Krugman's Priceless Economics (on the minimum wage)

From David Henderson of EconLog.

"As regular readers of my posts on Econlog know, although I am often critical of Paul Krugman, I defend him when he's doing good economics (here, for example). His New York Times column yesterday, though, "Walmart's Visible Hand," essentially throws out basic price theory. Thus the title of this post.

The context is that Walmart has announced that it will raise wages for 500,000 employees. He uses this fact to reach this conclusion, which he states up front:

Second, and arguably far more important, is what Walmart's move tells us -- namely, that low wages are a political choice, and we can and should choose differently.

Already, that's an interesting statement for an economist to make: the fact that a private employer raises wages tells us the "low wages are a political choice." No, it doesn't tell us that. It tells us simply that a private employer raised wages. To establish that Walmart raised wages for political reasons, Krugman would have to make that case. Instead he moves on because he has bigger fish to fry. 

Krugman challenges the idea that wages are set by supply and demand. After stating that conservatives believe this, he admits (he even uses the word "admit") that so do many economists.

But he doesn't think that's true. He writes:

Specifically, this view [that wages are set by supply and demand] implies that any attempt to push up wages will either fail or have bad consequences. Setting a minimum wage, it's claimed, will reduce employment and create a labor surplus, the same way attempts to put floors under the prices of agricultural commodities used to lead to butter mountains, wine lakes and so on. Pressuring employers to pay more, or encouraging workers to organize into unions, will have the same effect. 

But labor economists have long questioned this view. Soylent Green -- I mean, the labor force -- is people. And because workers are people, wages are not, in fact, like the price of butter, and how much workers are paid depends as much on social forces and political power as it does on simple supply and demand.

Actually, this view not imply that "any attempt to push up wages will either fail or have bad consequences." We economists who believe that wages are set by supply and demand also believe that if the supply falls (shifts left on a graph of supply and demand) or if demand increases (shifts right on a graph of supply and demand), then an increase in wages will have good consequences. And that, after all, is the context for Krugman's article: not a government attempt to raise wages but an employer's decision to do so.

Also, wages are like the price of butter. This has nothing to do with the fact that the workers are people. Remember that the workers are selling their services--their hours--not themselves.

Then we get where he really wants to go: advocating higher minimum wages and more bargaining power (although he does not name the specific changes in law that he wants) for labor unions.

First, on minimum wages, Krugman, as is his wont, emphasizes only one part of the literature, the part that finds "little or no negative effect on employment" and treats that as an "overwhelming conclusion" of the so-called "natural experiments" with the minimum wage, rather than as the conclusion of one part of the natural experiment literature. 

Second, on unions, Krugman argues that the "sharp increase in unionization" after World War II reduced income disparities. But here's where he is most "priceless." The bottom line of the literature on the effects of unions and wages, most of the literature coming from the 1950s and 1960s, and much of it summarized by the "dean of labor economics," H. Gregg Lewis of the University of Chicago, was that unionization in the one quarter of the labor force that was unionized raised wages for those workers by about 10 to 15%. But, of course, with higher wages, the amount of labor demanded fell. Where did these workers go? They went to the non-union sector. That shifted out the supply of labor there. So wages for the 75% of workers who were not unionized were 3 to 4% lower. The only way this would reduce income inequality is if the 25% of the workers who were in unions would otherwise have had wages below the wages of the 75% not in unions. Unfortunately, many of the non-union workers had lower wages to begin with. So the effect of unions on income inequality was, at best, not clear.

Krugman concludes:

What this means, in turn, is that engineering a significant pay raise for tens of millions of Americans would almost surely be much easier than conventional wisdom suggests. Raise minimum wages by a substantial amount; make it easier for workers to organize, increasing their bargaining power; direct monetary and fiscal policy toward full employment, as opposed to keeping the economy depressed out of fear that we'll suddenly turn into Weimar Germany. It's not a hard list to implement -- and if we did these things we could make major strides back toward the kind of society most of us want to live in.

Priceless."