### Homer Nods

Well, nobody’s perfect.

When it comes to skewering bad reasoning — and making the right arguments crystal clear — Don Boudreaux is usually about as close to perfect as anyone gets. But this time I believe he’s committed a gaffe of his own.

In a column on the minimum wage, Don writes:

Suppose that I invent and use a machine to steal \$15,000 every year from each of 500,000 poor Americans, with the \$7.5 billion being transferred into my Swiss bank account. After skimming off a few hundred million bucks to cover processing and handling expenses, I share the bulk of these proceeds with about 16.5 million friends…Am I acting immorally? Most people would answer “yes”…

By way of context, a CBO study forecasts that raising the minimum wage to \$10.10 per hour will cause 500,000 workers to lose their \$15,000-a-year jobs, while raising the pay of 16.5 million others.

But Don’s analogy fails, because taking someone’s \$15,000-a-year job is not the same thing as taking someone’s \$15,000. I think it’s a fair guess that most minimum wage workers dislike their jobs. So losing one of those jobs has an upside, which has to be weighed against the downside of not getting paid. On balance, losing that \$15,000-a-year job might be no more painful than losing, say, \$5000 a year.

The right version of Don’s analogy, then, goes more like this:

Suppose that I invent and use a machine to steal \$5000 every year from each of 500,000 poor Americans, with the \$2.5 billion being magically transformed into \$7.5 billion and then transferred into my Swiss bank account. After skimming off a few hundred million bucks to cover processing and handling expenses, I share the bulk of these proceeds with about 16.5 million friends…Am I acting immorally?

This time around, I’m guessing that a whole lot of people would answer “no, you’re not acting immorally—in fact it would be immoral to pass up such a golden opportunity to make the world a richer place”.

I do not believe you can make an effective case against the minimum wage without focusing on the costs to a) business owners (mostly in the short run) and b) consumers (mostly in the long run). The costs to displaced workers just aren’t that high, because all they’re losing are jobs that pretty much suck.

Yes, some fraction of those people value those jobs very much, as stepping stones to greater things. But I think it’s extraordinarily implausible that, on average, a \$15,000-a-year worker values his job at anything close to \$15,000.

Come to think of it, though, isn’t it Paul Krugman, who, whenever the topic of stimulus spending comes up, tells us how devastating it is for low wage workers to be out of work, and how tremendously valuable those jobs are? It’s Paul, then, who should jumping in right about now to defend Don’s argument. If he does, it will make my day.

Share/Save

#### 38 Responses to “Homer Nods”

1. 1 1 Glen Raphael

You’re assuming that when the government forces companies to pay X\$ more to those employees who stay employed, THOSE workers value their new job as worth exactly X\$ more than they did before. But wait! Consider that “a job” is a complex negotiated bundle of which pay is only one component. If employers are forced to make the job pay MORE in dollars, they will necessarily make the job pay LESS in other areas. Less job security, less flexibility, fewer benefits, worse working conditions, etcetera. And we should actually expect the new overall bundle (including the higher pay) to be valued LESS by the employees than before the change. (because if it were valued MORE, they would have already chosen that bundle – we wouldn’t need the state to inflict it on them)

So if – as you suggest – we stop looking at dollars and focus on the net value to employees as perceived BY employees, a more accurate analogy might be “steal \$5000 every year from each of 500,000 poor Americans, with the entire \$2.5 billion being burned in a bonfire or otherwise destroyed. Then go steal some value from another 1.6 million other people and destroy that too, but steal it in forms that are hard to notice directly.”

2. 2 2 Lawrence Kesteloot

“But I think it’s extraordinarily implausible that, on average, a \$15,000-a-year worker values his job at anything close to \$15,000.”

Let’s say (hypothetically) that a job were the only way to get money to buy food. Then someone making \$15k may value their job quite a bit more than \$15k, since it makes the difference between eating and dying. Doesn’t the decreasing demand curve apply here, where you’re buying dollars with your labor? The first \$15k is worth a lot more to me than the second.

My guess would be the opposite of yours. Yes, you get the benefit of being unemployed, but it doesn’t do you much good now that you’re homeless and starving.

