I'm turning the "misconceptions" posts into a series, in which I will point out the follies in both sides of the argument. One of the most controversial issues in the public eye today is the minimum wage, and there is a lot of faulty reasoning and factual errors behind most of the discussion.
Starting with the right, the idea that supply and demand dictates that higher minimum wages will result in substantially higher unemployment is not true. The standard supply and demand model is based off perfect competition. There are a variety of different models in which one would get different results. There are many reasons to suspect perfect competition doesn't apply here. There are search costs for employees when it comes to finding new work, both in time and in lost income if they are not searching and working simultaneously (they also likely don't have much savings or assets they can sell of in order to do this). This also has the effect of encouraging workers to specialize, which reduces the amount of job opportunities they'd have when compared to what job would be available had they developed a more broad skillset. This can increase search costs. The number of firms employing low-skilled labor is greatly outnumbered by the number of low skilled workers. It's also worth noting that the fact they have little savings or assets means they have to accept a job to be able to live (welfare aside which one is not allowed to be on indefinitely), which also reduces bargaining power.
Perhaps the most convincing reason not to believe that a perfect competition model is applicable, is the economic literature on the subject. Prior to famous Card and Krueger (1993) study, the minimum wage literature overwhelmingly showed a correlation between higher minimum wages and higher unemployment. Afterwards, the relationship is much less clear, with most studies seeming to show a small (often significantly insignificant) negative impact. While many will point out Neumark and Wascher (2007) as a rebuttal, it is important to note that in this analysis the studies are taken from many different countries and weighted based off the authors' personal views as to what consists of more solid methodology. The most recent meta analysis, which does not make such subjective judgments, finds no disemployment effects of the current minimum wage. So, is it settled then? Let's all join the #FightFor15, or an even higher minimum wage? Not so fast.
If you go back to the link about the different models of the minimum wage that I shared earlier, it is evident that to when pushed above some degree, the minimum wage will kill significant amounts of jobs. The exception being the demand shock model, but the LRAS is vertical, so we can discard that one as a model of anything outside of recessions (I'll explain why this is in another post, and why in recessions raising the minimum wage is a bad idea as well). Dube, who is at the forefront of minimum wage research and is certainly significantly more optimistic towards the minimum wage than the average economist, has found that the optimal minimum wage is roughly 50% of the median wage. This would mean a $15 minimum wage wouldn't be fit anywhere, let alone in places like rural Alabama and other areas where $15 is close to, or above, the median wage. A clear cut example of a minimum wage causing massive unemployment effect is the unfortunate case of Puerto Rico, which the Federal Minimum wage used to not apply to. The reasoning is simple; push the minimum wage above the marginal value added by the average low skilled worker, and they will be laid off. In other words, if the employee is only able to add $10 an hour in value, and the minimum wage is $12 an hour, they will be laid off. Another way to think of this is through a hypothetical; imagine a minimum wage of $1000/hr. Obviously, this would cause mass unemployment.
In summary, a minimum wage can be a useful tool to mitigate the advantage the employers of low skilled labor have in bargaining power. However, it can be a risky tool, as pushing it above the marginal productivity of low skilled labor can cause mass unemployment. The optimal minimum wage also differs greatly by area, based off the productivity and cost of living of those areas. So both sides have solid points on the issue, and in a later post of my own I'll make some recommendations on how to go about designing minimum wage policy.
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