What is a better theory of the labor market? Maybe general equilibrium (which might say that immigration creates its own demand). Maybe a model with imperfect competition (which might say that minimum wage reduces monopsony power). Maybe search and matching theory (which might say that frictions make all short-term effects pretty small). Maybe a theory with very heterogeneous types of labor. Maybe something else.
Pointer from Mark Thoma.
This is the middle of the movie, so to speak. At the start of the movie, Smith looks at two stylized facts about the short run. One is that an immigration surge has little effect on wages. This suggests that labor demand is highly elastic. The other is that a minimum wage increase has little effect on employment. This suggests that labor demand is highly inelastic. It cannot be both.
Of course, you do have the option of denying the veracity of one or both stylized facts. But I do not want to go there. I vote for “very heterogeneous types of labor.” There is no such thing as “aggregate labor demand” in the labor market. There are patterns of specialization and trade. And these tend to be sticky, both in terms of wages and the quantity of each type of worker employed.
The “labor market diagram” makes it appear that you can have either a sticky wage or a sticky quantity of labor, but not both. Behind this (false) theorem lies the presumption that it is very easy to substitute among workers. This is an instance in which mathematical modeling serves to confound rather than help the modeler.
In fact, workers are specialized. Even relatively unskilled workers have been trained to perform their particular tasks. The substitutability that is implicit in the labor market diagram does not exist in the real world.
Labor market adjustment comes primarily from changes in the patterns of sustainable specialization and trade. Because it takes time for old patterns of trade to become unsustainable and for new sustainable patterns to form, neither wages nor quantities change as much in the short run as they do in the long run.
The effect of the minimum wage in the short run on existing firms can be small. They mostly just suck it up and pay the higher wage. However, over time, there will be a tendency for processes that use low-skilled workers to be less profitable and processes that instead use capital and high-skilled workers to be relatively more profitable. So the patterns of specialization and trade that break up will tend to be those that have been employing low-skilled workers, and the new ones that form will tend to employ fewer low-skilled workers than would have been the case otherwise.
As for immigration, what Noah calls general equilibrium I call creating new patterns of specialization and trade. There is no “lump of labor demand” that immigrants and natives are competing to fill. Firms do not say, “Oh, goody. Now I can now fire my native workers and hire immigrants for $1 an hour less.” Instead, entrepreneurs who are thinking of starting firms ask, “Where can I get the best workers for the least cost?” And in many cases immigrants are the answer. As this process plays out, my guess is that the main wage-depressing effect is on native workers just entering the labor force. But of course a lot of them have specialized skills that insulate them from competition from immigrants. So the effect on natives’ wages is limited in scope and stretched out in time.
This is so very important:
“The substitutability that is implicit in the labor market diagram does not exist in the real world.”
Even among office workers, those with experience in a big company, IBM, or Google; Ford or Exxon, they have experience and knowledge that has the most value for that firm.
Recently I spent a couple of years learning most of the details about a complex customer master system — but last year management decided to sunset the whole system. Lots of “experience” down the tubes. Virtually no transfer to any other company; and not so much inside the current company.
Most positions assume that there will be some good amount of local training for new folk “doing work”. Currently there’s a bit of a paradox in that most “management” doesn’t need to know nearly so much, merely how to tell folk what to do, what reports need to be written, what needs to be included on the reports — and when there’s not enough to do it all, what are the really most important things to do (doing this well is a good skill; one many techies don’t have.)
One undiscussed reason for increasing inequality is how so many middle class folk are learning specialized knowledge in their current jobs, which actually has no value to most alternative possibilities.
(As a more techie oriented guy, I’m learning Python now…)
Good post except I have a problem with the ending:
” But of course a lot of them have specialized skills that insulate them from competition from immigrants.”
Don’t you mean that they have specialized skills that happen to be protected from immigrants with the same skills through the power of regulations and the AMA and ABA, etc?
That’s certainly a good point. But he may mean that they can speak English.
In accepting that the minimum wage has little short run effect on total employment, you also assume it has no impact on composition. It is entirely possible (and likely) that it pulls slightly more productive workers into the labor force, and pushes slightly less productive ones out of it. Without that, there isn’t the paradox you note.
Of course this is testable with labor force participation rates.
‘Firms do not say, “Oh, goody. Now I can now fire my native workers and hire immigrants for $1 an hour less.”’
Ha, but they do say “Oh goody, I can fire my native workers, move the job overseas, and hire foreigners for $15 an hour less”. But yeah, I think that job market changes due to immigration and technology will play out in attrition at the employee level within firms (Bob just quit, lets install an ordering kiosk instead of hiring another cashier) and among firms as they go out of business entirely due to competition against more compelling firms