3. 3 3 Philip Maymin

Magically eh? Inflation is magic?

4. 4 4 Gabe

What is the wage cliff like for these folks? If a single, childless person were making \$15,000 a year, how much would they be receiving in welfare if they lost their jobs? I think that would be a fair way to realize how much they value the marginal dollars they make working a minimum wage job.

5. 5 5 Richard Quigley

“I think it’s a fair guess that most minimum wage workers dislike their jobs.”

Not a valid assumption. Would they like a better job? Yes. Would they like a lower paying job? No.

Consider too that many are part time workers: first time employees, students, weekend & night time workers.

That job is worth more than \$15K to these people because it’s making them the \$12K they need to get the education/training they need to get that better job.

6. 6 6 Gabe

I must say, after reading this paper, I’m not quite sure how one can explain why people work minimum wage jobs unless 1) they get really great benefits (somewhat doubtful), 2) they are teenagers and don’t NEED the money, or 3) there is some dis-utility associated with being unemployed.

7. 7 7 Don Boudreaux

I return Steve’s kind words – and double-down on them. There is no one whose reasoning I trust more than I trust Steve’s (and precious few whose reasoning I trust as much). I myself am among the many whose reasoning I trust less than I trust Steve’s.

On the matter of the minimum wage, though, Steve and I have long not seen as perfectly eye-to-eye as we do on nearly all other issues. While I concede that in my machine analogy I overlooked the costs to each worker of holding a minimum-wage job, my analogy was also silent on a non-wage benefit of such jobs, a benefit that Steve, too, overlooks. And this benefit of holding a minimum-wage job arguably makes the net loss (to each worker rendered unemployed by minimum-wage legislation) higher than \$15,000. The benefit I have in mind is the set of job skills and work experience obtained while working that first, entry-level job.

If the CBO, and many other economists, are right that minimum-wage legislation causes some workers to lose their jobs, then regardless of the dollar-valuations of the losses suffered by the losers, and that of the benefits enjoyed by the winners, the legislation forcibly transfers not only present incomes but also higher future incomes (in the form of lost opportunities to become more-productive workers) from some workers to other workers. I think that any such policy that forcibly prevents some people from working in order to raise the pay of other people is immoral.

8. 8 8 Don Boudreaux

One other matter (before I must run off to a conference discussing the work of the late, great Armen Alchian): In Steve’s amended version of my analogy, he reduces the losses suffered by the now-unemployed low-skilled workers from \$15,000 to \$5,000 (the difference being the presumed \$10,000 disutility suffered by each of those workers when on the job). But I think Steve then over counts the alleged benefits to the workers whose wages rise as a result of the higher minimum wage.

Not only do those still-employed workers’ work conditions likely worsen as a result, but even in the absence of such adjustments, there is disutility to THOSE jobs, too. So just as the disutility cost of the jobs destroyed by minimum wage should, in a more complete analysis, be reckoned, so too must the disutility of the minimum-wage jobs that continue to be worked after the minimum wage is raised.

9. 9 9 Glen Raphael

Don: any disutility of “having to work” to the people who keep their jobs is already priced into the situation. Yeah, they pay it, but it’s not a NEW cost when they suddenly get paid more money for the same labor they were previously doing.

10. 10 10 nobody.really

Well, nobody’s perfect.

You’re too kind.

11. 11 11 khodge

Gabe @6
There are people who enjoy doing some minimum wage jobs, notably in the health-care service area, who probably deserve to be paid much, much more, people who genuinely like working with other people.

12. 12 12 John Hall

Or the present value of a \$15,000 a year job.

13. 13 13 Jonathan Kariv

@nobody #10: and that wins this thread

14. 14 14 Austin Middleton

“This time around, I’m guessing that a whole lot of people would answer “no, you’re not acting immorally—in fact it would be immoral to pass up such a golden opportunity to make the world a richer place”.”

Does this not lead to supporting the argument for transferring wealth to a utility monster? Because if you can multiply overall human satisfaction by taking from Alan and giving it to Bill, and it’s immoral not to do so, then wouldn’t you be morally obliged to conduct a more extensive and thorough redistribution of utility-generating assets?

