Transfers ≠ Gains


Noah Smith at Bloomburg raises a question while bemoaning the lack of emphasis on ethics and morality in most undergraduate econ courses:

Suppose economists find that a $15 minimum wage raises the incomes of 99 percent of low-paid workers, but throws the other 1 percent out of jobs and onto the welfare rolls. Is it worth it? Should the government obey the principle used by doctors — first, do no harm — and avoid any policy that hurts anyone in any way? Or should the government take responsibility for any outcome, based on the idea that government sets up markets in the first place?

What was notable about Dr. Smith’s question was that he doesn’t even pay lip service to the main tool that economists use to assess situations like this: economic efficiency.  He seems to be alluding to the idea that economists face a choice between evaluating programs using Pareto or Kaldor-Hicks criteria, but almost all economists have converged on using Kaldor-Hicks, or cost benefit analysis in assessing the desirability of various policy outcomes.

Secondly, and more importantly, the cost-benefit analysis that Dr. Smith proposes is incomplete!  A full cost-benefit analysis of a minimum wage policy should include the costs and benefits to employers and consumers as well.  Under most models of the low-wage labor market, the gains to low-skilled workers who keep their jobs after a minimum wage hike have to come from somewhere, like higher prices for consumers or lower profits for employers.  That would make the higher incomes for low-skilled workers a transfer, not a gain, and thus even the one percent job loss is enough deadweight loss to kill the Kaldor-Hicks efficiency of the policy.  Other assumptions like a purely monopsonistic labor market or an upward-sloping demand curve could yield different results, but the economists’ toolbox could approach these situations just as easily.

It’s one thing to criticize the implicit consequentialist assumptions in the field,  like to say that the cost/benefit analysis we used ignores marginal utility of income or concerns for equity, but it’s another to ignore the evaluation tools it has entirely.

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