Right in the Short Run

I do not know a lot about labor economics, but I have been playing around with this idea for quite sometime now. Can we raise the minimum wage (or institute a minimum wage) and still see an uptake (or a non-decrease) in labor? Well, the standard response seems to be “yes” via a monopsony model, which is great, but not the viewpoint I was going for.

The vantage point I wanted to consider was a little more general. What if the industry is not monopsonistic? My idea stemmed from a discussion in which Steven Levitt was explaining his research about how most firms may not be profit maximizing though this seems to be a common assumption in economics.

The reason we say that increases in wage correspond to a decline in labor uptake and a substitution towards capital is because we assume profit maximization on the part of firms. Essentially, if data (such as Card’s research) points to the fact that labor does not decrease despite these increases in wages, then the change in slope of the hyperplane did not affect its tangency point! This means that capital and labor are perfect complements since the the only way a hyperplane can still be tangent to an isoquant manifold after changing slope is if it has met the manifold at a cusp/kink. Of course, perfect complementarity between capital and labor is probably not the case. What else can be the explanation?

Well, if firms weren’t profit maximizing in the first place, then certainly this could be explained. Differential changes in wage rates would not correspond to substitution away from labor since the firm would not even be at the tangency condition in the first place! Consider a situation in which firms only seek to profit “satisfice” as opposed to maximize. Threshold satisficing could mean that firms don’t respond to increases in wages by firing en masse. (This isn’t to say that one can make large increases in wage rate and still have the firms employing everybody.)

Ultimately, my discussion here is a general comment that when we institute policies based on assumptions such as profit maximization, some of the results may be contingent on that fact. These are not general results, but are rather specific implications of our particular assumptions. Remove those assumptions (perhaps they do not actually happen in real life) and many policy implications may change. Of course, the framework I have discussed makes no claim to understanding how firms decide to target profits … we can discuss further theories about that

Reading Robert Frank’s reply to Greg Mankiw’s post, I came across a really interesting passage. I’ve always wondered how we could say that a nation “prefers” to supply labor in some way or another when the options individuals face on the labor market are so dependent on the simultaneous (and competitive) actions of others. It turns out that there’s an economic concept addressing this very issue, called “context externalities”.

For present purposes, by far the most important externalities are those stemming from the link between context and evaluation. As decades of behavioral evidence clearly demonstrates, virtually every evaluation is heavily shaped by local context. As Richard Layard put it, “In a poor society a man proves to his wife that he loves her by giving her a rose, but in a rich society he must give a dozen roses.” Because evaluation drives consumer choice, context is an important determinant of consumer demand. The upshot is that almost every consumer choice generates significant context externalities.
Consider, for example, a job applicant’s decision about how much to spend on an interview suit. His goal is to make a favorable impression. But his ability to do so depends far less on the absolute quality of his suit than on how it compares with those worn by other applicants. And when he spends more on a suit, he shifts the context within which other candidates will be evaluated.

Context externalities are pervasive. A good school, for instance, is one that compares favorably with other schools in the same local environment. The amount parents must spend to ensure that their children attend such a school is thus an increasing function of the amounts spent by other parents. The evaluations that guide an employer’s promotion decisions are similarly dependent on context. A worker’s odds of promotion depend less on his absolute performance than on how well he performs relative to his coworkers.

The dependence of evaluation on context lays waste to any presumption that individual decisions about how many hours to work or how much to spend on interview suits will be socially optimal. The general result predicted by theory is that if context shapes evaluation more heavily in some domains than others, too many resources will flow to the most context-sensitive domains and too few to the least context-sensitive domains. In my forthcoming book, Falling Behind, I summarize what available evidence says about the extent to which context differs across domains. For the discussion at hand, the relevant finding is that evaluations of leisure tend to be far less context-sensitive than evaluations of income. The implication is that individual valuations of leisure tend to understate social valuations. Thus people work longer hours in the hope of moving higher on the income ladder, only to discover that when others do likewise, their position remains unchanged.

Just wow!

Most people who live in New York love the fact that subways run 24/7. Although it might take a long time, it is possible to get to every single subway stop in New York city at any time of day, any day of the year.

