15 Mar 2013

Responding to a Particular Argument on the Minimum Wage

Economics 39 Comments

Before my trip, someone on Facebook asked me to respond to his perspective on the minimum wage. He thought the free-marketeers, by rushing to their textbooks, were overlooking something important. I’ll try to distill his position down into a single paragraph (in my words), then respond:

CRITIC OF STANDARD FREE-MARKET DISCOURSE ON MINIMUM WAGE: I’m not saying I’m in favor of the government setting a minimum wage, but I think you guys are overlooking a crucial point. All of the food stamps, public education, and other forms of welfare represent an implicit subsidy to businesses. By giving workers the ability to survive on lower wages, the government increases the bargaining power of the employers. They can get away with paying a wage that is literally below subsistence level. So when we rail against the unfairness of violating the sanctity of business profits, let’s not forget this implicit subsidy.

I told this guy that my only objection to the above, was that the economics were totally wrong. Generally speaking, the reality is the opposite of what he says. Welfare payments make wages higher than they would otherwise be. They make the workers have a stronger bargaining position, not weaker.

As usual in these issues, exaggerate the numbers to see it clearly. Suppose the government gave out vouchers entitling people to steak dinners every night and a room with a king sized bed at a posh hotel. Would you see a lot of people working at menial jobs? Probably not. If you could have a decent standard of living by doing nothing, then on the margin you’re less willing to give up your leisure for a little bit of money picking tomatoes.

Suppose there’s no minimum wage law, so employers can charge whatever the market will bear, but we still have food stamps etc. in place. Think about whatever the new equilibrium will be, in terms of people working. Now, in this setting, all of a sudden the government takes away all of the food stamps etc. I submit that this would make workers willing to work for less than they did before. If they hold out now, they will literally starve to death; they need to work or else they’ll die. But before, with food stamps, they could refuse to work and still manage to survive.

One final attempt: You’ve got two guys who get laid off from a factory in Detroit. They both had identical jobs paying $40,000, and would like to get a comparable job. But there’s nothing like that available, so they have to settle for jobs they think are beneath them, like becoming a janitor or working at Wendy’s. The only difference is, one guy has $20,000 in savings in the bank, while the other guy has $200 in savings. Which guy is going to buckle first, and take the menial job? Which guy is going to hold out longer, looking for a job more similar to what he’s used to?

It’s the same logic with government support programs. They allow poor people to survive without earning labor income. It’s as if they are endowed with a bank account and savings, that they can draw down while unemployed. It gives them bargaining power against employers, meaning that they need to be offered a higher wage to make it worth their while to take a job. They can afford to walk away, since the government is providing them with food.

THE PROBLEM: I think what was throwing off my critic was that he is viewing the labor market as being determined by bare subsistence levels. In other words, businesses pay workers the very least amount necessary, to keep them from starving. If that were how labor markets worked, then yes, food stamps etc. would lead to lower wage rates. But that’s not how labor markets work. If it were, then we’d all be earning the minimum wage right now, yet we’re not. Even though it’s imperfect, and even though libertarian economists sometimes exaggerate the beneficence of real-world capitalists, it’s still true that there is enough competition in the labor market so that most of us earn well above the minimum wage. And that insight shows why raising the minimum wage will throw unskilled people out of work, which is hardly a good way of helping them or of taking their side against Big Business.

39 Responses to “Responding to a Particular Argument on the Minimum Wage”

  1. Hermonta Godwin says:

    I think your critic is correct but perhaps incomplete. The situation is in fact a subsidy to business. The reason that you don’t see this is that you are looking only at production without looking at the same time at demand. It is true without the government welfare the employer could in fact pay less money to the worker because the income floor has been eliminated. However that same employee will have less money to spend/have spent on his behalf by government. So the effective aggregate demand decreases and that will be felt in the employer’s profits. With food stamps etc., the aggregate demand stays approximately constant with the employer being able to spend fewer dollars on wages.