The disutility of employment notwithstanding (and it’s necessary for jobs to be recognized as the costs they are), it’s hardly a desirable principle of governance to rearrange property to equalize some bureau-calculated marginal utility.

15. 15 15 Steve Landsburg

Austin Middleton:

Does this not lead to supporting the argument for transferring wealth to a utility monster?

Not evene remotely. Maximizing wealth and maximiaing utility (if that even means anything) are two different things entirely.

16. 16 16 Philip Maymin

Inflation aka magic does not create, let alone maximize, wealth. And if a project could actually create actual wealth if it only had enough funding, then extracting that funding involuntarily is still morally wrong.

17. 17 17 Russell

“The costs to displaced workers just aren’t that high, because all they’re losing are jobs that pretty much suck.”

I disagree completely. The costs are extremely high, both to the workers and to society.

18. 18 18 Austin Middleton

“Maximizing wealth and maximizing utility (if that even means anything) are two different things entirely.”

Perhaps so, but you engage in both when you say: “I think it’s a fair guess that most minimum wage workers dislike their jobs. So losing one of those jobs has an upside, which has to be weighed against the downside of not getting paid.”

If utility maximization by legislation is untenable, undesirable or otherwise, then that part of your wealth maximization argument which relies upon relieving low-wage workers of their disutility is similarly so.

“On balance, losing that \$15,000-a-year job might be no more painful than losing, say, \$5000 a year.” How is the net social gain generated by this differential, because the newly disemployed may now enjoy their involuntary leisure, not a creature of utility?

19. 19 19 Eric Hammer

@Steve Landsburg: It isn’t clear that wealth and utility are being separated here; you discount the income of workers put out of a job by their disutility of work, saying they don’t value the job at the full dollar amount. You are saying that the now out of work folks would be just as happy if you gave them 5000\$ of that magically multiplied cash and left them out of a job, (leaving you with plenty left over for your friends.) It isn’t clear that it is true, however, and even if it were, it assumes the people on the job possessing end of the stick value the extra money more than the people losing their jobs. In other words, you are assuming your friends’ jobs remain constant and they simply get extra money, instead of experiencing an increasing disutility of work such as Don described.

I must add, it isn’t clear to me that stealing money from random strangers to divide amongst your friends is ever going to be moral, even if you very cleverly invest the funds and come up with more money afterwards than you stole. Even from an amoral maximization perspective, it is impossible to know whether those put out of work are hurt more or less on whole than those who get some more income.

20. 20 20 Steve Landsburg

Eric Hammer/Austin Middleton: You continue to confuse welfare with utility.

Suppose I have a \$15,000 job that is worth \$5000 to me, in the sense that I’m indifferent between receiving \$15K for working and \$5K for not working. By taking that job away from me, you can somehow cause your cousin Fred to be \$10K richer.

Then it is definitely welfare-improving to make this transaction. But we have absolutely no information on whether it’s utility-improving. Even if we assume that the notion of utility is meaningful, we have no idea whether \$7500 is worth more or fewer utils to Frank than \$5000 is to me.

The argument in the original post is a pure welfare argument. It has absolutely nothing to do with utility.

21. 21 21 RJ

@ SL #20

Wait, I’m confused too. I’ve always been taught that welfare in economics is defined as the utility one gets when they consume a good or service.

Are you differentiating between cardinal (for utility) versus ordinal (for welfare) measurements of well-being? If so then I don’t think welfare is the correct term, but rather efficiency.

22. 22 22 Steve Landsburg

RJ: “Welfare” and “efficiency” refer to exactly the same thing in this context.

I’ve always been taught that welfare in economics is defined as the utility one gets when they consume a good or service.

This is not consistent with the standard use of the word “welfare” in economics.

23. 23 23 Keshav Srinivasan

Steve, to clarify, you’re talking about Kaldor-Hicks efficiency, not the Pareto efficiency that most non-economists are familiar with, right?

