Micro, Macro, and the Minimum Wage

Meme showing man in office with coffee mug looking skeptical saying "Yeah, I'm going to have to go ahead and disagree with you there."Economists disagree. It’s so common that there are jokes about.  For example,

If all of the economists in the world were laid end-to-end they would scarcely reach a conclusion.

and

Economics is the only field in which two people can get a Nobel Prize for saying the opposite thing.

Why?  I can’t explain all of economists’ disagreements here (I don’t have enough pixels!), but I can explain some of the disagreement over questions of raising the minimum wage.  There are numerous calls for Congress to raise the minimum wage, yet Congress has remained bitterly divided on the issue. Their disagree to a large extend reflects the disagreement among economists. To non-economists, the disagreement seems to either indicate that there really isn’t any science in economics and it’s all opinion, or that some economists must be lying or deliberating obfuscating.  In truth, though, there’s another reason for the apparent disagreement: the difference between micro and macro level economic analyses.

First, let’s establish some historical perspective on the debate. I want to clarify the difference between “normative” and “positive”.  Positive arguments are statements or conclusions about what the predicted effects of a proposal will be without taking a stand on whether those effects are desirable or tolerable. (note that the word “positive” here denotes “factual or likely”, not “good”) Normative arguments are when someone argues whether a proposal should be done. Normative arguments typically are based upon a combination of predicted outcomes and a value judgement as to whether those outcomes are desirable or tolerable compared to the alternative.  For a long time in economics, economists were actually largely in agreement on the positive science, or the predicted effects, of a rise in the minimum wage.  It was generally agreed that raising the minimum wage would give larger incomes to those who continued to work at minimum wage (i.e. low skilled) jobs but that the rise would decrease the numbers of those jobs and thus raise unemployment rates among those seeking low-skilled jobs. Historically the disagreement over minimum wage hikes was over the normative aspects: was the rise in unemployment and loss of jobs worth the increased incomes to others.

The agreement over the predicted positive effects wasn’t always unanimous. There have always been some dissenters. But in the early 1990’s Card and Krueger studied a “natural experiment” by comparing fast food restaurants on two sides of a state line when one state raised the minimum wage and the other didn’t. Their results started a fierce debate that still rages over the predicted effects of rises in minimum wages.  On one side there are now many economists who side with Card & Krueger in saying that raising the minimum wage, even if raised very significantly such as to $15 per hour from less than $8, will not decrease employment and will have a very large increase incomes. On the other side, maintaining the older stance are those such as Don Boudreaux who doggedly argue that any rise in minimum wage must increase unemployment significantly.  Like most topics in economics the practicality of measuring and analyzing the empirical data is somewhat equivocal.  Although there have been numerous studies since Card and Krueger that have buttressed their results, the empirical data along always leaves enough room for some argument.  So what does the theory say?

Don Boudreaux and others of the “increases in minimum wage MUST increase unemployment” camp, would have use believe that theory is unequivocal. The essence of their argument is that low skilled labor is a commodity sold in a market. It has a demand (firms want to buy it) and a supply (low skill workers want to sell it and get paid).  The wage that gets paid is the price of this labor commodity. The most basic supply-and-demand analysis tells us that if the government forces the price up somewhat artificially by setting a price floor (i.e. a minimum wage) below which transactions cannot occur, then there will a smaller quantity of hours of labor demanded. In other words, firms will hire and pay fewer workers. There’s often an appeal to the concept that if the price (cost) of an input or resource goes up, then the firm’s profits will go down and the firm will be less inclined to produce that good or service and therefore will buy less (hire fewer workers).

How can good theory-toting economists dispute this?  Isn’t it supply-and-demand, the most basic micro economic concept as taught in the first few chapters of any principles of econ text?  It’s easy actually. The key is that this supply-and-demand theory as argued against a rise in minimum wage has three major flaws. Two flaws are the result of the theory as applied being too simple (there’s more chapters in the micro text!) and the other  flaw reflects the difference between micro and macro in economics.

The first flaw in the simple supply-and-demand model application to minimum wage type jobs is that there’s really very little evidence that labor markets behave like commodity markets or that they conform to the assumptions necessary to use a supply-and-demand model.  Most jobs, including minimum wage jobs, are more like long-lasting relationships. They aren’t commodity, transaction based like a market for selling widgets or apples or even theatre tickets.  There are dramatic transaction costs involved. Put another way, it’s expensive to hire people (and to fire them and then replace them). Minimum wage jobs aren’t homogenous (they aren’t all the same) the way the theory requires.  Further, the wage paid affects the productivity of the worker, which in turn affects the value of that worker’s output to the firm. When the wage is boosted, workers work harder, stay longer on the job, quit less often, and gradually acquire more productivity and skills. Firms often find that when forced to pay the higher wage, the firm’s total costs, including hiring costs, etc, stays level or even declines.  This is the essence of Arindajit Dube’s studies.

