Advantages and Disadvantages of the Minimum Wages. Comparing the Neoclassical and Post-Keynesian...

University of St. Gallen VW 75 Spring Semester 2014

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Advantages and Disadvantages of the Minimum Wages. Comparing the Neoclassical and Post-Keynesian Perspectives.

Pierre-Louis Marchal Metzgergasse 26 9000 St. Gallen

+ 41 (0)79-562 2983

Term Paper University of St. Gallen

Introduction to Economics Ermira Mehmetaj

Group 2 9 April 2014


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Abstract:

Since the first minimum wage law was passed in New Zealand in 1984, the debate over the

relevance of such legislations has always been around. However, economists, in now more

than a century, have never come to a consensus on the matter.

Whereas most textbooks have adopted a neoclassical perspective criticizing those laws, others

believe this neoclassical model is incoherent and tend to argue in favor of (high) minimum

wages. Renowned among them are the post-keynesians.

Relying on post-keynesian and neoclassical theoretical findings, as well as many empirical

studies, this paper is an attempt at understanding and comparing two prevailing , and radically

different, views on an identical topic.


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Table of Contents 1 INTRODUCTION....................................................................................................................4

2. THE NEOCLASSICAL PERSPECTIVE

2.1 Neoclassical Theory .........................................................................................................5 2.2 Neoclassical Economics on Minimum Wages .................................................................6 2.3 Neoclassical Empirical Studies ......................................................................................11

3. THE POST-KEYNESIAN PERSPECTIVE

3.1 Post-Keynesian Theory ..................................................................................................14 3.2. Post-Keynesian Economics on Minimum Wages .........................................................16 3.3 Post-Keynesian Empirical Studies .................................................................................20

4. CONCLUSION ......................................................................................................................24

5. DECLARATION OF AUTHORSHIP ...................................................................................25

6. BIBLIOGRAPHY..................................................................................................................26

7. FIGURES ..............................................................................................................................28


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1 Introduction

Forbidding companies to pay wages inferior to a certain threshold has important effects on the

labor market and even on the global economy. Indeed, wage levels influence not only the

rates of employment, and the living conditions of part of the payroll, but also a country’s level

of education, how much outsourcing is done to countries where (minimum) wages are lower,

and even market prices and therefore rates of inflation. Yet, all around the world, and for

more than a century now, «since the first minimum wage law was passed in New Zealand in

1894” (The Economist, 2001), economists, policymakers, business owners, and many others,

have never ceased debating over the varying advantages and disadvantages of minimum wage

laws, and like often in economics, there is no consensus among economists.

Indeeed, “ there is a long-standing tension in economics between belief in the advantages of

the market mechanism and awareness of its imperfections.” (Solow, 1980, p.1).

Thus, supporters and opponents of market-based economic policies come to very different

conclusion when it comes to discussing the impacts of price floors such as minimum wages

(abbreviated MW).

In fact, there are many schools of thoughts on the subject and among them, the neoclassical

and post-keynesian approaches, basically arguing respectively against and in favor of high

MW and tackling the subject in two completely different ways making it particularly

interesting for one to confront their point of views.

This paper is organized in two sections. Beginning with the analysis of the neoclassical

perspective, this paper will start by formerly defining what neoclassical economics actually is.

Then, since effects of MW on the labor market have faced extensive academic attention, this

will allow us to continue by pointing out what arguments are brought forward by neoclassical

economists regarding the aftermath of MW laws. At last, these arguments will be supported

by empirical studies coming to neoclassical conclusions. Symmetrically, in the second part of

this work, I will proceed in the exact same way when addressing the post-keynesian

perspective, and then conclude on what we have gained from confronting those two very

different viewpoints.


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2. The Neoclassical Perspective

2.1 Neoclassical Theory

Neoclassical theory is an approach to economics emphasizing the efficiency of the market.

Neoclassical economists begin by describing certain distinctive and independent objects:

Individuals, firms, supply, demand, quantities, etc … and then attempt to draw connections.

(Resnick &Wolf, 2012, p.36)

The starting point in trying to establish those connections are the actor’s rational preferences

constrained by the information available as well as incomes for individuals and factors of

production like the technology available for firms. Neoclassical models indicate that the most

important influences on those connections, namely prices, can be logically explained as

results of shifts in supply and/or demand, and that consequently, actors of the market

according to those constraints and influences, will always act in the best possible way.

(Resnick &Wolf, 2012, p.37)

Because of its very causal, scientific, nature, this methodology is often described as

determinist and reductionist in the sense that, regardless of political and sociological

variables, once one or a few determining, essential causes have been found, then every event

can potentially be explained. (Resnick & Wolf, 2012, p.38)

Nevertheless, as reductionist as it may be, worldwide, the neoclassical model is very popular

and even considered to be the dominant economics model of our lifetime. Therefore many

neoclassical economics is often referred to as mainstream, orthodox, or conventional

economics. (Keita, 1992, p.6)

This mainstream model suggests, that the private, decentralized, competitive market is self-

correcting, and will thus correct any kind of occasional, temporary, market imperfection.