    • Matt M says:

      If aggregate demand worked the way you claim, every business would pay its employees as much as it possibly could, because this would stimulate the aggregate demand, thus making them more profitable.

      Under these circumstances, a minimum wage would be completely unnecessary and redundant. If simply getting cash into the hands of poor people made businesses more profitable, they would be dumping it from the helicopters themselves. Bernanke and Krugman would be made obsolete.

      • Hermonta Godwin says:

        At no point did I imply that by simply dropping dollars from heaven, then everything solves itself. I also simplified aggregate demand by leaving out the issues of debt and credit.

        For an individual, their demand is what they buy for themselves, either directly from earned income and/or credit and what is bought on their behalf (government welfare, friends etc.). Aggregate demand is what you have when you look at everyone together. Now if you start subtracting out various parts of that demand, one must either increase other parts or face a decrease in demand.

        Now if you want to look at the whole and say that the demand in aggregate demand does not decrease even though a certain segment of the population’s effective demand decreases, then you need to make the argument that the demand elsewhere is making up the slack. Good luck with that.

        • Jake says:

          The money that would have gone into the higher wage doesn’t just disappear. It stays in the pocket of the employer, who either spends it on something else or saves it. Savings get deposited in banks, which make loans to people who need money to spend.

          Seems to me the effect on AD is essentially zero.

          • Tel says:

            Or the business sells the same products at lower prices.

            • Hermonta Godwin says:

              Such a solution only makes sense assuming no debt and demand for all goods and services being elastic.

          • Hermonta Godwin says:

            Such assumes that basically all the money saved is in fact loaned out (or at least at the same rate it was being spent by the worker who was receiving it as income or having it spent on their behalf.)

            Also banks should not be loaning money without considering the loanee’s ability to pay it back. If a person needs a loan to buy food or pay rent, then is not a good loan risk.

            • Tel says:

              The money goes somewhere it either:

              [1] gets saved, and hence goes into loans elsewhere, eventually being spent on investment; or

              [2] gets spent and hence goes into other products and consumption; or

              [3] goes into making the business more competitive by dropping prices and capturing a larger market share.

              Where else would you suggest it could possibly go?

            • guest says:

              Also banks should not be loaning money without considering the loanee’s ability to pay it back.

              But if they don’t lend it to those who are credit risks, they get called racists:

              Recent Efforts to Overload the American System

              This strengthening of the CRA’s loan mandates, coupled with the authority that ACORN and other community organizations were given to intervene at yearly bank reviews, placed the activist groups in a position of great influence. Banks, eager to receive good reports from these groups (in order to avoid having their merger plans blocked or their lending practices challenged by the Justice Department), funneled immense sums of money to them. But the proliferation of risky loans to underqualified borrowers eventually caused Fannie Mae and Freddie Mac to suffer financial collapse in 2008. Many U.S. banks likewise folded.

              Also, it doesn’t help that government regulations actually INCREASE the cost of living:

              Defending the Undefendable (Chapter 20: The Slumlord) by Walter Block

              Guess Who Openly Admits That Gov’t Intervention Increases Prices? Joe Biden

    • Dan says:

      Huh? Can you explain where you think Dr. Murphy’s reasoning went wrong?

    • Anonymous says:


      You do realize that the welfare that the government gave to the employee was taken from a consumer elsewhere, right? Aggregate demand (theoretically) remains unchanged for the business’ product and profits are unaffected.

      • successfulbuild says:

        No it doesn’t. If the government spends money into the economy and a poor person uses that to shop at a business and they respond by expanding their business, then the economy expands and more is produced.

        Your logic is essentially saying that 5 is > 4.

        • successfulbuild says:

          That second paragraph should be 5 is < 4. Austrians believe that when the government spends, there businesses actually have less money with which to produce. This is essentially saying more is somehow less.

        • Richie says:

          If the government spends money into the economy …

          From where did the government get the money? The tooth fairy?

