Arnold Kling  

A High-Wage Equilibrium

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A commenter points me to Will Wilkinson's post where he links to The Economist Intelligence Unit's ranking of Denmark as the best country to do business. About the Danish labor market, they write


The system combines low non-wage labour costs and few restrictions on hiring and firing with high unemployment benefits (funded by the state via income tax, not business) and opportunities for workers to upgrade their skills. This provides a high degree of flexibility for employers, while generating a high level of employment and income security.

One of Will's commenters points to an article written last year by Jamie Galbraith.

The secret is in the wages. If you are a business in Sweden or Norway, there is one thing you are not free to do. You are not free to cut your wages. You are not free to compete by going after cut-rate workers, either native or immigrant. You are not free to undercut the union rate. Successful businesses must, therefore, find other ways to compete. They do it by keeping productivity high. This means that advanced industries thrive in Scandinavia, while backward ones die out.

This leads me to wonder what would happen if the U.S. adopted a high-wage policy. Suppose we, say, doubled the minimum wage, and enforced it uniformly in all industries and for all workers. What would be the general equilibrium consequences?

For example, the lawn mowing industry could not remain the same. You might see some capital-labor substitution, but there has been a lot of that already. My guess is that the relative price of lawn service would rise. Maybe the net effect is that more people devote leisure time to mowing their own lawns, which is a welfare loss.

Fast food would change. Probably you would see more "do it yourself fast food" (the kind you can pick up at a grocery store) and less of the current fast-food outlet model.

But I don't see any reason why would see a surge in "advanced" industries, just because the wages of unskilled workers have gone up. I think there has to be a net drop in demand for unskilled workers.

My guess is that illegal immigrants (and perhaps even a fair number of recent legal immigrants) would return to their home countries in droves, because far fewer of them would be hired at double the minimum wage. There would be a welfare loss from that, too, albeit borne largely by people who are not now citizens.

Basically, I think we could make a Denmark-like model work here (not that I would want to). It would serve the purpose of a massive deportation policy, except that the laws that we would be enforcing to get rid of people would be the labor laws rather than the immigration laws.


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COMMENTS (39 to date)
JohnathanA writes:

Arnold-

You probably just convinced a handful of right-wingers that minimum wages are a good thing because they deter immigrants. Congratulations.

-John

Mitch Oliver writes:
My guess is that illegal immigrants (and perhaps even a fair number of recent legal immigrants) would return to their home countries in droves, because far fewer of them would be hired at double the minimum wage.

This assumes that many illegal immigrants are currently making minimum wage. I don't think they are. Without additional (successful) wage and legal status enforcement pressure I would expect the illegal immigrant levels to either grow at the same rate or faster as employers seek to hire "under the table" rather than pay the legal minimum wage.

Dan Weber writes:

What the heck do teenagers do to earn money if there is no low-wage market?

Helder writes:

Jamie Galbraith's justification is a poor one. How does he explain the relative positions of Switzerland, Australia, Netherlands and (specially) Hong Kong? How about the US being a better place for business than Norway? The data doesn't fit the theory.
Three of our five largest trading partners are Canada, Japan, and the European Union (Germany, France and the UK are all individually in the top ten). All have average wages nearly as high as ours, and higher in some cases.
This is not true for France, germany and UK if you consider disposable income (after taxes and SS contributions)

Helder writes:

Note: germany doesn't have a minimum wage law.

Ironman writes:

I can't answer the immigrant question directly, as I don't know what how they might constitute the affected wage earners if the minimum wage were increased, but I do have a couple of tools that can answer the question of how a minimum wage increase would affect a small business or how it might affect the national economy.

Hope this helps!

Ironman writes:

Dan Weber: The short answer is that teenagers don't earn money with minimum wage increases. They make up the group whose rate of unemployment has increased the most since the federal minimum wage was hiked in July 2007, and also in those states who increased their own minimum wages above this level in January 2008.

The next big increase in the U.S. unemployment rate is scheduled to occur in or shortly after July 2008, when the next increase in the federal minimum wage will take place.

SheetWise writes:
Dan Weber: What the heck do teenagers do to earn money if there is no low-wage market?
Ironman to Dan Weber:The short answer is that teenagers don't earn money with minimum wage increases. They make up the group whose rate of unemployment has increased the most since the federal minimum wage was hiked in July 2007, and also in those states who increased their own minimum wages above this level in January 2008.