(Palley, 2004, p.1) Therefore neoclassical theory clearly points in the direction that the

economy will best manage itself when markets, solution to agents’ maximization problems,

are not interfered with.


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Hence, no matter how good the state’s intentions are, external intervention aiming at

controlling the market economy (in our case regulating the labor market and setting MW) will

only undermine the market’s otherwise successful properties. Moreover, neoclassical

economists actually argue that economic inefficiencies are due to an interventionist state

trying to regulate markets (Resnick & Wolf, 2012, p.3). For instance, according to

neoclassical economists, huge state deficits occur because governments borrow money to

rescue collapsed markets whereas private borrowers should be taking care of it instead. In

fact, private decisions of individuals and businesses reacting to and taking advantage of the

market power will always be considered as better means to solve economic issues.

Consequently institutions are completely de-emphasized and thus the starting point of all

neoclassical thinking is microeconomics. In other words an efficient economy and social

welfare can only be obtained via deregulated markets. From this basic assumption comes a

wide range of neoclassical theories about various areas of economic activity. Therefore it is

not surprising to see that neoclassical administrations like republicans argue in favor of less

government intervention and therefore no MW as they believe that “free markets will not let

valuable factors of production, including labor, go to waste. Instead, prices will adjust to

ensure that demand for labor is forthcoming and that all factors are employed.” (Palley,

2004, p.1)

2.2 Neoclassical Economics on Minimum Wages

It has just been highlighted that the neoclassical theory is extremely easy to understand.

Applied to the labor market framework; it could be summed up in one sentence. State

intervention will only lead to an inefficient labor market.

Indeed, the neoclassical model demonstrates that flexible wage rates are key for supply and

demand for labor to coincide, thus eliminating shortages and surpluses in the labor market

while determining appropriate real wages. Therefore, the neoclassical theory gives the

impression that market forces alone tend to establish full employment. Consequently,

government policies attempting to reduce involuntary unemployment appear to be absolutely

unnecessary.


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Indeed, exogenous shocks such as MW laws can only lead to price distortions and

consequently inefficiencies in the market. (Asia monitor, 2010, p.6). Thus, since the market

ensures that factors of production are paid what they are worth, price floors preventing

downward adjustment of salaries, as well as other obstacles like social protection institutions

and strong trade unions for instance, “actually lower social well-being and cause

unemployment by interfering with the market process.” (Palley, 2004, p.4)

In fact, for neoclassical economists, the reasons why MW not only do not help but actually

disserve the ones they were supposed to help in the first place (i.e. the unskilled workers) are

pretty straightforward.

As always, neoclassical economists base their reasoning on the elementary demand and

supply model. Of course, this model can produce results that some will not like as low

demand for labor may lead to very low wages (especially for unskilled workers). Even though

governments can’t simply ignore the distress caused by extremely low wages, neoclassical

economists believe that relying on MW to artificially increase the incomes of low skilled

workers; in other words, to fight against the market rather than to make use if its power to

address those who suffer from the outcome of supply and demand, is perilous and unlikely to

be effective since it’s based on two errors. (Stiglitz &Walsch, 2006, p. 91)

The first error is to assign the responsibility to someone (or a group): in our case, the

employer. Neoclassical economists insist that it is anonymous market forces that determine

equilibriums. Therefore, the reasons for changes in equilibriums lie in the market itself and

not in a particular actor of this market, namely the employer. (Stiglitz &Walsch, 2006, p. 91)

The second mistake is that no matter how powerful one is, one can’t interfere with the laws

of supply and demand (no more than it can, for instance, interfere with the law of gravity.) By

attempting to, the result will be a market out of balance with either excess supply or excess

demand. Stiglitz &Walsch (2006) summarize it in a small sentence « one ignores the

workings of the law of supply and demand only at one’s peril” (p.94).

That’s why conventional wisdom in economics states that by forcing up MW above the

equilibrium wage, supply for labor will excess demand for the latter and the surpluses created


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will, inexorably, lead to unemployment, or underemployment at least. Moreover, quite

logically, the bigger the difference between the equilibrium wage and the MW, the bigger the

surplus. Therefore, labor markets, either with low equilibrium wages (reflecting low

productivity) or where MW are set at a high level, will be particularly exposed to job losses.

On another hand, if the difference between the MW and the market equilibrium is minimal,

then the distortion will be insignificant and in that case, neoclassical economists won’t

consider MW to be a problem anymore.

When the difference is significant however, setting arbitrary MW above the equilibrium wage

prevents a market from moving toward its natural equilibrium price, leading to shortages in

demand for labor.