          • guest says:


            And the businesses that are able to “respond by expanding their business” due to government stimulus are only able to do so because they now have political connections, which would be attacked as crony capitalism under other circumstances.

        • Tel says:

          The economy consists of real people doing real work. The only way it can expand is for people to do more work, which either means working longer hours, or finding jobs for unemployed people, or using technology to boost productivity.

          Welfare up to a point is good, not because it expands the economy, but because it protects people from accidental effects that are beyond their personal control (like a market crash, or rapid restructuring). However, welfare also discourages people from taking up work, so it makes it difficult for the economy to expand.

          Shopkeepers seeing higher demand could offer to hire more people, or they could just raise prices. Which choice they make depends on the relative cost of hiring people, as compared to how quickly the demand falls off at higher prices.

          • guest says:

            Welfare up to a point is good, not because it expands the economy, but because it protects people from accidental effects that are beyond their personal control (like a market crash, or rapid restructuring).

            Market crashes are due to government interventions. Welfare, since it takes from the productive, reduces the incentive to produce, thereby reducing wealth.

            Welfare is also theft, so there’s that.

          • successfulbuild says:

            The creation of new goods is also an “expansion” (which is not merely just “boosting productivity”), the goods may not even used to be produced productivity.

            Like I said, if the government spends money and it only leads to the invention of new goods or creation of more of the same goods, it’s an expansion.

            What actually happens in societies that do not expand the money supply is that they operate on a lower point of the ppf curve, i.e., they get stuck producing the same consumer goods over and over again, without any capital investment. This is how it works in third world countries.

            • Major_Freedom says:

              “What actually happens in societies that do not expand the money supply is that they operate on a lower point of the ppf curve, i.e., they get stuck producing the same consumer goods over and over again, without any capital investment. This is how it works in third world countries.”

              What a ridiculously uninformed comment.

              The same money supply can facilitate growing production as costs fall before revenues on the physical basis of capital accumulation, and on the mental basis of technological progress. Prices can gradually fall while more and more complex, sophisticated, and advanced goods are produced.

              Third world countries aren’t stagnating because they aren’t expanding their money supplies. Not are most third world countries MORE expansionary than first world countries, which in fact hampers production, but the main reasons for why they are stagnating go beyond money supply growths.

              • successfulbuild says:

                The same money supply cannot facilitate it if velocity is constant and there are no enhancements in productivity.

                This is simply a mathematical fact.

                By Major_Freedom’s stupid logic, 1 dollar would be enough to run an entire economy.

              • Major_Freedom says:

                The same money supply cannot facilitate it if velocity is constant and there are no enhancements in productivity.

                If there are no enhancements in technology, then the money supply is obviously not the reason for why the economy is not progressing.

                You’re changing contexts.

                This is simply a mathematical fact.

                By Major_Freedom’s stupid logic, 1 dollar would be enough to run an entire economy.

                Mathematically, yes, an economy CAN run on just one dollar. Prices would be extremely low, and there would probably arise new names for 0.001, 0.0001, 0.00001, 0.000001 dollars, and so on.

                You can just imagine the economy right now being run on one dollar, which is the current money supply in dollars, and all the transactions taking place, are the portions of the single dollar that is the entire money supply.

                Mathematically, one can divide the number one by any sized real number, and the result would be a positive real number.

                You don’t even know basic mathematics.

              • Joseph Fetz says:

                MF, I think that he is confusing divisibility with quantity. You’re correct that an economy could easily run on $1, because that one dollar can be almost infinitely divisible to facilitate greater and greater numbers of transactions. His confusion comes in that he is essentially taking this idea (without realizing it), turning it on its head, and then concluding that expansion of the quantity of money is the same thing (it’s not).

                The thing that he entirely ignores is the fact that money is not at all required for an increase in production (e.g. the Crusoe Model).

              • successfulbuild says:

                You guys are idiots.

                What you’re saying is just a different type of expansion.