It always seemed to me that the big winners from this service were the poor. Certainly anyone who would like to work flexible shifts without owning a car — and it seems reasonable to me that many people in this boat are relatively poor — benefits greatly. Without late night subway service, a lucrative overtime shift could entail a cab ride back home, which could easily eat up most of the benefit of the shift itself.

Looking at it from another direction, 24/7 subway service means that it is feasible to work strange shifts without owning a car. Everyone benefits from that, but the poorest, for whom the car purchase means the most sacrifice, benefit the most.

Lastly, the guarantee of being able to pay $2 for a ride means that people can work strange hours far from home. It is not hard to imagine that the poor stand to gain from having a wider array of jobs open to them, particularly if the neighborhoods they live in are less hospitable at night or tend to offer lower wages.

Things to read up on:

1. Relative utility functions. Let’s go find the literature on u_1(x_1) = f_1(x_1,x_-1) where x_-1 = vector of others’ wealth or consumption vectors.

2. Addiction literature. Under what conditions does it make sense to describe drug consumption in the expected utility framework?

3. Causal inference tools employed in labor economics. See this text by Angrist (MIT) and Krueger (Princeton).

To most economists, the answer to the question posed in this post’s title is simple: no.

That’s because economists view jobs as a quantity that is set in the labor market. For a given job, the number of people doing that job will be determined by the supply of labor and the demand of labor. Labor supply is how much labor everyone in the economy is willing to do at all the different wages imaginable, and labor demand is how much work employers in the economy want done for them at all the different wages imaginable.

At some wage rate, the number of people willing to work equals the amount of work employers want to supply. That’s called equilibrium, and the number of people willing to work at this wage will determine the number of jobs in the market.

When someone says that immigrants are doing jobs that Americans just won’t do, they are claiming that American labor supply for a given job is always zero. No matter the wage, no American is willing to get off his behind and do the work. I find it hard to believe that this could be the case for any kind of work, even if the task is extremely dangerous.

A slightly more interesting question is “Are there jobs Americans won’t do at certain wages?” Well the answer to this question is probably yes! Not too many Americans would mine coal for $4 an hour. On the other hand, some immigrants may well be willing to do the job at wages lower than any American’s. At low wages, there are plenty of jobs that immigrants will do that Americans won’t.

Just something to keep in mind when someone trots out the argument that immigration allows us to get jobs done that no domestic resident would be willing to do. Certainly there may be other benefits to immigration, but this is not one of them.

(See also Andrew Samwick)

This is from McSweeneys:

Social Security Denies Gregor Samsa’s Disability Claim: We are writing about GREGOR SAMSA’s claim for Supplemental Security Income (SSI) payments. Based on a review of his/her medical condition, he/she does not qualify for SSI payments on this claim. This is because he/she is not disabled or blind under our rules. […]

You listed the following impairment(s) on your SSI application:

I AM A GIGANTIC COCKROACH

DEPRESSION

BACK PAIN

You said the above impairment(s) affected you in the following way(s):

I CANNOT STAND OR WALK UPRIGHT OR SPEAK ANY HUMAN LANGUAGE

I CANNOT HANDLE OR MANIPULATE OBJECTS WITH MY MANY LEGS OR ANTENNAE

WHEN I AM ON MY BACK I HAVE DIFFICULTY RIGHTING MYSELF

MY FAMILY HAS IMPRISONED ME IN MY ROOM AND IS FEEDING ME SCRAPS

Steven Levitt and friends answer some interesting questions for students planning on entering PhD programs in the next few years: 

Do graduate students who do well in core microeconomics (Micro) courses also do well in core macroeconomics (Macro) and econometrics (Metrics) courses? Are students who achieve higher grades in their first-year core classes or general exams more likely to complete their Ph.D. and to obtain higher ranked positions in the job market?

Apparently answering these not very difficult, though somewhat interesting quesitons takes the efforts of not one, not two, but five of the world’s top labor economists.

Lest you think they were engaged in heated debate on intricate points of methodology, let me reassure you. They were not. They produced a single sixteen page paper on the topic.

It is probably not a coincidence that the authors are each from a different school, and each represent one of the five schools whose data is analyzed within the paper.

The content of the paper itself is interesting, but for those who truly want to succeed in the world of economics its implications are clear: if you want good data, first become a good politician.