Figure 1. Supply Surplus From Price Floors. This figure illustrates that in a competitive

market employment will fall if the wage is exogenously raised. At W1>W0, quantity of labor

demanded has decreased from L0 to L2 while the supply of labor has increased from L0 to L1.

Therefore the surplus caused by the instauration of a MW, in other words the unemployment,

is the difference between L1 and L2.

Moreover, MW laws are often the first step of a cycle making all wages rise. Namely, after

workers with lower skills are raised to the MW, more qualified workers who used to earn the

amount now corresponding to the MW will in turn seek higher wages thus intensifying the

distortions in the market.


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To fully understand the neoclassical perspective however, one also has to understand why

firms decide to hire or not to hire in the first place. To simplify things, we consider a model in

which labor is the only factor of production. Therefore decision to produce is equivalent to

decision to hire. Hence, once the market price of a good (or service) is known to a firm

(regardless of whether the firm acts as a price taker, or price setter), depending on its marginal

cost curve, it will see how much units if this good it can produce. Logically the higher the

price, the more a company will decide to produce and consequently hire. (Stiglitz &Walsch,

2006, p. 182)

Fig. 2, The Demand for Labor. These two graphs illustrate what labor input L1 is required in

order to produce a certain level of output Q1. Graph A: Looking at price p1, the firm will know

what output Q1 to produce. Graph B: Looking at output Q1, the firm will know how much

labor L1 to hire in order to produce Q1.

Sticking with the conventional analysis, while keeping in mind that firms are always

considered to be price-takers in the market for labor, there is another way of looking at firm’s

decision to hire. It is pretty simple, they "hire labor up to the point at which the value of the

output produced by the last worker employed equals the money wage which he or she must be

paid.” (Appelbaum, 1979, p.40)

As a consequence, the lower the equilibrium wage, the lower the value of a marginal worker,

and the more workers firms can hire. Thus neoclassical analysis insists on the fact that once

MW are instituted, the ones who manage to get a job might be better off; but because the

model suggests that high MW lead to unemployment, most of the unskilled workers are likely

to loose their jobs and be driven into driven into extreme poverty instead. In fact, MW make it


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impossible to “share the pie” in more but smaller pieces. In this way, MW, by forbidding

basic work to be poorly compensated penalize the less skilled fraction of the payroll as it is

excluded from the labor market. Therefore, “in the simplest, as in the more sophisticated,

neoclassical models of employment, unemployment is essentially caused by excessive real

wages.” (Lavoie, 1998, p.17) Thus, if the objective of MW laws is to eradicate poverty, then,

the MW, from this perspective, seems counterproductive.

Fig. 3, The Demand Curve for Labor. This figure describes how an increase in wages leads to

unemployment. Since demand for labor can’t exceed the value of a marginal worker, at wage

w1>w2, employment is L1<L2 and at wage w2>w1, employment is L2<L1

The model explained here above explains why according to neoclassical economists,

mandating an arbitrary MW is an improper public policy measures making it harder to reduce

unemployment. However, one could argue that, by slightly increasing their prices, firms could

be able to pay out higher wages without it having any effects on employment. Neoclassical

economists respond that by stating that in an increasingly competitive economy, you can’t

realistically expect firms to raise their prices in order make adjustments in their labor force

without their products losing most of their value in the eyes of the customers. (Rivera, 1999)


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2.3 Neoclassical Empirical Studies

The perspective described in the previous chapter is consistent with several (recent) empirical

studies suggesting that increasing wage floors has unfortunate effects on the employment

opportunities of uneducated workers.

Among those studies, the ones of Professors David Neumark who compared US cities and

countries that implemented living wages to those that did not. While results slightly vary from

study to study, they all come to the conclusion that MW cause (small) reductions in

employment, especially among low-skilled workers (Neumar & Wascher, 2008).

For instance, Neumark and Adams (2003) found that a 10% increase in MG reduces

employment by 1.3% for those with low levels of income. Two years later, two independent

studies conducted by the same professors transformed that 1,3% into a wider range oscillating

between 1.2% and 1.8% (Adams and Neumark, 2005). Moreover, by finding that living wage

in Los Angeles reduced employment by 1.0% with every 10% increase, Fairris (2005)

confirmed the tendency of living wage policies to cause slight job losses.1

Empirical evidence on the effects of MW increase in Vietnam is very interesting as well

because there are continuing debates about positive and negative impacts of MW increases in

this developing country which has seen its poverty rates drop from 58 to 16 percent between

1993 and 2006 . (Nguyen. 2013, p. 584)

Nguyen’s empirical study (2013) indicates that, even though the overall impacts of the nine

adjustments in MW that occurred during that period (all of the latter being increases) were

small, they did significantly reduce employment, in formal sectors in particular, and were

therefore not the reason for the downfall in the country’s poverty rates.