The governemnt definition of an "employee" is the key to any argument concerning "employment".

The answer is education. While there are many restrictions preventing teens from 'employment' and contracting -- they pretty much disappear if they're self employed. Give them one good 'partner' (i.e. sponsor), and that law all goes away.

Anyone defined by the government as an 'employee' is a slave -- so we protect children from being enslaved. We do not protect them from engaging in and conducting business.

While this applies to all 'children' -- very few figure it out until they're in their late 20's ...

Anonymous writes:

As others have said Jamie Galbraith's comments are based on little scientific justification. I live in Ireland, which is also a rich country, it has weak minimum wage laws, and no laws against pay cuts in the private sector.

The blunt fact is that no economist really knows why the Scandanavian countries are successful, or how to emulate their success.

Bob Knaus writes:

To take lawn mowing as a specific example, doubling the minimum wage would result in many small lawn care companies going out of business, and many people entering the lawn mowing business as solo operators or small partnerships. The latter would happen because minimum wage laws do not restrict how much you pay yourself, i.e. how much you make from your own enterprise.

This would be a lose-lose-lose situation. Lawn owners would pay more to have their grass cut. Existing small businesses would go under. Average wages for lawn mowers would go down.

Here's why: the lawn mowing business is most profitable when you have a team of workers who come in, do a great job in two hours, and impress the neighbors so much that they hire you on the spot. Soon, you build up a base of "cluster customers" in the neighborhoods you service. Your team of workers can do 8 or 10 yards at once, because they don't have to travel. They achieve productivity that is impossible working solo.

Sorry for the detailed micro example here, but I get the impression that some commentors have little experience with the way small labor intensive businesses work.

Peter St. Onge writes:

We are considering something analogous, with proposals to allow accelerated business depreciation. Of course this reduces the cost of capital, relative to labor, so we might expect as a result fewer jobs.

As you correctly point out, illegal immigrants seem to be our marginal workers, so this sort of policy may well be more effective than a border fence at achieving nativist goals.

8 writes:

Scandanavian countries are small homogenous groups. Outside of Scandanvia, what countries have copied the model?

The EU is too diverse for it to work, and the U.S. is more diverse than the EU. Furthermore, the EU cannot even agree on the best policy for the ECB, let alone a standard wage rate.

George writes:

Arnold wrote: "I think there has to be a net drop in demand for unskilled workers."

This is pretty straightforward: unskilled workers are largely low-productivity, low-wage workers. If you make it economically infeasible to employ low-wage workers, all your low-productivity jobs go away.

Thus, your remaining jobs are, on average, higher-productivity. And your unemployed are, on average, lower-skilled and lower-productivity. And more numerous.

As the kids say, big whoop.

Gary Rogers writes:

This reminds me of the early eighties when we looked at Japan's industrial plan and decided that we could not compete unless we had a similar plan to promote "good" industry over other businesses that were competing for resources. This turned out to be completely false and I see no evidence that a Danish wage plan would do any better. Show me some evidence.

vinod writes:

OR... instead of illegal employees, you'd end up with more illegal employers.

the % of unlicensed employers in the home trades and janitorial services is pretty impressive and their ranks would swell --> more off the books, cash-only contracts, etc.

spencer writes:

Actually, the US has conducted exactly the experiment you propose.

From 1950 to 1980 the real minimum wage was increased seven time for a net gain of about 35%. Over that period teenage employment rose some 120%. Moreover, over this era teen age employment rose virtually every year except when the economy was in a recession. The change in the minimum wage did not appear to impact teen employment.

From 1980 to 2006 the real minimum wage fell about 40%. During that period teenage employment fell around 25%. Moreover, during this period the drop in teenage employment does not appear to be related to the changes in the minimum wage. Rather, it seems to go up and down with the business cycle.

The results of this experiment generated exactly the opposite results that your theory called for.

Maybe it is time you rethought your theory.

P.S. I know that the number of teenagers changed over the periods. but if you look at the teen participation rate you find that it rises when the real minimum wage rises and falls when the real minimum wage falls.

So we have extremely strong and robust data that implies that your theory about the minimum wage is wrong. Moreover, you find the exact same results no matter what sub-period of these last 50 years you look at.

