much exactly the same thing I said...Dialectic of Unintended Consequences.

    How many people does it take to answer the question of what the private sector should produce? Every single one of us. But every single one of us Americans...or every single person in the world?

    When Obama says that we need to bring manufacturing jobs back to the US...how many of you wonder how he could possibly know that this is the best answer? It's one thing if he's sharing an idea with us...or encouraging us...but it's another thing if he's going to mortgage our country to try and make it happen.

    That's the very definition of a "fatal conceit". It's the same condition that Mao suffered from. It's when you think that your idea is so good that you're willing to gamble on your neighbors' homes...without their consent.

    If you think that the US should do something then feel free to gamble on your idea with your own home. In other words...it's noble, admirable and courageous to put your own money where your mouth is...because chances are really good that your idea is total crap. That's why it was a good thing you didn't gamble on your neighbors' homes. And that's why we shouldn't allow our government to mortgage our country in order to try and pick the winners and losers.

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  41. Darryl6:26 PM

    Question: What do you mean when you say "we... should consider whether something like (the German model) would work for us"? Specifically, who is "we," what is "something like it," and what would it mean for it to "work for us"?

    If by "we" and "something like it," you mean unions making wage concessions to preserve jobs, I'd just remind you that unions in the U.S. do that all the time. I'm a union guy. I've actually done it. If an employer can show a set unit labor cost they need to compete at point of sale, unions will negotiate. We're not idiots. An out-of-business employer pays zero wages. We can do spreadsheets like everybody else. The myth of the intransigent union driving companies into the ground is exactly that: a myth. Strikes are the only real measure of any supposed intransigence, and in the U.S. they have become virtually non-existent.

    But I think you know this. Just as I think that by "would work for us" you don't simply mean a situation in which unit labor costs fall so as to make the U.S. more competitive internationally, since, as Menzie Chinn's data shows, that is already happening. What I think you mean by "would work for us" is a situation in which nominal cash wages adjust more flexibly across the economy, in response to specific competitive pressures, without becoming socially destabilizing and destructive.

    When I imagine "something like Germany," I imagine socializing the primary costs of health care and retirement, rather than burdening the individual firm or worker. At the benefits level, the world competes with Germany Inc., not any single enterprise or worker. Headline wages are therefore a smaller part of real social income, and a modest relative wage decline is not an existential threat. Germany may have greater nominal wage flexibility, not despite its comprehensive social safety net, but precisely because of it.

    But wage flexibility is only a stopgap (however necessary) to higher productivity. Nobody wage-cuts themselves to a bigger GDP. For that you need capital investment. The tradeoff to any temporary wage cut is visible capital investment by the employer, together with a commitment to send a share of productivity growth back to the workforce. (And here come those strong German unions, backed by strong federal labor law and nation- and sector-wide agreements.) That is always the deal we are trying to get in the U.S., but all too often the whole thing blows up when legacy costs (back to socialized benefits) or other debt forces the company into bankruptcy, which allows them to tear up their bargaining agreements. (Another U.S. anti-union myth: "They forced into bankruptcy." Employers L-O-O-O-VE bankruptcy as a labor-cost-management strategy. Unions hate and dread it.)

    So, yes, by all means let's have a German model. Let's have nationally subsidized benefits that follow the worker, not the job. Let's have binding commitments to share future productivity growth, not one state's labor force trying to underbid another. Let's have wage concessions where you might bet next year's new car on the company, but not your kid's education or your wife's cancer treatment. (Yes, that free education through the university does take the edge off those family cashflow worries, doesn't it?)

    So... just a few items to add in the social contract category before we can be like Germany in a way that truly "works for us." Meantime, who's standing in the way? Hint: It sure ain't the unions, or misguided progressives. To borrow from Peter Dorman, "It's the (broader) political economy, stupid."

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  42. Anonymous10:54 PM

    Your reasoning is built upon a false premise. You assert that wages have been stagnant since 2000. In fact, for the majority of poor and middle class Americans, wages have been stagnant since the 1980s. All that follows this false premise is therefore suspect due to willful bias.