Moreover, 7 years ago, Neumark and Wascher (2007; 2008) reviewed more than 90 empirical

studies, moving “beyond the issues that arose out of the first round of the new minimum wage

research” (p.43). Thus, they provided more details on the procedures and results for these

studies as well as more evidence from industrialized countries as well as developing

countries. The results are pretty difficult to interpret, however, they tend to match up as a

1 The results of all the studies mentioned in this paragraph are exposed in Karabegovic & Veldhuis, 2011, p.7&8


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substantial majority of the studies in the monograph relatively consistently conclude that the

low-wage labor market can be reasonably approximated by the neoclassical model,

reinforcing the idea that “minimum wages reduce employment of low-skilled workers.”

(p.166) Moreover, the consensus employment elasticity was set in a range from –0.1 to -0.3

(i.e. a 10% increase in MG leads to additional employment of 1 to 3%) suggesting that even

though MW cause unemployment among low-skilled workers, the effects are relatively

modest. (p.163)

However, right after this study was published, Fairris and Bujanda (2008) examined the

impact of the Los Angeles wage policy and found empirical evidence of another “perverse”

effect of MW on the labor market. To compensate for wage increase, employers tend cut

down hours the number of hours and/or overtime hours during which employees can be paid.

The result is a decrease in weekly wages. Therefore, even if workers are lucky enough not to

be fired after MW are instituted; they may actually not be much better off. Hence, when the

living wage was implemented in Santa Fe, workweeks were shortened by 1.6 hours on

average and even 3.5 hours for those with 12 years of education or less (Yelowitz, 2005 in

Karabegovic & Veldhuis, 2011, p.8)

What’s more, the New York State has rather recently substantially increased the amount of

the State’s MW and the effects of that raise have been investigated by Burkhauser et al.

(2012). Their results provides some persuasive indications that generous MW increases can

actually have considerable adverse effects for the most vulnerable part of the workforce, with

elasticities far from the consensus range of –0.1 to –0.3. (p.372)

Indeed, by creating a unique set of circumstances enabling them to isolate the effect of a MW

hike on younger, less educated, lower skilled individuals, Burkhauser et al. (2012) found

robust evidence that raising the New York MW from $5.15 to $6.75 per hour significantly

reduced employment rates of low-skilled New Yorker workers. Their estimations show that

the employment rates of the 16 to 29 years old uneducated workers moved from 20.2 to 21.8

%, implying an elasticity of around –0.7! (p. 372)

At last, the effects of the most recent global crisis on unemployment are also illuminating for

neoclassical economists. Of course, MW laws aren’t the only element to affect employment

and the labor market. Therefore, they don’t determine alone the living conditions of poor


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workers. An appropriate analysis would have to be much broader. Nevertheless, to see that

Spain, partly because of it’s inflexible labor laws, has to deal with unemployment rate of over

25% while the US, considered to have a more flexible labor market, are doing four times

better with has an unemployment rate of under 7% is no surprise for neoclassical economists.

That’s without mentioning the extremely low unemployment rates of countries, like

Switzerland, with no MW and therefore very flexible markets …

Before we move on to the second section of this work, and even though this an economic

paper focusing on how MW laws affect the labor market, it is important to mention that MW

regulations often affect society as a whole and not only the low-skilled workers on whom the

focus has been put on so far. For instance, in 1938, by deciding to set a federal MW, the US

abolished the low-wage South, which helped to end the exploitation of black workers and thus

helped to abolish this extremely racist idea of white supremacy, while at the same time

transforming the South into a way more dynamic region paying higher wages. However, as

expected by neoclassical economists, interfering with demand and supply and thus the general

equilibrium also had some non-desirable effects. In this case we are talking about the

dramatic migration that resulted from those laws and that led to the establishment of high-

unemployment urban ghettos like Harlem. (Stiglitz & Walsch, 2006, p.232).

Now, given all the neoclassical evidence hostile to MW, any argument in favor of high MW

would require that the expected gains from MW outweigh the costs of potential employment

losses. Actually, this is exactly what post-keynesians believe.


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3. The Post-‐Keynesian Perspective

3.1 Post-‐Keynesian Theory

Post-keynesian economics is a pretty recent school of thought that has emerged along with

important changes in the market economy such as the fall of the Eastern block which resulted

in capitalism triumphing over communism and as a consequence asserted the virtues of the

liberalized market defended by the neoclassical school. (Holt & Pressman, 2001, p.1)

Unlike neoclassical economists, however, post-keynesians believe that public intervention is

key to accommodate market changes and therefore to improve public welfare. (Galbraith,

1978, p.1)

For post-keynesians, the belief that rational microeconomic principles can explain

macroeconomic outcomes is absurd. Hence, the role of the state in economic affairs is to be

re-emphasized, and pricing decisions, as well as motives of unemployment, reanalyzed.