Care to explain why your theory is inconsistent with 50 years of data?

urbanleftbehind writes:

Scandinavian models worked because they dumped all their poor people into America's Upper Midwest during the 1800s. I kid you not...in 1800s Sweden was a poor relatively undeveloped nation numbering over 10 MM people, mass migration to America, Canada, and other areas ensued; by 1900 its population had cratered at about 5 MM - this is about the time when the social safety net could be contemplated, especially as industries ravaged by the Great War on lower continental Europe moved to Scandinavia.

Also I feel that more restrictive teen driving laws are also affecting teen employment. If they cannot drive or carpool with their HS buds to a job, they cannot realistically get that job. If they cannot drive altogether until age 18, they lose a big motivation for even getting a job.

Anonymous writes:

Spencer, why would what you say occur?

If you wish to build a robust theory you must have a path of cause and effect.

Matt writes:

Seasonal weather as in the Nordic case mismatches in trade with temperate zone nations. The volatility of season change is great enough that it triggers readjustments during winter onset. The result is that government is practiced at making quick updates to the social laws, to offset weather freezes coming in phase with cyclic downturns.

It is the efficiency of government program updates that makes it work. Nordic governments have quantum efficiency, they can react quick, implement an N-1 rank, then return back to N. And this capability should be place near the top of competitive measures.

spencer writes:

Why is teen employment growth positively correlated with the real minimum wage?

I do not know.

It is like when I took physics in high school. I learned that gravity has exactly the same impact on a pound of lead that it has on a pound of feathers. Consequently, according to the laws of physics and gravity I should be indifferent as to whether I get hit over the head with a pound of lead or a pound of feathers.

I know that that is not correct because many other things besides gravity act on the pound of lead and the pound of feathers. One would be air resistance. But I do not know what all the other are.

So I look at your theory about the minimum wage and the data and realize that your theory can not be correct. I'm sure there are many, many things that act to make it incorrect but I do not know what all of them are. Milton Freedman said a theory should be judged by its ability to predict.
On that basis the theory that the minimum wage causes teenage unemployment is a complete and abject failure.

Mark Seecof writes:

Taking Spencer's data as correct[1], I can suggest an explanation: first, assume many teenagers will command only the minimum wage. Assume also that for plausible values of the minimum wage there will be plenty of jobs worth hiring even a teenager to do (e.g., burger flipping). Next, observe that many teenagers will take jobs when the wages offered exceed the subjective value of leisure time[2]. At any given time, some teenagers (still fed and clothed by their parents, say) value extra leisure time more than the minimum wage. When the real minimum wage rises, work becomes more attractive than additional leisure time for many teens. The inverse is also true. This model is intuitively at least as attractive as one which assumes an infinite supply of teens ready to work at any wage, so that employment is limited by the intersection between the marginal productivity of teenagers and the mandated minimum wage.

Separately let me point out that while stuffy labor laws don't seem to predict productivity very well, national IQ average does. The average Dane is very smart.

[1] I mean no insult. I haven't tried to research Spencer's data so I can't confirm it, but I find it plausible and think it's worth considering why things could be that way.

[2] Or the proceeds of crime, in some cases.

Arnold Kling writes:

Spencer,
Didn't immigration accelerate in the 1980's? Perhaps that's what made it harder for teenagers to find jobs. Teenagers and immigrants are both in the low-wage job market.

Conny writes:
It is like when I took physics in high school. I learned that gravity has exactly the same impact on a pound of lead that it has on a pound of feathers. Consequently, according to the laws of physics and gravity I should be indifferent as to whether I get hit over the head with a pound of lead or a pound of feathers.

Oh, my! Spencer, they sure taught you about impulse and elasticity as well and that the being hit over the head has actually nothing to do with gravity, except maybe that you fall to the ground afterwards.

Indregard writes:

You forget important consequences:

The value of basic education rises sharply, because low-paid jobs with no education requirements (like elevator operators, lawn-mowers etc.) suddenly disappear. My econ prof at Oslo University was very surprised to see a few elevator operators in the US. In Norway, this has been automated decades ago. This is a net benefit to society, because young people have greater incentives to become more effective, educated workers instead of lawn-mowers. And yes, Norwegians do mow their own lawn.

Obviously, this policy has to be supplemented by massive investments in free, public education. Not your favourite tool, but the net effect is that we produce your level of GDP even if we work hours less per day. That gives us plenty of time to mow our lawns.