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  43. Anonymous2:18 AM

    It's ironic that Smith, a self-proclaimed Keynesian, did not consider this as extremely important: employers don't employ people because it is cheap, they employ them because there is a demand that justifies additional staff. If there is no demand, there is no need for further hirings, however cheap.

    In other words, if I were a manufacturer, I would not hire people, however cheap, to produce ice-cream in the Arctic: not many consumers.

    However, I assume Smith is considering this in the context of accelerating the US recovery. In this context, there is another consideration.

    Let's assume that a fall in wages were nevertheless accompanied by additional hiring. As wages fall, so does effective demand at the household level. The increase in aggregate employment should be large enough to offset this effect. In other words, it's a matter of elasticity. I might be mistaken, but I didn't see Smith considering this: reduce wages by 10% and increase employment by 5% and you are worse off.

    (It's related to the paradox of thrift Keynesians usually hold so dear.)

    Magpie

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  44. "You dump a kabillion Chinese workers on the global markets, and you're going to get downward pressure on wages (and upward pressure on the return to capital). I don't like it,"

    So... why is this not an argument against free trade with countries with poor labor protections? And I'm curious if the minimum wage opponents on this blog would go so far as to say allowing laborers to be treated as poorly as they are at Foxconn is the economically efficient thing to do and perfectly fair if workers knowingly agree to it...

    The question isn't whether the demand curve for labor slopes up or down, the question is whether the concept of a demand curve is even a useful way to think about this issue, as what workers are paid affects how much of others' labor is demanded. This idea of cutting wages to get out of our problem fails for me for all the same reasons as the idea some in the Austrian camp have that we can deflate our way out of the problem. Lower wages mean we are further from digging our way out of our debt hole.

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  45. a few questions:

    if workers pay is cut in half, how are you going to raise adequate revenue to service the debt?

    if workers pay is cut in half, what will housing prices fall to if interest rates ever rise? what will happen to the banks & other holders of the related MBS?

    if workers pay is cut in half, how will households ever repair their overextended balance sheets?

    if workers pay is cut in half, how will anyone afford sending their children to college? all you profs will be out of a job...

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  46. If break down the data you will find that the improvement in manufacturing unit labor cost stemmed exclusively from higher productivity.

    Nominal manufacturing compensation has not fallen a single quarter as far back as the data goes --1987.

    So maybe you should reconsider your thesis about lower wages since it never happened.

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  47. If break down the data you will find that the improvement in manufacturing unit labor cost stemmed exclusively from higher productivity.

    Nominal manufacturing compensation has not fallen a single quarter as far back as the data goes --1987.

    So maybe you should reconsider your thesis about lower wages since it never happened.

    Moreover, unit labor cost is a nominal number, not a real number.

    Real compensation is an important measure of what is happening to standards of living, bu it is not a relevant measure for competitiveness.
    Rather to make a judgement of US manufacturing competitiveness against another country you should compare nominal unit labor cost in the two countries.

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  48. Leaving aside the issue that you can make any low-wage economic system work if you have enough guns; and leaving aside the fact that the horizontal world supply price curve is significantly lower than in the US (and the UK where I am writing from)largely as a consequence of aformentioned guns,is it not true that wages as a share of national income in the USA have been falling continually since the 1970s, and most precipitously over the last 10 or 15 years. Corporate profits meanwhile are at an all time high as a proportion of national income.
    If high prices are responsible for the ongoing uncompetitiveness of US industry, surely wages are only a small (and declining) element of that problem.

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  49. Anonymous6:10 PM

    Is the worker in the picture looking up to thank God for how much less taxes he is going to be paying as a result of his reduced salary?

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  50. So if you're advocating that wages be cut to the bone across the board, who's going to be buying your goods, exactly?

    And why did an entire piece on price levels get through Noah's keyboard without even the slightest reference to exchange rates?

    Progressives aren't "overlooking" anything. We just content that concentrating wealth in a tiny minority of lucky financiers isn't going to help the economy. Since your wages argument is really a distribution argument, that's what you're now advocating. And, honestly, it's pretty bizarre, considering what you've written in the past.

