University of St.

Gallen
VW 75
Spring Semester 2014

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

University of St. Gallen

VW 75
Spring Semester 2014

Abstract:
SincethefirstminimumwagelawwaspassedinNewZealandin1984,thedebateoverthe
relevanceofsuchlegislationshasalwaysbeenaround.However,economists,innowmore
thanacentury,havenevercometoaconsensusonthematter.
Whereasmosttextbookshaveadoptedaneoclassicalperspectivecriticizingthoselaws,others
believethisneoclassicalmodelisincoherentandtendtoargueinfavorof(high)minimum
wages.Renownedamongthemarethepostkeynesians.
Relyingonpostkeynesianandneoclassicaltheoreticalfindings,aswellasmanyempirical
studies,thispaperisanattemptatunderstandingandcomparingtwoprevailing,andradically
different,viewsonanidenticaltopic.

University of St. Gallen

VW 75
Spring Semester 2014

Table of Contents

1INTRODUCTION...............................................................................................................4
2. THE NEOCLASSICAL PERSPECTIVE
2.1NeoclassicalTheory..........................................................................................................5
2.2NeoclassicalEconomicsonMinimumWages..................................................................6
2.3NeoclassicalEmpiricalStudies.......................................................................................11

3. THE POST-KEYNESIAN PERSPECTIVE

3.1PostKeynesianTheory...................................................................................................14
3.2.PostKeynesianEconomicsonMinimumWages..........................................................16
3.3PostKeynesianEmpiricalStudies..................................................................................20
4.CONCLUSION.................................................................................................................24
5.DECLARATION OF AUTHORSHIP.........................................................................25
6.BIBLIOGRAPHY.............................................................................................................26
7.FIGURES...........................................................................................................................28

University of St. Gallen

VW 75
Spring Semester 2014

1 Introduction
Forbiddingcompaniestopaywagesinferiortoacertainthresholdhasimportanteffectsonthe
labormarketandevenontheglobaleconomy.Indeed,wagelevelsinfluencenotonlythe
ratesofemployment,andthelivingconditionsofpartofthepayroll,butalsoacountryslevel
ofeducation,howmuchoutsourcingisdonetocountrieswhere(minimum)wagesarelower,
andevenmarketpricesandthereforeratesofinflation.Yet,allaroundtheworld,andfor
morethanacenturynow,sincethefirstminimumwagelawwaspassedinNewZealandin
1894(TheEconomist,2001),economists,policymakers,businessowners,andmanyothers,
haveneverceaseddebatingoverthevaryingadvantagesanddisadvantagesofminimumwage
laws,andlikeoftenineconomics,thereisnoconsensusamongeconomists.
Indeeed,thereisalongstandingtensionineconomicsbetweenbeliefintheadvantagesof
themarketmechanismandawarenessofitsimperfections.(Solow,1980,p.1).
Thus,supportersandopponentsofmarketbasedeconomicpoliciescometoverydifferent
conclusionwhenitcomestodiscussingtheimpactsofpricefloorssuchasminimumwages
(abbreviatedMW).
Infact,therearemanyschoolsofthoughtsonthesubjectandamongthem,theneoclassical
andpostkeynesianapproaches,basicallyarguingrespectivelyagainstandinfavorofhigh
MW and tackling the subject in two completely different ways making it particularly
interestingforonetoconfronttheirpointofviews.
This paper is organized in two sections. Beginning with the analysis of the neoclassical
perspective,thispaperwillstartbyformerlydefiningwhatneoclassicaleconomicsactuallyis.
Then,sinceeffectsofMWonthelabormarkethavefacedextensiveacademicattention,this
willallowustocontinuebypointingoutwhatargumentsarebroughtforwardbyneoclassical
economistsregardingtheaftermathofMWlaws.Atlast,theseargumentswillbesupported
byempiricalstudiescomingtoneoclassicalconclusions.Symmetrically,inthesecondpartof
this work, I will proceed in the exact same way when addressing the postkeynesian

University of St. Gallen

VW 75
Spring Semester 2014

perspective,andthenconcludeonwhatwehavegainedfromconfrontingthosetwovery
differentviewpoints.