The second flaw is in focusing on the cost of the worker’s wages as if it were the sole consideration in the firm’s decision of how much to produce. The standard theory of the firm and production, which is covered in-depth just a few chapters later in the same economics textbooks after the supply-and-demand model makes it clear:  a firm will produce whatever quantity makes it the most profit. The primary constraints on the output are the demand for the end product, the pricing of the end product, and the core technology used. In other words, if the firm can still sell the output to consumers, it will produce it and the technology (means of production) will require it to hire the necessary labor. A rise in the price of a particular input does not necessarily mean a drop in the quantity produced.

The other two flaws in the arguments against minimum wage increases require shifting to a macro perspective. Micro economics is often described as studying individuals and individual products/markets.  That’s only partially true. Actually micro is a methodology. It’s more properly called “comparative statics using partial equilibrium analysis”.  Micro theories and models explicitly focus on only one particular shifting variable (the wage in this case) and it assumes that all other variables or influences are held constant or unchanged. (Economists call this the ceteris paribus assumption).  In contrast, macro theories are often described as focusing on large aggregate phenomena such gross national product or the inflation rate or the national unemployment rate.  But again, there’s actually a methodological difference. Macro theories require a general systems approach accounting for multiple effects and ripples of many variables that are interrelated.  Let’s look at minimum wage increases as an example of these differences in methodology between macro and micro.

In micro, there’s really only the price (i.e. the wage itself), the quantity of jobs offered, and the quantity of workers available, all of it in the low skill arena.  That’s it. So the micro analysis sees that when the minimum wage is boosted, the firm pays more per worker and each employed worker gets more. End of story.  The only micro question is how it all affects the quantities of jobs.

Macro, however, recognizes that nothing happens in isolation in the economy. There’s a circular flow. Workers are also simultaneously customers. So when the minimum wage goes up, yes, the workers get paid more and firm pays out more money. But what do those workers do with the additional money income? They buy things. Who do they buy them from? Firms that sell and produce products. So the firms not only pay out more money to workers, the firms also get to collect more money by selling more to the increased consumer demand.  But, you say, Acme’s newly enriched minimum wage workers don’t buy that much stuff from Acme. Doesn’t matter. The workers spend it somewhere. And that firm uses the additional money and additional demand to buy more inputs and pay more profits. And those firms and workers then experience income increases and so on and so on as the money circulates throughout the economy. Eventually even Acme sees an increase in sales and revenue collected which in turn helps pay for the wage boosts.  Macro looks at the whole system.

In recent years, many cities and some states have taken it on themselves to raise the minimum wage, often to a so-called “living wage”.  The empirical results have pretty clearly supported the macro analysis. Rises in minimum wages tend to not depress employment and actually tend to stimulate the local economy.  This is the macro analysis.

Sometimes economists just disagree and sometimes they let their ideological and political biases color their professional arguments. Some of that happens in the debates on minimum wage increases.  However, much of apparent disagreement arises from the choice of whether to view the issue through a micro lens or a macro lens.

To read more about the economic analysis of minimum wage increases see these earlier posts:

 

 

There’s No “Skills Shortage”

There are plenty of reasons why higher education in the US needs to change. There are plenty of good reasons why community colleges in particular deserve greater investment. But the American Association of Community Colleges (AACC) gets it wrong when they claim

There is a skills gap in our country, causing employers to have unfilled positions and too
many Americans unable to find family wage supporting jobs.

Wrong. Wrong. Wrong.  This is a zombie economic idea.  It’s enormously disappointing when leaders in higher education can’t even get the basic economic thinking straight.  First, let’s just apply some basic economic thinking to it.  Although there are good heterodox reasons for not thinking of the labor market is not an ordinary market (i.e. it’s institutional, not transaction-based), but let’s roll with the idea since so many purveyors of the “skills shortage” myth act like it is.  The implication is that there are multiple “job markets” and that many, perhaps, most are suffering a “shortage”.

