Random thoughts of an economist

A redistribution effect of minimum wage legislation

Posted in Economics, Minimum wage, Regulation by kafuwong on May 4, 2011

Consider the low-end boutique market.  The low-end market is rather competitive.  Barrier to entry is almost none.  A typical boutique will buy clothes from other countries (likely mainland China) and sell them in Hong Kong.  To operate a boutique, we will need to rent a shop space, hire some salespersons, etc.  The “etc” can include a lot of things that I do not want to talk about.  I would like to focus on rental and wage of salespersons. 

Imagine that there is an influx of uneducated immigrants.  Since sales do not require much skill, an un-educated, unskilled person can do the job.  Thus, we expect the influx will lower the wage of salespersons in these low-end boutique.  If a typical boutique was earning a zero profit before, the lower wage due to the influx will give the boutique a positive profit. 

Did I say positive profit?  With an increase in profit, a lot of people will find operating a boutique more attractive.  Since there is no barrier to entry, some will want to enter the market.  What is needed to operate a boutique?  Salespersons and a shop, and etc.  Salespersons are not a problem.  The shop is.  In Hong Kong, land supply, and hence shop space supply, is rather limited.  So, new boutique entrants will have to compete with existing boutique owners for shops.  Consequently, the rental of shop space will rise.  As rental rises, the boutique owners will find themselves with a higher cost of operation and hence a lower profit.  When will the rise in rental stop?  It will continue to rise until the profit becomes zero again.   Of course, such adjustment will take a long time. 

What is the impact of the influx of immigrants?  The land owners gain and the salespersons lose.

Now, let’s talk about how minimum wage legislation will affect the rental to the land owners and the wage to the salespersons.  If a minimum wage is set higher than the prevailing wage of the salespersons, the shops will have to pay a higher wage to the salespersons.  If the boutique owners were earning zero profit before the legislation, they will incur a loss (or negative profit).  Negative profit drives some boutique owners to leave the market, releasing the shop space they rented before.  So, unemployment will result.  But more importantly, with a fixed supply of shop space, the smaller demand for shop space will drive the rental to fall gradually.  How far will the rental fall?  The rental will continue to fall until the boutique owners are earning zero profit again.  The fall in rental will encourage some boutique owners to stay or re-enter the market.  Likely, we will end up with the same number of boutiques in the market, hiring the number of salespersons.  Of course, this adjustment will take a long time.

To conclude, if we (including the salespersons and consumers) are willing to suffer in the short run, the minimum wage legislation is a way to redistribute income from shop space owners to salespersons.

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Minimum-wage-push inflation

Posted in Economics, Minimum wage by kafuwong on May 2, 2011

Imagine an economy with three persons (or three groups of persons), two workers and one capitalist. There is only one good in this economy — apples. The two workers differ slightly in productivity. John can produce twenty apples per hour and Tom can produce two apple per hour. The capitalist likes to keep half of the output herself and pays half of the output as wages. :Let the price of apples be $1 per apple so that John receives $10 per hour and Tom only $1 per hour.

Recently, John’s productivity has increased substantially and can now produce 200 apples per hour, and hence recieves $100 per hour.  Seeing the widening disparity (from 10 times to 100 times), Tom feels bad and would like to see a minimum wage legislation.  The minimum wage is proposed to be $10 per hour so that the disparity will be reduced to 10 times from 100 times.  The legislation is passed.  John feels bad now: “How come Tom had a 1000% increase in wage, but I have none?”  Thus, John goes to ask his boss to a pay rise.   John’s boss accommodates a little. 

With higher income, Tom can afford to buy more apples, driving the price of apples to go up.   The increase in the price of apples allows John’s boss to pay more to John.  Now the price of apples goes up due to the increase in John’s income.  The adjustment process would stop when the price of apples reaches $10 per apples, and John’s wage is now $1000 per hour.  In real terms, John still gets 100 apples per hour and Tom 1 apple per hour.  Now, we are back to square one, aren’t we? 

Seeing the disparity to return to the initial situation (100 times), Tom asks to adjust the minimum wage.  Assume that Tom target the disparity to be 10 times.  He asks for a 10 times increase in minimum wage.  The story goes on. ….

It is not hard to imagine that such cycle repeats over time.  Inflation then results.  If we assume that the above adjustment takes one year to complete, we will have 1000% inflation per year. 

The real world is of course more complicated than this story.  However, the idea of minimum-wage-push inflation cannot be dismissed. 

[Additional assumption for the curious readers: Central bank sets the interest rate but do not control the money supply.  Thus, the story above is still consistent with Milton Friedman’s famous quote that “inflation is always and everywhere a monetary phenomenon” (http://en.wikipedia.org/wiki/Milton_Friedman).]

Minimum wage legislation as a tool of income redistribution?

Posted in Economics, Hong Kong, Minimum wage, Nguyen Phuong Thuy, Regulation, teaching by kafuwong on October 29, 2010

[Written jointly with Nguyen Phuong Thuy]

Although most economists believe that free market is most efficient, a lot of markets remain regulated.  Labor market is among the most highly regulated.  Most countries have implemented minimum wage.

Hong Kong, the freest market economy, (http://www.heritage.org/index/country/HongKong), is setting a minimum wage in its labor market as an effort to reduce poverty, income disparity and to achieve social stability. The city passed its first-ever minimum wage bill on July 15, 2010, after a long and heated debate among legislators.

The government says the minimum wage will benefit more than 18% of the city’s population who are living in poverty and boost consumer spending. The legislation is also expected to help narrow the rich-poor gap.

At the time of writing, the level of minimum wage is being finalized.   The Labor Union wants at least $33 per hour.  A group of employers say they can only afford hourly wages in the range of $24 to $25, and that any high floor will lead to layoffs and even push them into bankruptcy.

Honestly, I fail to understand why the minimum wage legislation helps underpaid workers in aggregate.  We can understand that the legislation may help the currently underpaid workers to earn more. However, an underpaid person will bring home more bread only if he continues to be employed under the new legislation.  The problem is that the competition in Hong Kong is so keen that small and medium enterprises can barely survive.  The legislation will raise cost and consequently reduce profit.  Chances are that some marginal companies cannot survive under the new legislation and will have to close.  Chances are that some marginal companies will reduce labor usage.  In short, employment will suffer.

Who is the most likely to lose their jobs? Those who were previously paid well below the minimum wage! If wages are proportional to productivity, we can imagine that the most unskilled, disabled and elder workers, who are supposedly intended beneficiaries of the legislation, will suffer the most.  Their suffering is due to the loss in employment!

Of  course, these people will most likely fall into the social security safety net, adding to the burden of the government, and hence the taxpayers.  In this sense, the minimum wage legislation is an indirect way of redistributing the wealth from the rich to the poor.  [Of course, the follow-up question is whether this way of redistribution is better than its alternatives.]

The extent of the legislation’s impact is an empirical issue.  In the next few years, we need to watch the figures of employment and figures of social security recipients closely.

[Jointly written by Nguyen Phuong Thuy and Ka-fu Wong]