Post-Keynesian economists are convinced that Keynes's “General Theory” (1936) is

misinterpreted by the other principal Keynesian schools; but above all support that the

neoclassical model is not a suitable one for describing long term growth since it doesn’t take

into account the notion of progress and focuses solely on capital accumalation. “ In other

words, it offers an exogenous theory of long-run economic growth” (Breedon et al. 2012,

p.105) thus suggesting that state intervention is useless as the strive for profits is considered

sufficient to produce growth forever.

On another hand, Breedon et al. (2012) explain that, in the view of endogenous growth

models like the post-keynesian one, the neoclassical model seems erroneous to understand

what mechanisms actually cause long-run economic growth. In order to pick up the challenge

in the right way, being concerned with the Macroeconomic Policy Framework is essential.


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In fact, the father of post-keynesian economics is Keynes who is considered by many as the

first to have seriously studied macroeconomics as such and not as a sum of micro based

principles. (Holt & Pressman, 2001, p.4)

Therefore, contrary to the ones working in the neo-classical tradition, for Keynes (and for

post-keynesians), the labor market is unlike any other market and can’t be isolated and even

less analyzed as such. Thus, Keynes believes that any wage adjustment policy will not only

directly affect demand and supply for labor (as predicted by the neoclassical model), but also

indirectly affect aggregate demand in the market for trading goods. However, if the latter rises

firms will need to produce more and therefore hire more. It follows that a raise in real wages

for instance, doesn’t necessarily lead to the loss of jobs described by neoclassical economists.

(Seccaraeccia, 1991)

From this reasoning follows the idea that that “demand-led economics is relevant, both in the

short-run and in the long run” (Lavoie, 1998, p.2). Thus, government intervention to boost

that demand might potentially be very useful. Therefore, post keynesians believe markets will

not naturally arrive at their best outcome if left to their own device and consequently do not

accept the neoclassical idea that all markets have a natural tendency towards full employment

and that price floors like MW necessarily lead to market failures. In fact, they consider the

economical equilibrium dear to neoclassical economists to be overrated and the notion of

stability inherent to equilibrium analysis to be inappropriate for a discipline, like economics,

that deals with a constantly changing world. (Holt & Pressman, 2001, p.5)

All in all, post-keynesian economics is truly the first school of thought to state that, in order to

achieve higher levels of output, growth, and employment rates; we ought to move away from

the impersonal authority of the market, and adopt a macroeconomic point of view instead.

(Galbraith, 1978, p.9)

Unfortunately for post-keynesians, countries that have indeed adopted a Keynesian

macroeconomic policy continue to traditionally study the market. Therefore, this kind of

policy has often failed and lead to an unpleasant combination of inflation and unemployment,

thus making other governments reluctant to moving away from the conventional analysis of

the market. (Galbraith, 1978, p.10).


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However, post-keynesian economics, if conducted properly, offer a real alternative to the

neoclassical widespread model. That is to accept the decline of the market and consider how

economic performance can be made, socially, and sustainably, acceptable to a country’s entire

population. That is really what post-keynesianism is about. (Galbraith, 1978, p.11)

Today, the post-keynesian models are still approximation because more time is needed before

better models can be formalized. However the theory elaborated by post-keynesian authors up

to now, gives us more than enough information for us to assess the impact of high MW in a

macroeconomic, post-keynesian, setting.

3.2. Post-‐Keynesian Economics on Minimum Wages

The fundamental aspect of post-keynesian theory to keep in mind in order to fully grasp their

whole argumentation is that post-keynesians believe that at a real wage rate W1 associated

with a surplus in supply for labor, no natural adjustment mechanism towards a wage rate W2

of full employment exists. On the contrary, if labor costs were to be freely depreciated

according to the neoclassical self-adjusting mechanism of imbalanced markets, the ultimate

effect of this decrease in real wages would be to make unemployment rise even more.

Therefore, according to post-keynesians, involuntary unemployment can’t be the result of

wages set above the market hypothetical equilibrium but can be explained by an insufficient

effective demand caused by weak real wages at a macroeconomic scale. (Seccareccia, 1991,

p.169) Consequently, the only way for an economy to come near to its level of full

employment is to follow a policy in favor of rises in real wages.

Graphically illustrated, this is what can be added. In particular, one has to think differently

when applying this theory to developing and developed countries


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Fig. 5, The labor market in developing countries. This figure illustrates that in developing

countries, in compliance with the traditional neoclassical model, the labor supply curve LS has

an elastic slope positively related to the real wage rate. This can be explained because of the

strong desire to reach consumption norms comparable with those of developed countries.

