The advice that “everything should be made as simple as possible, but not simpler,” often attributed to Albert Einstein, should be heeded by economists.
Deciding just where to draw that line between simple and too simple isn’t easy. Two issues facing our nation, President Barack Obama’s proposed increase in the minimum wage (also being proposed on the state level in Minnesota) and changes in U.S. immigration law, are good examples.
Applying the basic economic theory that students learn in introductory microeconomics gives unambiguous answers to a key question: What is the economic impact?
The answers: Imposing a minimum wage above that which would prevail without government action will raise the unemployment rate; increased immigration will push wage rates lower than they would be without such immigration.
Are these conclusions too simple? This isn’t clear. In both cases, one can find economists who examined the issue in depth and then concluded that the predictions of very simple models are correct. One can find other economists who, after similar study, conclude that the results of simple models are misleading.
How can this be?
Let’s start with the minimum wage. Textbooks typically cite the minimum wage as an example of “the effects of a price floor or ceiling,” an application of supply-and-demand.
Supply and demand is a price-quantity relationship where the quantities of a thing that producers are willing to sell or consumers are willing to buy vary with different prices.
With regard to the minimum wage, the “thing” for sale is labor.
At a higher price, producers (workers) would like to sell more and buyers (employers) want to buy less.
So with a law that sets the minimum legal price higher than would otherwise prevail, the quantity wanted for purchase drops and the amount offered for sale increases. The result is a surplus.
When the item in question is labor, a surplus is called “unemployment.”
Is this the end of the story? No. Our intro textbooks present this analysis in Chapter 2; but the idea that “everything thing else be held constant” was introduced in Chapter 1.
Increasing a minimum wage unequivocally increases unemployment only if there are no other factors.
But labor markets are highly complex and the minimum wage level is only one factor among many that determine unemployment levels.
Labor is not a “homogeneous commodity” like construction steel or white bread. The U.S. has myriad labor markets, differentiated by geography, skill level and occupation.
Some employers are large enough to have “monopsonistic” power in hiring. There is imperfect information on both employer and employee sides of the equation.
Fiscal and monetary policies affect unemployment, as do “exogenous shocks” from new technologies like electric motors in the 1920s, or the Internet in the 1990s, or robots in present-day automobile factories. Foreign demand from Europe in the two decades after World War II or from Asia in the past 20 years played a role, as do imports from such regions, the relative price of which is dependent on the relative cost of labor.
With all these considerations, how does one separate the impact of a minimum-wage hike on unemployment from everything else? One historical case where an increase in the minimum wage was followed by an increase in unemployment does not negate another instance where the opposite occurred. As a Jewish adage says, “For instance is not a proof.”
Using statistical techniques that separate the relative importance of causal factors is what modern economic research is about. But it is far from an exact science. Economists David Card and Alan Krueger started a cottage industry of renewed minimum-wage research with a 1994 study of fast food employment in New Jersey and Pennsylvania and the effects of the state minimum wages. They found no decrease in employment from the higher minimum. Not surprisingly, Krueger is now the chairman of the President’s Council of Economic Advisors.
Other researchers soon countered this, and then there were counter-counter studies that led into a debate that is now in its 19th year.
For a summary of all this, enter “minimum wage,” “discernible effect” and “John Schmitt” into your favorite search engine.
I think most economists would agree that small increases in the minimum wage result in little, if any, increase in the unemployment rate, but the issue remains contentious. The freshman textbook model clearly is inadequate, but sophisticated research has not produced an answer that convinces nearly everyone.
The same is true for research into the effects of high levels of immigration on wage rates. The intro-level theory is unambiguous in its prediction. A shift in the supply of labor — that is, an increase in the number of people willing to work at each of a series of wage rates — all other things being equal, lowers wages. So all our wages would be higher if the millions of immigrants, both legal and illegal, now working in the U.S. had stayed home.
But sophisticated research, even by economists who start with the conviction that this must be the case, does not confirm this. And research that does support it, such as the work of George Borjas, himself an immigrant from Cuba, shows the effect is much smaller than commonly assumed.
Even more than for minimum-wage studies, work on immigration has to include the effects of a larger work force on the value of overall national output, national income and the rate at which these grow. Some studies find that while immigration may lower wages for those workers who directly compete with immigrants, whether roofers, fruit pickers or computer scientists, there is an offsetting indirect effect of faster growth of the economy and thus of per capita incomes.
Bare-bones economic theory does not always provide reliable answers to policy questions, and in these two cases, research doesn’t produce a consensus, either.