Obama's Economist and Wages

President Obama consistently nominates high-quality economists to top positions. His recent pick, Alan Krueger, is one of the best labor economists on the planet, which, given what it takes to be a labor economist, means that he is also one of the best statisticians on the planet.

Krueger has extensively studied the effects of minimum wage increases, and found that in many cases, they do not result in low-wage workers losing their jobs. There has been a massive academic fight about these results, which did uncover some problems with Krueger's early papers, but in the end   the consensus is that the evidence is mixed, and it is hard to find any clear proof that raising the minimum wage causes unemployment.

A few days ago, I saw a very ignorant editorial in response to this nomination. The writer was blasting Krueger, saying 

Alan Krueger can be counted on to ignore fundamental economic principles...a higher minimum wage reduces employment opportunities for young, low-skilled and inexperienced workers. After all, this is Economics 101.

Think about this for a minute. The author is claiming that a model from simplest kind of economics is better than a top expert in the field. He is saying that if you take an introductory course, then you know everything you need to know about labor economics.

All models are simplified representations of reality, and the 'Economics 101' models are very simple indeed. A lot of detail gets left out, and a lot of assumptions get put in. The basic supply and demand model does work surprisingly well in most cases, but it is not universally true.

Yes, basic economics says that in a competitive labor market, a minimum wage will reduce employment. But intermediate economics says that in a labor market where employers are price searchers, a minimum wage can increase employment. Being a price searching buyer means that you have some choice about the price you pay for things. Instead of being forced to take a market price, you can pay less and get less, or pay more and get more. In such a setting, employers will maximize profits by paying workers less than the free-market price and hiring less of them, just like a monopoly will maximize profits by charging more than the free-market price and selling less stuff.

So there are two competing models. The only way to choose between them is by collecting data. It becomes an empirical question, and Krueger has spent his life answering these kinds of questions. There is a lot of data to show that employers are price searchers, especially when dealing with workers who find it very costly to move to a different job. In the extreme situation, where there is only one factory in a town and it is hard for workers to move, a minimum wage law or a union will increase wages while actually increasing economic efficiency.

This, by the way, helps you understand the 'company towns' of the Industrial Revolution. Providing workers with houses, schools, doctors, churches, and social clubs is a way to trap them. It is not benevolence. If you want to be nice to people, it is always more efficient to simply pay them more. If you can afford to hire a doctor for your workers, you can afford to pay them enough to hire a doctor themselves. People, even poor and ignorant ones, are better off making their own decisions. If you live in a paternalistic company town and you quit your job, you lose everything. So the employer has much more pricing power over your wages. It is no accident that the people working for the most 'benevolent' employers, like Pullman, were more likely to unionize, because they were most likely to be underpaid.

As a population of workers becomes more mobile, more willing and able to switch jobs, their wages will rise. When workers can easily quit, the employers have to pay fair market wages to keep them. Highly skilled urban professionals are extremely mobile; if you have a good resume and a good network and live in a place with lots of employers, you can find a new job without too much trouble. The basic econ model works well to describe these labor markets. The best way to raise wages for everyone is to make all labor markets more competitive and all workers more mobile.