    (Not to mention how you normally pay such close attention to Paul Krugman, who's knocked this down more than a few times.)

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  51. Oh, and as spenser pointed out, the productivity of American manufacturing has been growing by leaps and bounds. Since productivity is fundamentally a multiplier of the effectiveness of workers at a particular firm, you'd expect that wages would be going up, not down, all else being equal.

    Of course, all else ain't equal. Which means that trying to deduct from micro—which isn't something that I'd expected you to be doing—is a bit misguided in this case.

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  52. Sheesh, folks, when did he say wages should be "cut in half" or "cut to the bone?" The proposition seems to be to be a much more moderate one: that wage increases are, cointerintuitively, not always the most desirable thing, and there are even circumstances when some wage cut could potentially be beneficial. Taking the argument to its extreme (and beyond its logical extreme)isn't constructive.

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  53. @rosebriar: i used "cut in half" merely as a rhetorical technique to illustrate the related macro issues, which wont be solved until the population is both employed & earning enough to contribute to areas i mentioned...

    you cant look at workers wages in isolation without looking at their impact on the entire economy...

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  54. rjs - And that is a good point. I don't claim to know much about economics, just about argumentation! I do think, though, that when you say "cut wages in half," that's going farther than the proposition for which this post stands, and would imply a much more dramatic effect on the economy than just not increasing wages all the time. Of course it makes sense that the effect of not raising wages shouldn't be considered in a vacuum either.

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  55. I don't know Noah. Even if that's technically right there enough conservative economists out there making the point.

    What I never hear is that low wages aren't always a good thing.

    Then too, don't higher wages mean higher demand? That's what Ford believed interestingly.

    You see what you get though when you make common cause with Righties? Now they want you to eliminate the minumum wage.

    Think how high employment would be if we could pay workers $1 an hour!

    Also there are people out there who make some interesting counter intuitive claims like Sadnwichman-if you haven't read him I reccomend him highly

    http://ecologicalheadstand.blogspot.com/

    Who claims that somehow we can get lower hours and higher pay. I'm not entirely sure about how this works either-although it is true that during the New Deal we got the minimum wage and the maximum work week which together increased pay and unemployment.

    My point is not that you are necessarily wrong but that so much license is taken with this point that I for one treat almost any claim of this quite cautiously.

    If we tomorrow creat 2 million new jobs that all pay $4 an hour you can't convince me this is taking us on the right track

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  56. Of course, Noah, if you in any way are claiming that there is no involuntary employment you've lost me on that one.

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  57. Of course, Noah, if you in any way are claiming that there is no involuntary employment

    WHAAAAAAAAAAAAAAAAAAT

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  58. Well gee Noah was it that confusing? I was giving you the benefit of the doubt-if you believe there's no voluntary unempoloyment-as some comments seemed to think that you do believe that like a Freshwater econoist.

    Certianly SlackWire seems to believe you don't think there's any such thing as voluntary unemployment. MY point is if you believe that then you have lost me totally in this argument.

    Howevecr you do also say this in fairness,

    "Of course, in these models, the optimal solution is for government to use policy to cancel out the demand shock, thus preventing wages from falling while preserving employment levels"

    Now if you agree with "these models" then I'm with you. Of course maybe such a model is guilty of being "Old Keynesian"

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  59. In other words I said if you believe it-leaving room for the possiblity that it's not your view that nobody is ever involunatrily employed.

    I wouldn't want to assume you believe such a thing though if you answer this I'll know for sure hopefully.

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  60. Ok, sorry, I see a comment where you say you're not saying that though sticky wage models say that.

    I'm not sure that's true either. Didn't Keynes say wages are sticky but that there is voluntary unemployment?

    I don't know that even New Keynsian models say that. I agree I'm not an expert on NK but I don't think that's it's view.

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  61. @Mike Sax:

    OK, first of all, there is no reason why involuntary and voluntary "unemployment" cannot coexist.