24. 24 24 Steve Landsburg

Keshav Srinivasan: In this context, what difference do you see between KH and Pareto efficiency?

25. 25 25 RJ

This is not consistent with the standard use of the word “welfare” in economics.

Okay. I’m still not 100% in understanding so I might repeat myself. It seems all this time I’ve been using marginal benefit and marginal utility synonymously, which might explain a bit of my confusion.

I have my old introductory textbook (Glenn Hubbard and Patrick O’Brien) and they don’t even use the term “welfare”. What they did use is the term “Economic efficiency” which is defined as “A market outcome in which the marginal benefit to consumers of the last unit produced is equal to its marginal cost of production, and in which the sum of consumer surplus and producer surplus is at a maximum.”

This seems to be what you’re talking about when you use the term welfare. Is it so? If not, could you give a definition and a source?

26. 26 26 RJ

Sorry for the double post, but this is itching at me.

I’ve been doing a google browse for a bit to see what I can find. Now, I know wikipedia isn’t a legitimate source, but what was written is very close to what I remember hearing concerning welfare in a microeconomics context:

(Search “Welfare economics”)

Social welfare refers to the overall welfare of society. With sufficiently strong assumptions, it can be specified as the summation of the welfare of all the individuals in the society. Welfare may be measured either cardinally in terms of “utils” or dollars, or measured ordinally in terms of Pareto efficiency. The cardinal method in “utils” is seldom used in pure theory today because of aggregation problems that make the meaning of the method doubtful, except on widely challenged underlying assumptions. In applied welfare economics, such as in cost-benefit analysis, money-value estimates are often used, particularly where income-distribution effects are factored into the analysis or seem unlikely to undercut the analysis.

27. 27 27 Keshav Srinivasan

Steve, wouldn’t your example in comment 20 only work for KH efficiency?

28. 28 28 Steve Landsburg

RJ: The wikipedia definition is basiclly correct except that:

a) Measuring in utils and measuring in dollars are not two different methods of calculating the same thing; instead they measure entirely different things.

b) Where it says that the cardinal method in utils is “seldom used”, I think it’s more accurate to say that when people are interested in measuring utility, they seldom use the word “welfare”. To most working economists, the word welfare *implies* an efficiency calculation.

Here’s my favorite example to illustrate the difference:

I live next door to Bill Gates. He wants to play loud music at night that keeps me up. The value of that music to him is practically nothing in utility terms — he’d be willing to pay \$50,000 for it, which to him, is barely noticeable. The value of my sleep to me is enormous — I’m willing to pay \$100 for it, which happens to be 90% of everything I’ve got.

If you’re maximizing utility, you’ll want Bill to turn the music off so I can get my sleep. (This glosses over all the many problems with aggregating utility, but those problems are irrelevant here so we’ll pretend they’ve all been solved.) If you’re maximizing welfare, you’ll allow Bill to play his music because \$50,000 is greater than \$100.

There’s a good argument to be made that the welfare calculation, not the utility calculation, is the right guide to policy analysis. Here’s why: If you require Bill to turn off his music, you’ve cost him the equivalent of \$50,000, and therefore demonstrated your willingness to (in effect) take \$50,000 from him. But if you’re willing to take \$50,000 from Bill for my benefit, the right way to do it is to confiscate \$50,000 in cash from him and hand it over to me —- that would presumably make me a lot happier than \$100 worth of sleep. So there’s no point in arguing about whether Bill should turn off his music; instead we should be letting him play the music and arguing about whether \$50,000 of his money should be redistributed to me.

As far as the pure redistribution goes, welfare analysis is silent on whether it’s desirable. Bill’s \$50,000 loss is exactly balanced by my \$50,000 gain. So welfare analysis says “Let Bill have his music, and you guys decide whether to do a monetary redistribution — I have no opinion on that”.

Note that the welfare analysis does not even require us to have a *notion* of utility, let alone to employ it.

My analysis of the minimum wage was a pure welfare calculation. It had nothing to do with utility.