Martin Kronborg writes:

Just to clarify since there seems to be some confusion. Denmark does NOT have a minimum wage law, what it has is a highly unionized system which has negotiated minimum wages with private companies (this covers almost all of the workforce).
Teenagers (under 18) are not part of this, they have their own seperate minimum wages, which are lower than that of adults (and not taxed).


As to why Scandivian countries are doing so well, the conventional wisdom is because we have everything else going for us. High tech industries, 60 years of stability, advanced neighbouring countries and free trade (which may have something to do with this whole flexicurity discussion).
Having no low-wage jobs for adults is not a good thing and is very taxing on the working class; the unemployment number may be only 2% atm (Denmark), but this ignores all the ones who are put outside the workforce for an endless list of more or less valid reasons (students, disability and such).
Good thing just about everything else is in our favour (we even have a bit of oil ;-) )!

Floccina writes:

BTW Teenagers are often better workers than other low wage workers.

Anonymous writes:

Spencer: "So I look at your theory about the minimum wage and the data and realize that your theory can not be correct. I'm sure there are many, many things that act to make it incorrect but I do not know what all of them are. Milton Freedman said a theory should be judged by its ability to predict.
On that basis the theory that the minimum wage causes teenage unemployment is a complete and abject failure."

Friedman was a careless thinker at times.

Certainly you provide evidence for your case, but you provide no proof. The economic situation at the time you mention has never been replicated before and never will be again.

If you are to make a real case you need logic behind your observations as well as observations.

Imagine if a physicist said that he had examined a complex process occurring in a volcano for twenty years. He said that variable A is proportional to variable B. But, he has observed no other volcano and has no idea why. The physicist does not have a theory that can be used for the basis of engineering, if he claimed to have one he would be laughed at.

Floccina writes:

BTW my work takes me to North Dakota periodically. North Dakota, home to mostly children of Scandinavian immigrants, seems to have much less poverty (whatever that is in modern America), crime and other social ills than the other places in America where I have spend time.

Floccina writes:

Anonymous in regards to Spencer I think that it is sufficient to say to him: way too small a dataset. The more the number of complexities that can change the variable we are observing (unemployment) he larger the dataset you need for it to considered strong evidence. Considering that no other demand curves slope up and that even he would admit that at some minimum wage a higher minimum wage would increase unemployment, I think that we can say the evidence needs to much stronger than what we have.

Ray G writes:

Hmm, I wonder 1) how big the gray market is in Denmark/Sweden (I'm assuming small enough to be inconsequential) and 2) how insanely huge our own gray market would be if we tried something like this.
As homogenous as those other populations are, under the table pay-rates might not be a problem, but in America, I think we'd see millions of workers drop off the radar while our lawns continued to be mowed by other people.

George writes:

Indregard wrote:

My econ prof at Oslo University was very surprised to see a few elevator operators in the US. In Norway, this has been automated decades ago.

The only place I've seen elevator operators in the U.S. is at fancy hotels (where they make you feel important) and in New York City apartment buildings (where they provide security and other services).

And yes, Norwegians do mow their own lawn.

Yeah, but we have to have ours mown for months, not just the two weeks in August when it sticks up out of the snow.

Obviously, this policy has to be supplemented by massive investments in free, public education. Not your favourite tool, but the net effect is that we produce your level of GDP even if we work hours less per day. That gives us plenty of time to mow our lawns.

Sweden does about what you do, and their per-capita GDP is only $36,900, two-thirds of your $55,600.

Are you completely sure producing 3 million barrels of oil a day isn't the secret to your prosperity? That's around $66 per capita every single day at current prices. Without that activity, your per-capita GDP plummets from Kuwait-like to amazingly close to the EU average of $32,900.

Snark writes:

And yes, Norwegians do mow their own lawn.

Yeah, but we have to have ours mown for months, not just the two weeks in August when it sticks up out of the snow.

LOL! My apologies, but I can't help picturing Norwegians mowing their lawns with snow plows?

Rick writes:

This article is dead on with its analysis, with one or two minor, but not deadly, flaws.
Immigrants would not suffer, because of the very reason they are here today - working off the books. Sure, lots of industries would suffer badly (fast food, lawn care), but the illegal sector would boom. Teens would earn more, like my son, by going door to door (like I did as a kid) and asking to mow lawns of homes who can no longer afford a lawn service.
Illegals wouldn't leave...they'd come in droves, as small businesses hired more and more cheap workers off the books.