                If I have a pizza and I use it as a currency by cutting it into slices, more slices will be more currency. Theoretically I could cut it into infinitely many slices.

                By your logic, you could theoretically think of the Federal Reserves expansion of the money supply as slicing up an incredibly large pile of money. It’s meaningless.

                Theoretically, both could extend to infinity.

                However, on a pure gold standard you could not do that because a dollar HAS to equal that much in gold

                What I said was if you have an equation essentially in the form x = y, and y increase by some multiple, x increase by the same amount.

                It is you guys who are logically illiterate.

            • Richie says:

              Like I said, if the government spends money and it only leads to the invention of new goods or creation of more of the same goods, it’s an expansion.

              Like I asked, from where does the government get the money to spend? Santa Claus?

              • successfulbuild says:

                The government can either create money or “borrow” money, or private banks can expand the money supply. This facilitates the expansion and is the ONLY way to facilitate it if you’re simply adding people/new goods.

                Austrians foolishly believe I must produce FIRST, and THEN get the money (the money must be “paid” for in some way), ignoring the essential role of “credit’ in the economy.

                It is has now been proven in the anthropological sciences that credit was vital, it was essential, to the flourishing of early human communities. (So for example if I want to produce something I either get credit from someone – take their goods for free – or go to a pre-designated area where goods are available for me to use, and take them to produce something — I do NOT have to purchase the goods first.)

                This isn’t even MMT it’s just macro 101.

                For example, Japan is expanding their money supply to facilitate their new resources and their production of more resources.

                However, they are so efficient, that they are again struggling with deflation, even though they are increasing the money supply.

                So we see yet another area where Austrian economics is wrong in addition to their false belief money must be “paid for”: expanding the money supply does not lead to deflation

              • Richie says:

                Hmmm, oooookkkkkk.

              • Richie says:

                The government can either create money or “borrow” money, or private banks can expand the money supply.

                So, in other words, the tooth fairy AND Santa Claus is where the govt. gets the money. Gotchya.

            • Tel says:

              What actually happens in societies that do not expand the money supply is that they operate on a lower point of the ppf curve, i.e., they get stuck producing the same consumer goods over and over again, without any capital investment.

              So the 17th, 18th and 19th Centuries in Europe were using gold and silver as their money supply (thus unable to expand) thus by your theory they must have been stuck doing the same stuff over and over with no investment.

              The mere historical fact that this was probably the most expansionary time in all of human history would be irrelevant I suppose. Most of our present day science and technology came out of this gold and silver based economy, including the discoveries of Newton, Gauss, the rise of the great Krupp steel, the building of railroads, the invention of the Bessemer process, the design of the internal combustion engine, chemistry, electricity, radio, … I could go on for some pages.

              All done without needing an expanding monetary supply. How do you explain this? Just stuff in books right? Nothing important obviously…

              • successfulbuild says:

                The `16th and 17th centuries were not the most expansionary times in modern history. That is rather ridiculous.


                As you can see, total output was flat in the 16th and 17th centuries, and as you yourself noted, more labor + more resources is also an “expansion.” In fact, 10 years in the twentieth century was more expansionary than the entire 16th century. So what you’re saying is just false.

                Second, the 19th century was not a pure gold standard but largely consisted of credit and paper notes. The gold standard was sufficient at the time because, as you can see, there wasn’t much output.

                Third, you could expand the money supply at that time because not all of the gold had been discovered. As more gold is discovered you can expand the money supply, and that’s what people did.

                In fact, more gold was discovered during 1400-1800 (Your time frame) than prior to it. so you’re refuting yourself here.

                Fourth, it’s a bit ridiculous to attribute Newton’s and Gauss’s theories to a gold standard.

                Your points are way too irrelevant to prove the efficiency of a gold standard or that capitalism can exist without a government.

            • Joseph Fetz says:

              Let me get this straight. So by the logic of your statement, you would conclude that a non-monetary economy could not expand production and/or that it would be stuck producing the same goods over and over?