29. 29 29 Twofer

If the welfare argument is the right guide to policy analysis, than the same CBO study tells us to increase the minimum wage to \$10.10: “Once the increases and decreases in income for all workers are taken into account, overall real income would rise by \$2 billion.”

http://www.cbo.gov/publication/44995

30. 30 30 Steve Landsburg

Twofer: Wealth maximization is not welfare maximization.

31. 31 31 RJ

@28

I see now, thanks. That was thorough.

32. 32 32 Capt. J Parker

I’m still with Boudreaux (even though the comment engine on Cafe Hayek is the worst). As a former min wage worker I submit my min wage job was worth more than its cash value. I might have preferred to get paid for not flipping burgers at MacDonalds but no one ever told me that was a realistic option and I naively accepted that state of affairs as a reasonable consequence of living in a time when voluntary exchange deemed acceptable. I still look back on my so called career at chez MacD and marvel at their methods of training, work organization, team building and quality control.

33. 33 33 Capt. J Parker

Continuing from 32

And if you were late for your shift you caught hell – not from the boss, you caught it from your co-workers. That’s team building writ large. Every dime I earned under the golden arches eventually got sucked up by college tuition. I’m tempted to say I got a greater dollar value for my education by Ray Kroc and company than I recieved sitting in a formal classroom.

34. 34 34 Twofer

@#30 “Twofer: Wealth maximization is not welfare maximization.”

I’m confused I suppose. In post #22 you wrote ““Welfare” and “efficiency” refer to exactly the same thing in this context.” If that is the case, then no change to minimum wage can be Paretto Efficient and therefore welfare maximizing. Somebody is always worse off no matter what the change. This doesn’t seem terribly interesting or enlightening. I think you kind of finesse the efficiency question in post #20 when you write: “By taking that job away from me, you can somehow cause your cousin Fred to be \$10K richer.” I think a real world example of how you can get your \$5K for not working, and cousin Fred can ‘somehow’ get his \$10K without somebody else being worse off would help.

My understanding of real-world welfare economics was more like the piece of the wiki definition provided in post #26: “In applied welfare economics, such as in cost-benefit analysis, money-value estimates are often used, particularly where income-distribution effects are factored into the analysis or seem unlikely to undercut the analysis.” The money value estimate the CBO put on this thing was real income would rise over \$2B. Of course in the report the CBO provides further cost benefit breakdowns including who is hurt and who is helped by the change. Overall the CBO in appears to be recommending the change.

35. 35 35 Steve Landsburg

Twofer:

Somebody is always worse off no matter what the change.

You are confusing Pareto efficiency with Pareto improvement. A move from a Pareto-inefficient outcome to a Pareto-efficient outcome need not be a Pareto improvement (and in fact usually isn’t).

The money value estimate the CBO put on this thing was real income would rise over \$2B.

You are confusing money value with real income. The “money value” that is relevant to welfare analysis includes not just changes in income but also, for example, the value of changes in leisure (measured in dollars).

36. 36 36 Twofer

@SL #35

Well, you are right. I’m confused, struggling to translate the pages of the textbook into actual policy analysis.

In post #20, you are indifferent to working a minimum wage job and not working for \$5K. Presumbably I pay \$5K for you to not work. I could argue that the \$5K is worth less to an employed me than it is to an unemployed you, or I could argue that paying you not to work pisses me off mightily and is therefore a net overall loss between us, but that type of utility evaluation was assumed away later in the same post #20. So from a overall welfare perspective, there is no net change associated with you getting paid \$5K for not working because your gain is my loss. So that piece of the example is neutral from a welfare perspecitve.

What I don’t understand in the example are two things:

1) It was pretty subjective as to how you just assumed that minimum wage jobs suck and they are worth half of minimum wage, it’s certainly a controversial assumption based on the comments above – Are there any studies/science around this or is it always a subjective guess?

2) I also don’t understand the mechanism around how taking the job away can somehow cause cousin Fred to be \$10K richer. How does that work? And why is it important?