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,etcandthenattempttodrawconnections.
(Resnick&Wolf,2012,p.36)
Thestartingpointintryingtoestablishthoseconnectionsaretheactorsrationalpreferences
constrainedbytheinformationavailableaswellasincomesforindividualsandfactorsof
productionlikethetechnologyavailableforfirms.Neoclassicalmodelsindicatethatthemost
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,onceoneorafewdetermining,essentialcauseshavebeenfound,theneveryevent
canpotentiallybeexplained.(Resnick&Wolf,2012,p.38)
Nevertheless,asreductionistasitmaybe,worldwide,theneoclassicalmodelisverypopular
andevenconsideredtobethedominanteconomicsmodelofourlifetime.Thereforemany
neoclassical economics is often referred to as mainstream, orthodox, or conventional
economics.(Keita,1992,p.6)
Thismainstreammodelsuggests,thattheprivate,decentralized,competitivemarketisself

University of St. Gallen

VW 75
Spring Semester 2014

correcting,andwillthuscorrectanykindofoccasional,temporary,marketimperfection.
(Palley, 2004, p.1) Therefore neoclassical theory clearly points in the direction that the
economywillbestmanageitselfwhenmarkets,solutiontoagentsmaximizationproblems,
arenotinterferedwith.
Hence, no matter how good the states intentions are, external intervention aiming at
controllingthemarketeconomy(inourcaseregulatingthelabormarketandsettingMW)will
only undermine the markets 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
rescuecollapsedmarketswhereasprivateborrowersshouldbetakingcareofitinstead.In
fact,privatedecisionsofindividualsandbusinessesreactingtoandtakingadvantageofthe
marketpowerwillalwaysbeconsideredasbettermeanstosolveeconomicissues.
Consequentlyinstitutionsarecompletelydeemphasizedandthusthestartingpointofall
neoclassicalthinkingis microeconomics.Inotherwordsanefficienteconomyandsocial
welfarecanonlybeobtainedviaderegulatedmarkets.Fromthisbasicassumptioncomesa
widerangeofneoclassicaltheoriesaboutvariousareasofeconomicactivity.Thereforeitis
notsurprisingtoseethatneoclassicaladministrationslikerepublicansargueinfavorofless
governmentinterventionandthereforenoMWastheybelievethatfreemarketswillnotlet
valuablefactorsofproduction,includinglabor,gotowaste.Instead,priceswilladjustto
ensurethatdemandforlaborisforthcomingandthatallfactorsareemployed.(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
interventionwillonlyleadtoaninefficientlabormarket.
Indeed,theneoclassicalmodeldemonstratesthatflexiblewageratesarekeyforsupplyand
demandforlabortocoincide,thuseliminatingshortagesandsurplusesinthelabormarket

University of St. Gallen

VW 75
Spring Semester 2014

while determining appropriate real wages. Therefore, the neoclassical theory gives the
impression that market forces alone tend to establish full employment. Consequently,
governmentpoliciesattemptingtoreduceinvoluntaryunemploymentappeartobeabsolutely
unnecessary.

Indeed, exogenous shocks such as MW laws can only lead to price distortions and
consequentlyinefficienciesinthemarket.(Asiamonitor,2010,p.6).Thus,sincethemarket
ensures that factors of production are paid what they are worth, price floors preventing
downwardadjustmentofsalaries,aswellasotherobstacleslikesocialprotectioninstitutions
and strong trade unions for instance, actually lower social wellbeing and cause
unemploymentbyinterferingwiththemarketprocess.(Palley,2004,p.4)
Infact,forneoclassicaleconomists,thereasonswhyMWnotonlydonothelpbutactually
disservetheonestheyweresupposedtohelpinthefirstplace(i.e.theunskilledworkers)are
prettystraightforward.
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
demandforlabormayleadtoverylowwages(especiallyforunskilledworkers).Eventhough
governmentscantsimplyignorethedistresscausedbyextremelylowwages,neoclassical
economistsbelievethatrelyingonMWtoartificiallyincreasetheincomesoflowskilled
workers;inotherwords,tofightagainstthemarketratherthantomakeuseifitspowerto
addressthosewhosufferfromtheoutcomeofsupplyanddemand,isperilousandunlikelyto
beeffectivesinceitsbasedontwoerrors.(Stiglitz&Walsch,2006,p.91)
The first error is to assign the responsibility to someone (or a group): in our case, the
employer.Neoclassicaleconomistsinsistthatitisanonymousmarketforcesthatdetermine
equilibriums.Therefore,thereasonsforchangesinequilibriumslieinthemarketitselfand
notinaparticularactorofthismarket,namelytheemployer.(Stiglitz&Walsch,2006,p.91)