              • Major_Freedom says:

                Only if we have enough historical data that contains inflation, which can swamp out historical data without inflation, so that we can make counter-factual claims that no inflation would have otherwise obliterated economic progress.

    • Christian says:

      You’re doing the accounting wrong Hermonta. The money for welfare comes from somewhere. (For example, do you think the employer pays the other half of the FICA tax? Of course not, the worker pays for it with lower wages.)

      If we take this example, welfare payments reduce work effort because if the participant receives a higher income from working, the subsidy is taken away.

      I wouldn’t say worker bargaining power is enhanced, as Bob does, I would argue that the labor force has been reduced by a policy choice – and with a lower quantity of labor supplied given a certain quantity of labor demanded, higher wages prevail. (and prices)

      Essentially, there is a negative effect on aggregate demand because the business(es) employs fewer people than it otherwise would – at higher prices for everyone.

      Besides, businesses are good enough at getting subsidies from the government without the costs of going through workers….

      • guest says:

        (Bob Murphy, can you delete the previous copy of this comment, and keep this one, instead, please?)

        Against the “passing on the costs to the consumers” idea, I found the following article compelling:

        Papa John and “Passing On”

        The response of several businessmen to the upcoming implementation of Obamacare has made quite a splash. Both John Schnatter of Papa John’s Pizza and Denny’s franchisee John Metz announced that the law would impel them to cut employee hours and raise customer prices, which is fair enough.

        However, they erred when they both claimed that through such price hikes they would be “passing on” the costs of Obamacare to the consumer. Their error was not only strategic (“Passing on costs to consumers? What heartless, selfish capitalists!”), but conceptual. Rothbard demonstrated in Power and Market that the notion of such “forward tax/cost shifting” is fallacious:

        And here’s a helpful qualification by Rothbard from the same source as alluded to, above:

        Chapter 12—The Economics of Violent Intervention in the Market (continued)

        C. Shifting and Incidence: A Tax on an Industry

        This obscurantist tendency is fostered by treating “shifting” in too broad a way. Thus, if an income tax is levied on Jones at 80 percent, this will hurt not only Jones, but also—by decreasing Jones’ in­centives as well as capacities—other consumers by reducing Jones’ work and savings. It is therefore true that the effects of taxation diffuse outward from the center of the target. But this is far from saying that Jones can simply shift the tax burden onto the shoul­ders of others. The concept of “shifting” will here be limited to the case where the payment of a tax can be directly transferred from the original payer to someone else, and will not be used when others suffer in addition to the original taxpayer. The latter may be called the “indirect effects” of the tax.

  2. Ben H. says:

    Instead of arguing for an increase in the minimum wage, they need to call for an end to the income, FICA, sales, gas, property, and inflation taxes.

    Then maybe these poor people will have some money.

  3. Tel says:

    I agree with your economic logic. Food stamps and welfare are not a subsidy to business, they actually drive wages up, and this is easily evident when you compare with very low-welfare Asian countries where wages tend to be low. I mean if welfare was really a “subsidy to business” then no one in their right mind would move a factory to China. Either the USA has a lot of incredibly dumb factory owners, or welfare isn’t helping business as much as some might think.

    Personally though, I think the minimum wage is especially bad in as much as it imposes a totally artificial price control. In contrast, a welfare safety net has a much more natural effect, and can offer benefits beyond just driving wages up.

    Consider this example, suppose someone is choosing between a better paying job that is also physically dangerous, or a lower paying job with comfortable and safe conditions. Well, with no safety-net, the person knows that starvation is dangerous, so in comparison the dangerous job offers protection from starvation. However, with a safety-net in place, maybe the low paying job is comparatively more attractive because starvation is no longer on the table. In other words, the worker is betting some benefit from the job, but not specifically high pay. Lots of other benefits may exist — the work may be genuinely interesting, or educational, or a stepping stone to a better job, or there are just really cool people who work there with a great social scene, or lots of other stuff.