It seems like I could make the same argument from the point of view of the employer instead of the employee and come up with a different set of conclusions. The employer pays minimum wage, but the value of the work performed is actually worth more to the employer than miniumum wage so the employee benefit is actually more than the employer loss so ‘the cost to employers just isn’t that high because all they are losing is some of the value they get out of employing somebody.” Perhaps this is where the \$2B in extra income comes from that the CBO is talking about.

I admit. I don’t understand what a welfare analysis to guide policy would look like in this case, but I can at least understand the cost benefit analysis the CBO attempted (which prior to reading this string I thought a cost benefit was about the best an applied welfare analysis could be).

37. 37 37 bigjeff5

@Twofer
“2) I also don’t understand the mechanism around how taking the job away can somehow cause cousin Fred to be \$10K richer. How does that work? And why is it important?”

This is all based on the estimate that if minimum wage rises to \$10.10 an hour, 500,000 people will lose their \$7.25 an hour jobs.
So you’re taking about \$15,000 from 500 thousand people, or \$7.5 billion, and giving it to 16.5 million people.

That’s where the taking from me to give to cousin Fred is important. Steve is saying that those \$15k jobs aren’t worth \$15k to the job holders. He’s saying they are probably worth more like \$5k. So instead of taking \$7.5 billion, from a welfare standpoint you’re only actually taking \$2.5 billion, yet are still able to spread \$7.5 billion around. This is where giving me \$5k to not work and giving Fred the \$10k difference becomes a very moral thing to do – you’ve just maximized the available welfare, since I didn’t care about that \$10k so long as I didn’t have to work.

Personally, I find Steve’s \$5k figure extremely dubious. It seems only natural that, since a company has to pay \$15k per employee, they are going to do everything they can to make sure that each such employee is actually worth \$15k. It’s only anecdotal, but Capt. J Parker’s story backs that up. More than likely, in my opinion, there isn’t anybody working full time who doesn’t value the job at or very near \$15k.

Those for whom the job is only worth \$5k will only work 1/3 of the time, not full time. Why would they give the company \$10k worth of work when they didn’t value that \$10k? These will be people who only work in winter, or in summer, or only work one or two days a week. More anecdote, but this is not a hypothetical scenario. I know people who do this personally; it’s not an uncommon thing. The average for all minimum wage workers should work out to pretty much right at \$15k.

38. 38 38 Twofer

@bigjeff5 #37

A bigjeff thank you for taking the time to help me with my understanding. This is where a message board is going to prove to be a challenge and I wish we could sit down over a cup of coffee and scribble on napkins instead.

I get the math, what I’m struggling to wrap my mind around is how theoretical it is and how it would actually work. I think I’m adding in an extra step that maybe I shouldn’t be. Because of a minimum wage policy change, 500K jobs disappear which are priced at ~\$7.5B.

Accepting for a moment that the given \$5K worth to the newly unemployed is correct (which I also think is way low), this means two payments are now due: One to the unemployed person in the amount of \$5K and one to the former employer in the amount of ~\$10K.

The step I’m adding in seems to be that I assume an almost entirely 3rd party taxpayer is the one paying the total ~\$15K/unemployed person, and I don’t see where this is taken into the total welfare account (I assume overall its neutral). Further I assume that unemployment insurance is analogous to the payment to the newly unemployed person in the amount of \$5K — So it’s easy to envision that payment because we basically have it today. What I can’t wrap my mind around is how this payment of \$10K to the former employer could ever be implemented in any practical sort of way.

I mean if I once had a struggling business dependent upon \$2/hour employees that is now no longer a business at \$7.25/hour, does that mean I’m entitled to some kind of payment too? How would I file my claim cuz I was ready to franchise? I don’t see any practical way to take the textbook theory and actually turn it into a policy. At which point this exercise appears to be a mathmatically buttressed way of saying abolish minimum wage laws entirely…and probably unemployment insurance too. Which are probably more questions about what kind of society we want to be.

FWIW – In this scenario as outlined by the CBO 16.5M people get a ~\$6k/year raise, officially lifting 900K of them over the official poverty line. This piece of the puzzle also seems to be getting overlooked in the welfare analysis (is it neutral because employee compensation is offset by employer payment – short term, higher consumer prices long term?)