University of St. Gallen

VW 75
Spring Semester 2014

Thesecondmistakeisthatnomatterhowpowerfuloneis,onecantinterferewiththelaws
ofsupplyanddemand(nomorethanitcan,forinstance,interferewiththelawofgravity.)By
attemptingto,theresultwillbeamarketoutofbalancewitheitherexcesssupplyorexcess
demand. Stiglitz &Walsch (2006) summarize it in a small sentence one ignores the
workingsofthelawofsupplyanddemandonlyatonesperil(p.94).
Thats why conventional wisdom in economics states that by forcing up MW above the
equilibriumwage,supplyforlaborwillexcessdemandforthelatterandthesurplusescreated
will, inexorably, lead to unemployment, or underemployment at least. Moreover, quite
logically,thebiggerthedifferencebetweentheequilibriumwageandtheMW,thebiggerthe
surplus. Therefore, labor markets, either with low equilibrium wages (reflecting low
productivity)orwhereMWaresetatahighlevel,willbeparticularlyexposedtojoblosses.
Onanotherhand,ifthedifferencebetweentheMWandthemarketequilibriumisminimal,
then the distortion will be insignificant and in that case, neoclassical economists wont
considerMWtobeaproblemanymore.
Whenthedifferenceissignificanthowever,settingarbitraryMWabovetheequilibriumwage
preventsamarketfrommovingtowarditsnaturalequilibriumprice,leadingtoshortagesin
demandforlabor.

University of St. Gallen

VW 75
Spring Semester 2014

Figure 1.Supply Surplus From Price Floors.This figure illustrates that in a competitive
marketemploymentwillfallifthewageisexogenouslyraised.AtW 1>W0,quantityoflabor
demandedhasdecreasedfromL0toL2whilethesupplyoflaborhasincreasedfromL 0toL1.
ThereforethesurpluscausedbytheinstaurationofaMW,inotherwordstheunemployment,
isthedifferencebetweenL1andL2.
Moreover,MWlawsareoftenthefirststepofacyclemakingallwagesrise.Namely,after
workerswithlowerskillsareraisedtotheMW,morequalifiedworkerswhousedtoearnthe
amountnowcorrespondingtotheMWwillinturnseekhigherwagesthusintensifyingthe
distortionsinthemarket.
Tofullyunderstandtheneoclassicalperspectivehowever,onealsohastounderstandwhy
firmsdecidetohireornottohireinthefirstplace.Tosimplifythings,weconsideramodelin
whichlaboristheonlyfactorofproduction.Thereforedecisiontoproduceisequivalentto
decisiontohire.Hence,oncethemarketpriceofagood(orservice)isknowntoafirm
(regardlessofwhetherthefirmactsasapricetaker,orpricesetter),dependingonitsmarginal
costcurve,itwillseehowmuchunitsifthisgooditcanproduce.Logicallythehigherthe
price,themoreacompanywilldecidetoproduceandconsequentlyhire.(Stiglitz&Walsch,
2006,p.182)

Fig.2,TheDemandforLabor.ThesetwographsillustratewhatlaborinputL 1isrequiredin
ordertoproduceacertainlevelofoutputQ 1.GraphA:Lookingatpricep1,thefirmwillknow
whatoutputQ1 toproduce.GraphB:LookingatoutputQ1,thefirmwillknowhowmuch
laborL1tohireinordertoproduceQ1.