Fig. 6, Employment in developed countries. The rather inelastic supply curve indicates that

once real wages allow households to reach their norms of consumption; above a certain wage

Wb, the opportunity costs of not working and having time for leisure activities aren’t

compensated anymore by the ones of working more. From this point B onwards, employment

starts to inversely increase as wages continue to rise. (Seccareccia, 1991, p.171)

As a consequence, the supply and demand curve cross at two different points, thus bringing to

our attention that a developed economy can be in equilibrium at high wage rates Wb and an

employment level Lb, or at low wages rates Wc and an employment level Lc. This is a major

difference with the neoclassical theory that considers only one equilibrium.

All post-Keynesian models, however, show that “multiple equilibriums should be considered

as the rule, and single equilibria as the exception. In addition, the better equilibria cannot

generally be achieved by laissez-faire and free market forces.” (Lavoie, 1998, p.17).

In fact, the two intersections aren’t equivalent at all. Equilibrium C represents a third world

solution to reach full employment. Even though supply equals demand, Lb - Lc is a measure

of loss of production indicating that aggregate demand is below the potential output of the

economy. Consequently, less aggregate demand means producing less, meaning that wages

paid out will decrease. In turn this will lead to a further decrease in demand and even lower


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wages… Thus wages are always pushed down towards the reservation wage (the wage level

under which workers are not willing to work for anymore). Once that level is reached, firms

can’t lower their wages anymore, and have no choice but to get rid of part of their workforce.

Therefore, economies gravitating around that point C will have to deal with unemployment in

the long run. Intersection B, on another hand, represents a hypothetical state of true full

employment in a capitalistic and developed economy. (Seccareccia, 1991, p.172)

Unfortunately, in the 1930s, Keynes found that developed countries always have to deal with

shortages in effective demand and as a consequence tend to stand between the “good

intersection” B and the “bad once” C where disguised unemployment exists. (Seccareccia,

1991, p.172). Therefore, reaching equilibria B described in fig. 6 can only be achieved with

the help of government intervention and national institutions.

However, before drawing anticipated policy lessons from this simple model, one needs to

understand the key notion behind it: productivity. Whereas the neoclassical school considerers

productivity to be an exogenous parameter of the system depending on the innate

characteristics of individuals: their education, training, attitude, family values, work ethic,

etc…(Prasch, 1996, p. 393); in the view of the post-keynesian theoretical approach,

productivity is essentially an endogenous variable depending on global demand. Post-

keynesians believe that if wages are pushed up, aggregate demand and business volume will

rise, which will in turn make the level of measured "productivity" to increase as well. (Prasch,

1996, p. 392). The fundamental idea behind this approach is that, in a company, increasing

real wages will encourage employees to redouble efforts, thus offsetting additional wage costs

by increased productivity (The Worklife Report, 1999, p. 18).

Moreover, in addition to the important causal link between wages and productivity, in the

1950s, important post-keynesian authors like Kaldor and Robinson have indicated that there is

also another important causal link between productivity and investment. (Seccareccia, 1991,

p.173). Namely, in the long term, a rise in real wages will also stimulate business investments

(in addition to productivity) and therefore positively influence growth rates, hence reducing

unemployment rates. Indeed, if they don’t want to go bankrupt, firms faced with high wages

are forced to quickly and massively invest in advanced equipment and eliminate all


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inefficiencies in their production process. The result, therefore, is a more productive society.

(Prasch, 1996, p.1)

On the contrary, “A decline in both money wages and prices would tend to undermine

business confidence and reduce investment, demand, and employment.” (Appelbaum, 1971,

p.41)

However, one might argue, legitimately, that when firms value the benefits and costs of

investing in production capabilities or paying out higher wages, they aren’t concerned with

the macroeconomic consequences of their acts but only consider if the costs will cover the

potential benefits for them. Unfortunately, social returns often exceed private returns, and

therefore firms tend to under invest (Breedon et al., 2012, p.108). However, governments

have the power to fix this by granting financial support until private return equal costs, thus

providing the necessary incentive for firms to choose the socially optimal option, namely

undertaking investments and therefore contributing to boost long-run economic growth,

giving the state another reason to intervene in economical affairs! (Breedon et al., 2012,

p.108).

