Higher minimum wage – higher employment?

Over at Not Sneaky they are discussing how a higher minimum wage may lead to higher employment when we have a firm that has market power in the labour market (hat-tip CPW). The argument is a very interesting one as economists often view a minimum wage as a way of placing a price floor, which leads to a lower level of employment and social ‘surplus’.

On the blog he uses this fine graph to explain the result. The purple line illustrates the path of wages and employment. According to that, there is a range where higher wages create greater employment in the labour market. Let me attempt to explain this.

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Flexible working hours – Genius or madness


The flexible working hours bill aims to increase the degree of ‘flexibility‘ in the labour market for households with a child under the age of 5 or a disabled child under the age of 18. Now I’ve heard all sorts of complaints and complements about this bill, so I’ll try to talk about the way I see it.

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Income tax and tax incidence

There seems to be a significant debate between the left and right wing blogs about whether Bloomfield Hills is over-taxed or not. However, there is one thing that both sides agree on, if taxes are cut by $1,000, this gives people $1,000 more to spend. This is the point I’m going to discuss.

Households receive a net wage, which is their gross wage – income tax. The household requires a certain net wage before it will enter the labour market (say the benefit + the opportunity cost of leisure time), and may also require a premium to choose one firm before another firm (when labour supply is restricted).

Now the gross wage + non-labour costs (which we will assume are exogenous, even though they aren’t really 🙂 ) is the cost to the firm of hiring that employee. If taxes fall, the net wage the household receives would be higher. However, the relationship between employers and employees determines the gross wage. If the employer knows that taxes will fall, they can reduce their employees gross wage and leave their net wage the same (I know that firms often can’t do this because of labour laws and wage stickiness, however in a dynamic sense they could just reduce the rate at which they increase an employees wage). Ultimately, the division of the tax depends on the relative bargaining power of the different agents.

If there were ‘many’ firms and ‘many’ employees, the incidence of tax would depend on the relative elasticities of demand and supply for labour. Often labour demand is assumed to be relatively elastic while labour supply is highly inelastic. In this case most of the tax is borne by the employee and so a cut in taxes will mainly benefit them.

However, if we have a high rate of unemployment, labour supply will become relatively more elastic, which implies that some of the burden shifts onto employers.

If we have a monopoly firm and many (homogeneous) low-skilled employees (flat labour supply curve) the tax burden will be fully taken up by the firm. This is because the monopoly will only want to pay enough to get the employees to work, and so the net wage will be set at the reservation level. If you cut taxes you cut the gross wage required to get this net wage. Note: This result would not hold with asymmetric information (worker effort) or heterogeneous agents (as a higher net wage would then be required to intice more workers – labour supply would be upward sloping).

Ultimately, where the burden of income tax falls is a difficult issue, and depends on the specifics of the labour and goods markets. However, it is not clear cut that if my taxes are cut I would end up with that much extra money. As a result, we have to realise that a cut in income taxes will result in a reduction in firm costs as well as an increase in consumers spending power.

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Trust the professionals?

I was talking to a keen cyclist a few days ago who told me that he never fixes so much as a puncture on his gleaming pride and joy. “I’d rather leave it to a professional who knows what they’re doing than risk stuffing it up myself,” he told me. I was bemused at the time by his unwavering faith in ‘professionals’ to be able to do a better job than him. It’s not that I don’t think there are some great mechanics around, but there are likely to be far more who are not as wonderful as they think they are. Why is it that people believe that professionals are the best at what they do, even when they have no evidence and little means of evaluating performance?

Part of it might be a misunderstanding of comparative advantage. This sort of reasoning is commonly used to explain international trade, but is equally applicable to micro-level bargaining and job selection. Suppose a (rather unusual) lawyer is a better plumber than the guy he hires to fix the pipes. Yet, because it would be very costly to the lawyer to take a day off work to fix pipes he’s better off going to work and paying someone else to do his plumbing. The plumber doesn’t have an absolute advantage at plumbing but he does have a comparative advantage over the lawyer at plumbing. The opportunity cost to the plumber of working in his trade is far lower than it is for the lawyer. The lawyer has an absolute advantage over the plumber at both plumbing and legal work but has a comparative advantage in only the latter. Thus, it is not the case that a person doing a job is the best at it: they just have a comparative advantage at what they do.

Of course, once a person has chosen a profession they build up specific job skills that allow them to be more productive at that job than most others. So it may be that the heuristic of assuming a professional can do the job better than you is usually correct. At least, the cost of obtaining more precise information about their skills may be greater than the expected benefit of the extra information. In that case it would be best just to let professionals do their job and quit micro-managing stuff cos you think you know better.