So what’s a “job market”.  A simple definition would identify the nexus of potential workers and potential employers in a specific geographic region in a particular occupation.  For example, “welders in metro Chicago” or “CNC machine operators in SE Michigan” or “software developers in Houston” would be examples. Now if there’s a “shortage” in one of these job markets, it means there are fewer sellers (smaller quantity offered, to be technical) and more buyers demanding a larger quantity at the going market price.  Now what happens in both theory and practice when a market has a persistent shortage? Anybody? Yes, the price rises.  Price goes up to attract more sellers and discourage buyers.  And the price keeps going up until equilibrium between quantity offered for sale and quantity demanded become equal and eliminate the shortage. If there were shortages in job markets we should see wages going up!  We should see companies tripping over themselves to offer more and better benefits.  But we don’t see that do we? Wages are stagnant across the board.  That’s because there really isn’t any widespread “skills shortage”.

What we have is business owners and managers reporting a shortage of highly skilled workers who would be willing to work for below-equilibrium and falling wages.  Remember as a nation we’ve drastically cut back on public funding of education and over the last generation  companies have drastically cut their spending on training and apprenticeships.  Those businesses now expect a free-ride from others.  They want workers to pay for their own education and training without paying the wages needed to make that human capital investment worthwhile.  If there were truly a skills shortage, not only would we see rising wages but we’d also see rising college enrolments as the rising market wage encouraged students to invest.  But we don’t see either rising wages or rising enrolments.  In fact for the last couple (few?) years, enrolments have been declining.

I’m not the only one pointing out how bad this zombie “skills shortage” myth is.  Paul Krugman pointed out recently:

    …this new EPI report is a useful reminder of the extent to which another doctrine that sounds serious retains a grip on discourse — namely, the notion that we have big problems because our work force lacks essential skills.

This is very much a zombie doctrine — that is, a doctrine that should be dead by now, having been repeatedly refuted by evidence, but just keeps on shambling along. EPI presents some very interesting evidence from a survey of manufacturing, but they’re hardly the first to show that the data don’t at all support the skills-shortage hypothesis.

But it’s not just Paul Krugman and progressives saying that the “skills shortage” idea is bunk, its leading conservative economists too, like Ed Lazear in this 2012 paper.   Even the Boston Consulting Group, who we might expect to take push the “skills shortage” idea since business owners like to push the idea, seems constrained to follow the data and their data show that:

So what accounts for the high and lingering unemployment?  The Economic Policy Institute looked at the whole issue and surveyed the literature and research in this January EPI report.

There is a sizeable literature on whether a skills mismatch is a driver of today’s weak jobs recovery, and the strong consensus is that the weak labor market recovery is not due to skills mismatch (or any other structural factors). Instead, it is due to weakness in aggregate demand.

That’s it.  We have a shortage of aggregate demand. We have a shortage of customers who spend. We have a shortage of spending. We don’t have a shortage of skills.

Higher education leaders who position their plans based on the false premise of a skills shortage do themselves and their institutions a dis-service, so we may have a shortage of higher education leaders willing to do their own critical thinking and rely on research instead of parroting politically popular zombie ideas. I can understand the temptation of many higher education leaders to use push the idea because they think it will help them get funding. But that’s a losing strategy. By embracing such zombie ideas, they destroy their own credibility with the faculty, the very people they need to implement the changes they’re advocating.

Healthcare Comes to America – The ACA Is Working

Last night was the cutoff for signing up for health insurance on the new Affordable Care Act (“Obamacare”) healthcare exchanges.  Despite a very rocky start and despite an incredible blitz of lies and propaganda against it by opponents, the program has met its first year target. Charles Gaba at ACASignups tracks the numbers so we don’t have to:

…in spite of everything–the terrible website launch of HC.gov and some of the state sites; the still-terrible status of some of the state sites even now; the actively-hostile opposition and obstructive actions in certain states, the negative spin on every development by some in the news media–in spite of all of this, over 7 million people nationwide enrolled in private, ACA-compliant healthcare plans between 12:01am on 10/1/13 and 11:59pm on 3/31/14…slightly surpassing the original CBO projection for that period.

Of course, the deadline isn’t that final depending on where you live and whether you already started an application or you fall into other special categories.  Again, Gaba tells us:

the enrollment “extension period”, which is 15 days in most states, but which actually runs until April 30th in Oregon (without any “started by 3/31” requirement that I can see) and even all the way out until May 30th in Nevada (with the “3/31 start” requirement). Only 3 states (CT, RI and WA) aren’t offering any extension period at all, and I’m not entirely sure about Rhode Island as their press release was a bit confusing. I also have no idea know what the status of Hawaii’s exchange is.

Of course the 2nd open enrollment period kicks off again this November, but there’s also the other types of enrollments which haven’t ended, even for the current year.