Despite all the advantages exposed here above, today, public officials fear that by granting

this financial support, and consequently increasing aggregate demand, rises in prices and

therefore inflation will follow. For post-keynesians, however, “the primary cause of inflation

is not excess demand for goods or labor, but rather the conflict over how the available income

and output are distributed.” (Appelbaum, 1971, p. 47) They believe that, by cutting down the

overall volume of income and output, restrictive monetary and fiscal policies, diminish the

level of economic activity and enhance more conflicts between the different actors of the

market. A fair distribution of income between wages and profits is therefore essential for

post-keynesians. The more fair the distribution is, the more dynamic the country, the higher

aggregate demand, and the best it is for the macroeconomic context. Moreover, the “Institute

for Policy Studies” reports that each dollar for low-wage workers adds roughly $1.21 to the

national economy, while every dollar of high-income workers adds just 39 cents. (Levinson,

2014) Consequently, many economists argue that the stagnation of developed countries

observed over the last couple of years is due to an ever-creasing gap between poor and rich

workers, which has led overall demand to remain stagnant and even decline in certain


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countries. (Prasch, 1996, 393). Therefore reducing these gaps (by increasing MW for

instance) could begin to address these countries’ overall growth issues and doing so might be

easier than we think. For instance, wall street bonuses alone would suffice to double the pay

of the 1,085,000 Americans currently working 40 or more hours a week at the current federal

MW of $7.25 per hour! (Levinson, 2014)

At last, one has to be conscious that because of the importance of many empirical factors, at

the present time, no post-keynesian model systematically addresses the impact of high MW

on the level of employment. However, according to post-keynesians, this is not very

surprising because their argument is precisely that wage and unemployment rates are two

completely different things. Indeed, levels of employment depend on aggregate economic

activity, and have little, if anything, to do with the marginal cost of labor described in chapter

2.2. Thus, low wage rates cannot eliminate unemployment and high real wages are not an

obstacle to full employment. (Appelbaum, 1971, p.47) In addition, for post-keynesians,

“flexible money wages would only subject firms to increased uncertainty and make planning

more difficult without having much of an effect on either employment or real wages.”

(Appelbaum, 1971, p.42)

Now, if the post-keynesian theory is confirmed by some empirical work, consequences on

economical policies could be huge.

2.3 Post-‐Keynesian Empirical Studies

While most of the empirical studies so far conducted have come to neoclassical conclusions,

others have reopened the debate about the appropriate theoretical description of the labor

market, arguing, like post-keynesians, that MW have no adverse effect on employment.

Even though they don’t formally adopt a post-keynesian perspective, and that neoclassical

economists have raised some doubts about the methodology used, Card and Krueger (1994)

are famous for being the first to have empirically called into question the supposed inverse

relationship between MW and employment.


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Contrary to neoclassical predictions, they found “no evidence that the rise in New Jersey's

MW reduced employment at fast-food restaurants in the state.” (Card & Krueger, 1994,

p.792). Actually, setting up MW boosted employment in the state and moreover, prices didn’t

increase more in stores that were most affected by the MW rise. (Card & Krueger, 1994).

Thus, these findings are completely inconsistent with the standard neoclassical model but

very close to what a post-keynesian economist would have expected.

Card and Kruger’s paper is very famous among economist and policy makers, but it is neither

the only, nor the first, study to have come to such conclusions. Indeed, 3 years before them,

Seccareccia (1991) had already come to similar conclusions when empirically investigating

how high MW influenced productivity and rates of unemployment.

To do so he had analyzed data from Canada from 1961 to 1988 describing the ratio between

average wage and MW as well as the annual growth rates of productivity. In this interval, the

government had deliberately let the real value of the MW fall by approximately 25 percent

but the promised reduction in unemployment simply failed to occur reinforcing the idea that

lower wages do not appear to be the high road to economic prosperity. (Seccareccia, 1991)

Therefore, in contrast to the neoclassical theory where MW can only have negative effects on

the employment of low-skilled workers, those findings argue that one can’t draw so simple

and definitive conclusion as the global effect on employment is actually unpredictable. Thus,

instead of being concerned by possible effects of MW on employment, and even though there

is a empirical evidence relating high real wages to high employment, in the short run at least

(Blanchflower and Oswald, 1994 in Lavoie, 1998, p.17), it would be best to evaluate the

impact of high MW on productivity, growth, and competitiveness of an economy.

Take Singapore, one of the very few countries nowadays not to have any kind of MW laws.

Post-keynesians don’t argue that instituting such legislations would be the panacea to resolve

all of the country’s problems. However, according to professor Hui’s researches (2013),

because of the country’s situation, it could be the central component of a set of coordinated

measures encouraging companies to make a better use of the workforce and choose a

competitive system based on productivity, quality, innovation and more efficient production

technologies… thus ensuring long-term growth. (Hui, 2013, p.133). According to the data

used by professor Hui, (high) MW would have a positive impact on the labor market, as it


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would reduce dependence on foreign labor, while state financial assistance to poor workers

would drop. Most importantly, MW laws would help increase Singapore’s international

reputation by marking the end of an era of exploitation of vulnerable workers and the

beginning of a productive society attracting qualified workers as well as increasing

professional training in the country. (Hui, 2013, p.132).

In fact, professor Hui points out that the main virtue of MW defended by post-keynesians,

namely stimulating productivity, is particularly relevant in countries and cities where

economical growth and social welfare depend qualitative improvements rather than

quantitative expansions. (Hui, 2013, p.133).

