By:  Peter Coy
Source: The New York Times

A Minimum Wage Can Create Jobs

Hello! This is the first issue of my newsletter on economics and business for New York Times subscribers. I’ll be hitting your inbox each Monday, Wednesday and Friday.

I joined Times Opinion in July after nearly 32 years at BusinessWeek and Bloomberg Businessweek, most of that time covering economics. I’m a journalist, not an economist, so my approach to the topic will naturally be different from that of the indispensable Paul Krugman.

I admire economists, and I hope to convey my enthusiasm for what they do in this newsletter. Some of the economists I most enjoy reading and talking to are outside of the academic and financial establishments; I’ll make sure to include their voices. Nothing pleases me more than discovering a cool new idea and sharing it.

Here’s one I’ve been thinking about lately: In certain cases, raising the minimum wage can actually create jobs.

Economics textbooks once confidently asserted that a government-mandated wage floor would reduce employment because companies would fire low-productivity workers who were worth less to them than the new minimum. That seems like common sense, and of course it’s true at some level: A minimum wage of $100 an hour would be devastating to the economy.

But starting in the 1990s, economists who went out and gathered data about the labor market found a surprise: Within a reasonable range, higher minimum wages did not appear to destroy jobs.

The economics profession slowly came around to this idea. A survey of academic economists published in the May 1979 issue of the American Economic Review found that 90 percent agreed, generally or with provisions, that “A minimum wage increases unemployment among young and unskilled workers.” By 2015, a survey of leading economists found only 26 percent who said raising the minimum wage to $15 in five years would substantially lower employment.

Why doesn’t a wage floor kill that many jobs? One factor is monopsony. In contrast to a monopoly, in which there’s only one seller in a marketplace, in a monopsony there’s only one buyer — in this case, only one buyer of labor, as might be the case in a small town in the woods where everyone works for the local lumber mill.

A monopsonist maximizes its profits by paying workers less than the value they create. What’s less obvious, but crucial, is that it also employs fewer people than would be employed in a fully competitive labor market.

In a competitive labor market, companies pay whatever the going wage is, no matter how many people they hire. It’s different for a monopsonist. If it wants to hire more people, it has to pay them more. That gets expensive quickly, so it restricts employment.

Now imagine the government imposes a minimum wage. The monopsonist is unhappy because it has to pay people more. But here’s the twist: It no longer has an incentive to suppress employment, because the amount it pays per worker will be fixed at the minimum wage, no matter how many people it hires. Because of the wage floor, its labor cost curve is flat — just as in a competitive market.

If the minimum wage is chosen well, the employer will keep on hiring right up to the point where workers are fully paid for the value they create. So higher wages, more jobs. You can find a clever explanation of this at Khan Academy, with diagrams.

This is standard microeconomics, not some heterodox concoction. The question is how common the situation is. Few of us live in company towns. But while outright monopsony is rare, economists have found that many employers have some ability to suppress wages below their competitive level. A 2019 study of the U.S. by Ioana Marinescu of the University of Pennsylvania and three other authors concluded that 60 percent of U.S. labor markets accounting for 20 percent of workers are “highly concentrated.”

I recently interviewed Arindrajit Dube of the University of Massachusetts at Amherst, a leader of the new thinking about the economics of the minimum wage. He said there are three sources of employers’ wage-setting powers. One is concentration of jobs at one employer or just a handful of employers, as in the company town example. The second is “search friction” — the difficulty of switching jobs, which lets your current employer get away with paying you a little below market. The third is job differentiation: You might stick with a job because it suits you best, even if your employer is paying you below the market rate.

Dube — who himself earned the state minimum wage flipping burgers in Seattle at age 16 — says monopsony isn’t the whole story. The decline of unionization has given employers more power to set wages as they see fit, he says. And societal norms of fairness in pay “have broken down,” he argues.

The seasonally adjusted annual pace of construction starts on privately owned housing units in the U.S. in July, according to an estimate by Action Economics. That would be up from the previous three months but down from a 15-year-high annual pace of 1.73 million in March. The Census Bureau will announce the official number on Aug. 18.