    Second of all, wages may be subject to coordination failures, rendering the idea of "voluntary" a bit meaningless.

    Third of all (and this is a nitpicky minor point), if the government set a minimum wage of $1000/hr., would the resulting unemployment be "voluntary" or "involuntary"?

    Anyway, JW Mason's rant doesn't really address my points. Not that I am upset, of course.

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  62. Well as long as you aren't saying there is no involuntary unemployment at all you haven't totally lost me.

    What are "coordination failures" in this context?

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  63. Well, let's look at this low wage thing from my experience. When the housing bubble started to deflate in 2006 our wages we frozen across the board, 200 workers. After the 'Oh God, we're all gonna die' moment in 2008, we slashed payrolls, people, hours and took a 10% pay cut that was to last 90 days. 3 years later, we are still living with cut pay, reduced hours and staff performing multiple position's duties. I went from money in the bank to living paycheck to paycheck. I never shopped at Walmart, now it is hard not to. Lower wages can only be good for those who skim off the low wage workers. Certainly not good for the workers or their communities. Yeah, yeah, could be worse, we could have lost our jobs, but due to the voodoo that is used to assign value to jobs, many of us see no recovery, while other professions are roaring ahead.

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  64. JW Mason's rant doesn't really address my points

    I'm going to write a substantive, non-ranty response soon.

    Altho, you really aren't doing yourself any favors by suggesting that the question of whether an arbitrarily high minimum wage would affect employment in the abstract, has any bearing on whether at the margin, today, lower wages would raise or lower employment.

    I think we can agree that if you pick *any* price and propose setting it by fiat at some multiple orders of magnitude away from its current level, that might cause problems. Does that prove that all prices are currently at their optimal level? Uh no.

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  65. @JW:

    I think we can agree that if you pick *any* price and propose setting it by fiat at some multiple orders of magnitude away from its current level, that might cause problems. Does that prove that all prices are currently at their optimal level? Uh no.

    Of course. I was merely using that example to illustrate that the terms "voluntary" and "involuntary" unemployment don't always make a lot of intuitive sense.

    As for your rant, it seems entirely directed at my aside about sticky-wage models. You apparently think that because I mentioned those models, I believe in neoclassical economics, labor market clearing, econ 101, etc. etc. I mean, do you really think I think that? Have you actually read this blog, like, ever?

    Assume labor markets are really really crappy. Which I believe they are, btw. So then if some external shock buffets our economy, it's better to keep our workers in their current jobs than to fire them and make them find new jobs. Right?

    So I'm saying, that shock is China. Dump 700,000,000 workers and essentially 0 capital onto global markets, and factor price equalization will put downward pressure on U.S. wages. Furthermore it will put differential amounts of downward pressure on different U.S. industries (more on tradables and manufacturing).

    SO, if we have long-term nominal wage rigidities (which I think we do!), those rigidities will tend to cause unemployment to rise in response to the China shock. This would be on top of the cyclical employment caused by a recession. Remember that even in 2007 there were a lot of unemployed and underemployed Americans.

    Also, if we respond to the China shock by firing a bunch of manufacturing workers and having them get jobs in retail, that will involve a lot of those labor market inefficiencies (especially when people move from skilled to unskilled jobs; think about the hysteresis!). So if, instead, we could make manufacturing wages very flexible, possibly by having German-style unions, we could keep manufacturing workers in their skilled jobs at lower wages, rather than forcing them to become low-wage unskilled retail workers.

    That is my point. Maybe it is wrong. But it is not an Econ 101 point. It is not a neoclassical economics point.

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  66. As you may know, the factor price equalization theory is very popular among Japanese neo-liberal economists as an explanation for ongoing deflation in Japan. But that explanation always puzzles me because it seems to ignore exchange rate. As Krugman once noted, it's the exchange rate, not the relative price level, that usually takes care of that kind of adjustment. Why exchange rate doesn't play its customary role this time?
    I think you should also address this problem in US, if you want to use the factor price equalization theory as an explanation for lower wage.
    (FYI, here is one of my blogpost on this matter (sorry, in Japanese).)

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