Inodensia now, the country with the highest unemployment rate in Southeast Asia. The

orthodox interpretation is that the labor legislations granting too generous wages are

negatively impacting employment rates. Thus, these laws are not helping Indonesia’s low-

skilled workers at all. In addition they are also creating recession, thus harming the

investment climate. However, “detailed sectoral analysis” (Chowdhury & Islam, 2011, p.269)

reveals very little evidence of that. In fact, available data suggests the country’s real problem

is a lack of aggregate demand because of a demand-constrained economy, where firms aren’t

operating at their full potential. (Chowdhury & Islam, 2011, p.269). However, investment,

domestic and foreign, responds to rising domestic demand and in Indonesia the latter is

constrained by the macroeconomic policy framework. Therefore, Chowdhury & Islam (2011)

show that the real thing damaging the economy’s long-term potential, by dragging down

investment and employment, is the country’s insufficient aggregate demand, along with

macroeconomic instability, policy uncertainty, corruption, tax rates, etc... (p.276). Labor

regulations, however, are one of the few measures helping to fight against this trend.

Moving to Europe now, there appears to be only a limited amount of empirical evidence

concerning the positive effect of MW on employment (Bradley et al., 1999). For instance,

after a minimum hourly wage was set on 1 April 1999 in the UK. (Bradley et al., 1999,

p.304), even though, increased labor productivity has been observed, corresponding dramatic

declines in employment occurred as well, thus making the subsequent effect of these laws on

real wages pretty insignificant. (Bradley et al., 1999, p.304),


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In fact, it is not yet clear, if empirical studies have much to say either about the adequacy of

the post-keynesian model, as it is quite difficult to draw conclusions from the existing

evidence. However, all of the work mentioned above challenges the neoclassical view on the

labor market and identifies a major weakness in this view: it doesn’t consider the fundamental

links between wages, employment and productivity at a macroeconomic level. Therefore,

according to them, because of this error, neoclassical policies will lead to the establishment of

a lower impoverished class, along with risks of social instability and political pressure.

Before concluding this work, it is important to mention that so many empirical studies coming

to different so many different conclusions indicates that some important questions remain

unanswered. Namely, what is the appropriate measure of the minimum wage? How long does

it take for MW laws to have their full effects on employment? What are the best data

gathering methods? What are the hidden employment effects of MW? (For instance the fact

that employers can adjust the number of hours worked by their employees.), etc… (Neumark

& Wascher, 2007)

Quite clearly, the logic behind the contradictory results reported in this work remains to be

investigated in order for more consistent views on the advantages and disadvantages of MW

to be eventually developed.


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4. Conclusion

Now that the two contrasting models of the labor market have been analyzed, one realizes that

we don’t have, on one side, the greedy neoclassical economists who believe that “the only

social responsibility of business is to increase its profits” (Milton Friedman, 1970) and that

low wages are just a way of always maximizing profits, and exploit vulnerable, unskilled,

workers; and on the other the post-Keynesians who argue in favor of high MW, since, even

though they might be a little disconnected from the reality of the labor market, pursue the

noble goal of making sure that companies don’t take advantage of their employees and the

lack of regulations.

No, in fact, we have two different schools of thoughts basing their rational argument on two

different economic models linking individuals to society as a whole in opposing ways.

Therefore the differences between the two viewpoints are far more complex, interesting and

deeper than one could think at first.

Even though one model might be more appropriate than the other depending on the context, I

have tried to remain as neutral as possible and do not wish to take position since until

additional fruitful research is carried out, no one (yet) can offer definitive evidence.

At last, I’d like to highlight, that in addition to all the insight I gained on the fascinating MW

problematic, I also learned that in our Manichaean world, where we always try to set clear

boarders separating black from white, good from bad, right from wrong, in reality things are

sometimes (often) more complex. Therefore, this paper has reminded me that in academic

studies, as well as in life, there are usually more than one conventional way to look at

political, sociological, ecological, or economical issues; and therefore more than one possible

response.


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5. Declaration of Authorship I hereby declare - that I have written this work on my own without other people’s help (copy-editing, translation, etc.) and without the use of any aids other than those indicated; - that I have mentioned all the sources used and quoted them correctly in accordance with academic quotation rules; - that the topic or parts of it are not already the object of any work or examination of another course unless this has been explicitly agreed on with the faculty member in advance; - that my work may be scanned in and electronically checked for. 44 080 characters


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Figures 2 & 3: Stiglitz J.E & Walsh C.E (2006), Principles of Microeconomics (4th ed.). New York, NY : W. W. Norton & Company, Inc. Page 170 Figures 4 & 5: Seccareccia, M. (1991), Salaire minimum, emploi et productivité dans une perspective post-keynésienne. L'Actualité économique, 67(2) :166-191. DOI : 10.7202/602032ar. Page 183

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