    However, the minimum wage law means employers are forced to take away all those low-pay jobs and also implicitly forced to try to leverage everything else they can in order to put the benefits into pay, and only pay. All that other sundry stuff falls by the wayside. Pay becomes the only thing that matters.

    That’s why I’m in favour of some sort of welfare safety-net (we can argue over the balance of exactly how generous), but I’m opposed to a minimum wage — even though they do have some similar economic effects.

  4. Scott Lazarowitz says:

    The argument against minimum wage shouldn’t be economic but rather a moral argument. The sanctity of private contracts is such that their terms are of and by and for the parties to those contracts only. The contract between employer and employee is a private contract, and when third parties such as government bureaucrats and lawyers intrude themselves into those contracts, forcibly and coercively imposing restrictions (or favors) against the will of any of the signers to the contract, those intruders are trespassing. They are criminal intruders, in my opinion. Their intrusions make those contracts less secure and less valid as private contracts. The association involved with the contract is a less moral one, as it no longer is a “voluntary contract,” but a coerced one with threat of violence.

    So, when those private contracts are trespassed by third parties, the contract is also less owned by the original signers to the contract, as the trespassers (who, as agents of government monopoly and compulsion) have taken upon themselves to seize ownership of those contracts. To me it doesn’t matter what the economics are, or what is more effective in “helping” people or not. So that’s my two cents worth.

  5. Daniel S says:

    This sounds good, but I feel it’s missing something and I’m having a hard time placing it.

    Assuming all government aid disappeared, wouldn’t workers collectively demand more for their services? Who is going to bid down wage levels if no one can afford to live below what they are asking? For example, a Dr. fresh out of med school can’t really afford to accept a job that won’t pay off his med school bills, unless someone is willing to undercut him. Furthermore, for the sake of argument, let’s assume that all Drs. are in the same boat financially, and so can’t accept wages below a certain level. Wouldn’t they be able to demand more total wages because nobody is undercutting them? And if so, doesn’t this also apply to workers on the bottom of the pay scale as well?

    Also, aren’t you assuming that all else remains equal, and that no workers will now seek out more education or skills to improve their utility? If low-wage workers are suddenly forced to accept a suddenly decreased standard of living, won’t they seek to improve their employment prospects, and thus decrease the supply of labor available to those low wage companies?

  6. Ghost of Christmas Past says:

    Dr. Murphy, haven’t you neglected to explain the perverse effects of the EITC which is now the biggest welfare program in the US? That program appears to subsidize employers of subsistence-wage workers, and may not raise recipients’ reservation wages because of the way it operates. To get any money from EITC the recipient must work (EITC doesn’t pay idlers) at a low-wage (only) job. Anyone who garners a job at higher wages becomes ineligible for EITC (there’s a phase-out) so it imposes a really stiff marginal tax rate on workers who increase their earnings above a certain point. But even more curiously, the EITC has a “phase in” scheme with a -40% maximum marginal tax rate– that is, EITC will add up to $0.40 to each $1 of wages the recipient earns in a very-low-wage job. It seems clear to me that EITC subsidizes the lowest-wage employers, since the government enables them to attract workers with higher reservation wages than whatever pay the employer actually offers– the government (middle-class taxpayers, really) makes up the difference. The EITC also incentivizes low-wage workers to have children, because it pays more to parents than non-parents (but still only parents who work for low wages).

    For a bunch of pretty recent details, see http://www.richmondfed.org/publications/research/economic_quarterly/2010/q3/pdf/athreya.pdf

  7. Gamble says:

    Walmart and the junk food industry first look at the Government welfare budget, prior to making their annual fiscal plan. The food industry knows they are guaranteed x amount of revenue every year.
    So in one respect, the original commentator is correct in saying there is a subsidy to the food producers union( farmers, agriculture)…

    Moving forward, since minimum wage is such a stellar idea, immediately increase minimum wage to 25 dollars per hour 😉

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