James Schneider, the new guy at EconLog, has an interesting post on an unintended consequence:
Some take it as a matter of faith that increasing taxes will dull people’s desire to work. However, higher taxes can sometimes cause people to work more. When higher taxes reduce the after-tax wage, people are poorer for any given number of hours worked. When they become poorer, many people are more anxious to earn extra money. Economists call this the “income effect.” (Although in this context, I like to call it the “poverty effect.”)
Increasing tax rates is not the only way that the government can reduce wage rates. If the government punishes your employer for hiring you, your services will be less marketable, and your wage will fall. This phenomenon is important when countries enact bans on child labor. If a country is so poor that many parents send their children to work, then it is unlikely to have the wherewithal to perfectly enforce a ban on child labor. When the wages of children go down, the poor families that depended on child income will become even more desperate. This might cause parents to have their children work more.
A recent paper shows that this is exactly what happened when India enacted the Child Labor (Prohibition and Regulation) Act of 1986. The law banned children under 14 from working in many industries. After these rules took effect, the wages of children under 14 fell relative to those over 14.
Something about this doesn’t feel right to me. I’m worried that if free-market economists embrace this, we’re doing the mirror image of the economists who come up with ways to explain how the minimum wage might lead to more employment.
I mean think about it: We’re saying that initially, employers in India hired x million children. Then the government said, “We are going to start randomly fining you for doing that.” In the new equilibrium, employers hired more children.
(Yes yes, I understand the theoretical argument of how this can happen; wages fall so much that even when you factor in the risk of fines, employers end up hiring more child labor. But it just doesn’t feel right to me. For one thing, why does it “overshoot”? And notice that there is a lot of emphasis on the fact that the enforcement is lax. Well OK, if the enforcement is lax, then the demand shouldn’t fall as much, meaning wages shouldn’t fall as much, meaning the income effect on the supply of labor shouldn’t be as big a deal… See what I mean? The whole thing just seems really convenient, sort of like how the ACA just so happens to boost employment precisely when the economy needs it, but then reduces employment precisely when the economy needs it.)
The actual paper is here. They have a Figure 1 (page 11) that tries to illustrate their explanation in a Supply & Demand framework, but I can’t make sense of it. Also, if I’m understanding it, they’re showing a constant Demand curve for labor and expressing the y-axis in terms of wages net of fines.
That approach is totally non-intuitive (which isn’t to say counterintuitive) to me. I want to draw initial Supply and Demand curves, with wages being the actual wage paid (and received), and then when the government threatens fines, the demand curve shifts left.
Because of the Giffen good stuff going on, you have to have regions of the supply curve that are downward sloping. So my question: Can anybody draw me a Supply and Demand curve for child labor, where the leftward shift of demand leads to a lower wage and a higher quantity?