Paul Krugman puts the IMF straight (and it is not what you think!)

This is from Market Watch:

The International Monetary Fund on Monday called on the U.S. to raise its minimum wage, but refrained from naming a specific level, saying that’s up to Congress.

In its annual review of the U.S. economy, the IMF said increasing the minimum wage and expanding the Earned Income Tax Credit would help raise the incomes of millions of poor, working Americans. Read the IMF’s review.

Christine Lagarde, the IMF’s managing director, told reporters an increase in the minimum wage — now $7.25 an hour — “would be helpful from a macroeconomic point of view.”

The fund’s recommendation will be well received by congressional Democrats and the Obama administration, both of which have been pushing for an increase to $10.10. The proposed increase has been hampered by an election-year stalemate over major policy issues. House Republicans don’t plan to take up a bill to increase it and Senate Democrats don’t have enough members to get it through their chamber.

Lagarde said the amount of an increase “needs to be decided by legislators.”

Frankly speaking I am somewhat shocked that the IMF would come up with this kind of policy suggestion, but it reminded me about what Paul Krugman once said about increasing the minimum wage (yes, yes he probably have another view today):

So what are the effects of increasing minimum wages? Any Econ 101 student can tell you the answer: The higher wage reduces the quantity of labor demanded, and hence leads to unemployment.

This graph tells the same story.

minimum-wage

W eq is the equilibrium wage that would emerge in an unregulated labour market with no minimum wage. In such a market employment would be N eq.

W min is the minimum wage, which is higher than the equilibrium wage (W eq). In such a world the demand for labour will be only N2, while the supply of labour will be N1. The difference between the N2 and N1obviously is the level of unemployment caused by the minimum wage.

No more discussion of this topic should be necessary…

PS I deleted a lot of horrible things I wrote about French lawyers…

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14 Comments

  1. Simon

     /  June 16, 2014

    Aaah, Lars, I see no reason why this should be the end of the debate. Here is the quote after what you quoted from Krugman (it doesn’t look to be Krugman who wrote it btw?):

    “This theoretical prediction has, however, been hard to confirm with actual data. Indeed, much-cited studies by two well-regarded labor economists, David Card and Alan Krueger, find that where there have been more or less controlled experiments, for example when New Jersey raised minimum wages but Pennsylvania did not, the effects of the increase on employment have been negligible or even positive.”

    Reply
    • Simon, we don’t need empirical confirmation that water runs downhill. The demand curve is downward slopping. I find it impossible to have any other view.

      Reply
      • dkuehn

         /  June 16, 2014

        Alternative views on the impact of the minimum wage do not rely on non-downward-sloping demand curves. I don’t know why people always reference this.

      • You’ve summarized my undergraduate economics education: when theory clashes with evidence, stick with the theory.

      • stephencataldo

         /  June 18, 2014

        Lars, thanks for summarizing my undergraduate economics education: when theory clashes with empirical evidence, stick with the theory.

  2. You might want to read the full article from Krugman, Lars.

    And I think it would be very unfortunate to cut off discussion of the topic where you’ve apparently decided to cut it off.

    Reply
  3. Paideia

     /  June 16, 2014

    I suppose it depends on whether firms are enjoying supernormal profits and what type of market we’re in.

    Assuming perfect competition, raising the minimum wage is very destructive.

    But in the current economic environment, firms seem to be doing well enough, they just aren’t hiring. I imagine this has to do with the supply of labor growing faster than the capital stock – due to population growth, expanding trade frontiers, and what have you.

    If Democrats really cared about the minimum wage, they’d impose a strict moratorium on low-skill immigration (90% of immigration to the US) and enforce current US law and deport illegals. This would automatically restrict labor supply for low-skill workers and increase wages. The consumers would hardly notice for agricultural goods, whereas many services would become pricier. But it would improve the Federal and State budgets.

    Reply
    • Paideia, closing the US borders would be even worse economics than an increase in minimum wages. The US needs more and not less immigration.

      Reply
      • Kindly expand upon this point Lars. :D

        In my view, the great mass of this country of 310 million would not benefit from even more immigration. Though as someone who sells labor and values a high trust society, I may be biased…

    • stephencataldo

       /  June 18, 2014

      It should be testable: “supply of labor growing faster than the capital.” If that was the case, we’d expect people to react to the capital shortages — companies would be desperate to borrow money to invest and grow, you’d never see companies holding on to cash or buying back stocks. Japan, with large capital stocks and neither natural nor immigration increases in the supply of labor, on the other hand, should be thriving: huge capital per person. None of the various graphs from basic economics seems to explain our current economy: simultaneous high profits and surplus of capital, financial-capital being locked up away from becoming physical-capital while people are unemployed.

      Does this theory match evidence: between mergers and inter-locking corporate boards, capital is often and increasingly taking on monopolistic behaviors: companies are slamming down wages rather than growing, buying competitors rather than trying to more efficiently outproduce them, paying CEOs obscenely *despite evidence that the high pay is negatively correlated with company profits,* financial markets increasingly extract wealth rather than profit by finding efficient investments. These steps not only decrease equality, they mean that people are getting paid for nonproductive activities, plus the Keynesian problems of inequality. Yes, cutting off immigration would likely help some workers low on the pay scale — and also mean some additional jobs would go overseas. But that can’t be central to what’s going on in our economy at a macro level, too many countries with wildly different labor patterns are having similar macro. If we ever want a functioning market economy again, we need to look at the busting of the giant conglomerations at the turn of the last century, get sane-scale competition happening again.

      Reply
  4. WaltFrench

     /  June 17, 2014

    “No more discussion of this topic should be necessary…”

    It’s really a bit insulting to your readers to quote the Econ 101 response and omit the next sentence, wherein he says the best studies to date have found negligible, or even positive effects.

    Go ahead and be as dogmatic as you like, but don’t pretend that Krugman was claiming the same position as you take.

    Reply
  5. “In such a world the demand for labour will be only N2, while the supply of labour will be N1.”

    If N1 > N2 then by definition there is slack in the economy. Why can’t the central bank by controlling the supply side drive N2 towards N1 even at the higher minimum wage?

    If the central bank refrains from moral judgments about the desirability of a minimum wage and simply targets NGDP then the economy will adjust with slightly higher capital substitution for labor and a slightly higher fraction to total NGDP going to labor. Labor will still be “fully employed” due to the macro environment.

    Leave the moral desirability of that decision to the elected representatives and just make sure macro policy is sound and workers will find the jobs even at a higher minimum wage. You are the voice that always reminds us we can’t ignore the monetary response in questions like these. Why draw supply/demand curves that do just that in this particular case?

    Reply

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