Denmark lacks easy access to cheap labor, the way the US has it. So it has to rig its laws to allow for competition. As a result, it creates a market system that encourages behaviors that currently exist in this country which nobody likes to talk about, or say they abhor. Fact is, everyone (myself included) has hired an off the books laborer from time to time to keep costs low (a nanny here, a painter there) because the professionals already charge far too much and frequently do a lousy job.

Matt writes:

"Denmark lacks easy access to cheap labor,..."

Just about right. Their labor supply being less flexible, Denmark and the Nordic countries have learned to fulucuate labor with fast updates to the social welfare laws.

When Sweden found out, a decade ago, that they had reached their Malthusian moment, what was impressive was that they could update their socialism in response.

In the USA, an entitlement update is a 16 year cycle, we would never adapt fast enough if we were a small Nordic, snow bound nation.

Ethnic Austrian writes:

Teenagers who want to start earning money usually enter the dual education system that exists in countries such as Denmark, Germany, Austria, etc. The dual education system combines an apprenticeship in a company, which initially pays less than the minimum wage, with some formal vocational training at a school. So instead of mowing somebodies lawn, european teenagers are happily acquiring usefull skills like plumbing, car repair, office assistance work or hairdressing.

Small jobs like nursing or lawn moving are if anything not legally declared. So minimum wage laws need not apply. However, which greedy f*ck would let the neighbours kids work for sweat shop wages anyway?

There is little demand for such services in central europe in any case. Home improvement is big. Efforts of certain companies that tried to introduce american style servicing have not been received well by customers. Being unnecessarily serviced doesn't jive with our mentality.

US writes:

@Ray G and others:

Some stats on the 'grey market' in Denmark from a Dane:

The amount of undeclared work was in 2005 approximately 153 million work hours, or appr. 40 hours/Dane in the age of 18-74. Roughly 1 in 4 of Danish males and 1 out of 7 Danish females admitted to either have done undeclared work themselves, or have undeclared work done for them, in the year 2005. The total amount of undeclared work in Denmark measured in market prices is appr. 3% of GDP, some international stats here:

http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/07/424

Between 2001 and 2005 the amount decreased almost by a whole percentage point. The Swedish numbers are a little higher, the source above put it at 5% of GDP in 2004.

As to who is doing it, students and skilled workers are in the top in Denmark, while unskilled workers come in 3rd. Almost half of all students admitted to having done undeclared work in 2004/5, for skilled workers the number was one third. Among unskilled the number was 25%. The country average is 20%. The average weekly amount of time spent on it - among those that do undeclared work - is approximately 4 hours.

Numbers are from this power point presentation by Claus Larsen, Rockwool Foundation's Research Unit:

www.srf.dk/lm2007/CL.ppt

Alas, only available in Danish. If you do want to know more about the subject, the Rockwool Foundation's Research Unit is probably a good place to start, they have a lot of publications on the subject, some of them in English, available here:

http://www.rff.dk/en/publications/black_activities_and_the_law_of_the_land/black_activities/all_publications/

Marsello writes:

The Danish style policy would not work in the US because of the strong pull by small businesses over here. Over the years I've seen many office workers making the switch to entrepreneurship, driven by the promise from books such as "Rich Dad Poor Dad" etc. In my opinion, you have to take into consideration the percentage of small business owners in Denmark compared to the US

Amused Observer writes:

A few observations: the differences between scandinavian countries with the oil numbers backed out are interesting.

Given a choice between working for high wages as a skilled laborer and mowing my own lawn to displace what was once the baliwick of low skilled, low paid, low cost, workers is hardly a plus in my eyes.

Teenagers whose baby boomer parents subsidize thier activities have little incentive to look for work.

Lastly, if the price of maintaining a nice green lawn, neatly trimmed, rises too high perhaps we will see fewer of them.

eccdogg writes:

Can we please stop comparing the united states to tiny European countries.

Denmark's population is 5.3MM Their GDP per capita is like 37k ($PPP).

Compare them instead to Minnesota 4.9MM population 41.2k GPD/capita.

When you show me a European country that is bigger than California or Texas that has a model that you think we should implement in the US then I will listen.

Until then I don't consider the outliers in Europe any different than the variation in states within the US.

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