  • Medicaid has no cut-off date; if you qualify, you can enroll at any time.
  • The SHOP exchanges (small business) don’t have a cut-off date. Most of them still aren’t functional (only about 70,000 people are covered by SHOP policies so far nationally), but some are, and they’re year-round.
  • If you’re one of the 5.2 million Native Americans living within the U.S., there’s no cut-off for you either.
  • Finally, for the rest of us, you can still enroll in an exchange-based QHP if you have a major life event such as getting divorced, giving birth, losing your job and so on.

This is a very good start for the country and for the economy.  My own preference, documented elsewhere, was and still is for a single-payer system similar to Canada’s.  But this is significant start.

Doctors Vote With Their Feet and Move to Canada

Opponents of universal healthcare tell a lot of tall tales.  In particular, one common tale we were told in the debates about whether the US could provide near-universal healthcare insurance coverage (the so-called Obamacare) was that “socialized” medicine doesn’t work. In fact, an oft-repeated tale is that the Canadian socialized insurance system is supposedly so awful that Canadians can’t get enough doctors and that doctors flee the Canadian system to go to the land of opportunity, the US.

Well, it’s more than a tall tale.  It’s a lie.  The Windsor Post points out how for the last ten years, the net flow of doctors has been from the US to Canada.  Yes, that’s right.  To the degree that doctors are migrating at all, they’re moving away from the bloated, inefficient, costly system that the US runs and moving to Canada.

“The job here is better,” is how Florida native Dr. Christopher Blue summarizes why he moved here in 2010 with his wife, Dr. Kristen Kupeyan (a Windsor native), after attending medical school in the Caribbean, and training in the United Kingdom and Michigan. Here, he works as a hospitalist, an emergency doctor and assists in surgeries at local hospitals, and has two practices with his wife. Having such a varied career is something he couldn’t do in the U.S. [bolding mine)]

But the lure of the Canadian system is more than the ability to have a more varied (and likely more meaningful) career, it’s also a matter of sheer economics.  Despite the US system ultimately costing Americans a multiple of what the Canadian system Canadians, and despite Canadians living longer and getting more out of their healthcare, for doctors, it’s dollars and cents.

 One of the big draws for him (Dr. Sajad Zalzala) was Canada’s system of universal health care. In the States, the health care system is like a class system, he said.

“If you have Blue Cross/Blue Shield (health insurance), you’re in great shape, you can go to what hospital you want, specialists, but that leaves everyone else not as fortunate,” he said.

…he has low overhead and fewer hassles. In the States, you need two or three staff just to fight with the insurance companies all day long, he said.

“It’s good. With the OHIP system you pretty much know how much you’re going to get paid as the patient leaves the room, as opposed to the States,” he said, explaining the insurance company may adjust your bill or reject it entirely.

The name for Canadians give to their healthcare system, Medicare, is a clue to how the US could dramatically improve its own healthcare system.  The US has a Medicare system also, and the two Medicares are actually quite similar in structure and operation.  The US Medicare system is also actually reasonably efficient, althought it could be more efficient if it, like its Canadian namesake had more power and authority to negotiate prices.  But the key difference is that the Canadian Medicare system covers all Canadians of any age.  The US Medicare system only covers Americans 65 years or older.  Much of the difference and savings comes from having a single payer insurance outfit.  Since the government system is the only insurer and covers everybody, it has no incentive to find administrative excuses to not pay or to exclude people.  Private insurance companies in the US do.  Thus the US spends 10-15% of every healthcare dollar paying for paper-pushers and phone-call-talkers that try to find reasons not to pay for services that have often already been performed.  That’s why US doctors need so many staff personnel to track the paper and fight the insurance companies and file claims.  The Canadian doctors don’t need that extra staff – staff that doesn’t add anything to the quality of care but adds a lot of cost.

Intergenerational Transfers, Social Security, and Medicare

The presentation I’m making to some open classes on campus this week and to a community group in early May.  Bottom-line: When media pundits and politicians tell us that the older generation is “screwing” the younger generation, they’re lying.  There sound economic theoretical and empirical reasons for intergenerational transfer programs and social compacts like Social Security and Medicare.  And, there’s not factual reasons to say “Social Security and Medicare are going bankrupt”.  Quite the contrary, these programs will be there in the future when the younger generation retires and even when my as-yet-unborn grandchildren retire.  The only real threat to Social Security and Medicare comes from an overly-privileged 1% of the wealth and income distribution that frankly doesn’t understand how the programs work.