University of St. Gallen

VW 75
Spring Semester 2014

10

Sticking with the conventional analysis, while keeping in mind that firms are always
consideredtobepricetakersinthemarketforlabor,thereisanotherwayoflookingatfirms
decisiontohire.Itisprettysimple,they"hirelaboruptothepointatwhichthevalueofthe
outputproducedbythelastworkeremployedequalsthemoneywagewhichheorshemustbe
paid.(Appelbaum,1979,p.40)
Asaconsequence,thelowertheequilibriumwage,thelowerthevalueofamarginalworker,
andthemoreworkersfirmscanhire.Thusneoclassicalanalysisinsistsonthefactthatonce
MWareinstituted,theoneswhomanagetogetajobmightbebetteroff;butbecausethe
modelsuggeststhathighMWleadtounemployment,mostoftheunskilledworkersarelikely
toloosetheirjobsandbedrivenintodrivenintoextremepovertyinstead.Infact,MWmakeit
impossibletosharethepieinmorebutsmallerpieces.Inthisway,MW,byforbidding
basicworktobepoorlycompensatedpenalizethelessskilledfractionofthepayrollasitis
excludedfromthelabormarket.Therefore,inthesimplest,asinthemoresophisticated,
neoclassicalmodelsofemployment,unemploymentisessentiallycausedbyexcessivereal
wages.(Lavoie,1998,p.17)Thus,iftheobjectiveofMWlawsistoeradicatepoverty,then,
theMW,fromthisperspective,seemscounterproductive.

Fig.3,TheDemandCurveforLabor.Thisfiguredescribeshowanincreaseinwagesleadsto
unemployment.Sincedemandforlaborcantexceedthevalueofamarginalworker,atwage

University of St. Gallen

VW 75
Spring Semester 2014

11

w1>w2,employmentisL1<L2andatwagew2>w1,employmentisL2<L1
The model explained here above explains why according to neoclassical economists,
mandatinganarbitraryMWisanimproperpublicpolicymeasuresmakingithardertoreduce
unemployment.However,onecouldarguethat,byslightlyincreasingtheirprices,firmscould
beabletopayouthigherwageswithoutithavinganyeffectsonemployment.Neoclassical
economistsrespondthatbystatingthatinanincreasinglycompetitiveeconomy,youcant
realisticallyexpectfirmstoraisetheirpricesinordermakeadjustmentsintheirlaborforce
withouttheirproductslosingmostoftheirvalueintheeyesofthecustomers.(Rivera,1999)

2.3 Neoclassical Empirical Studies

Theperspectivedescribedinthepreviouschapterisconsistentwithseveral(recent)empirical
studies suggestingthatincreasingwagefloors has unfortunateeffects ontheemployment
opportunitiesofuneducatedworkers.
Amongthosestudies,theonesofProfessorsDavidNeumarkwhocomparedUScitiesand
countriesthatimplementedlivingwagestothosethatdidnot.Whileresultsslightlyvaryfrom
study to study, they all come to the conclusion that MW cause (small) reductions in
employment,especiallyamonglowskilledworkers(Neumar&Wascher,2008).
For instance, Neumark and Adams (2003) found that a 10% increase in MG reduces
employmentby1.3%forthosewithlowlevelsofincome.Twoyearslater,twoindependent
studiesconductedbythesameprofessorstransformedthat1,3%intoawiderrangeoscillating
between1.2%and1.8%(AdamsandNeumark,2005).Moreover,byfindingthatlivingwage
in Los Angeles reduced employment by 1.0% with every 10% increase, Fairris (2005)
confirmedthetendencyoflivingwagepoliciestocauseslightjoblosses.1

1 TheresultsofallthestudiesmentionedinthisparagraphareexposedinKarabegovic&
Veldhuis,2011,p.7&8

University of St. Gallen

VW 75
Spring Semester 2014

12

EmpiricalevidenceontheeffectsofMWincreaseinVietnamisveryinterestingaswell
becausetherearecontinuingdebatesaboutpositiveandnegativeimpactsofMWincreasesin
thisdevelopingcountrywhichhasseenitspovertyratesdropfrom58to16percentbetween
1993and2006.(Nguyen.2013,p.584)
Nguyensempiricalstudy(2013)indicatesthat,eventhoughtheoverallimpactsofthenine
adjustmentsinMWthatoccurredduringthatperiod(allofthelatterbeingincreases)were
small,theydidsignificantlyreduceemployment,informalsectorsinparticular,andwere
thereforenotthereasonforthedownfallinthecountryspovertyrates.
Moreover,7yearsago,NeumarkandWascher(2007;2008)reviewedmorethan90empirical
studies,movingbeyondtheissuesthataroseoutofthefirstroundofthenewminimumwage
research(p.43).Thus,theyprovidedmoredetailsontheproceduresandresultsforthese
studies as well as more evidence from industrialized countries as well as developing
countries.Theresultsareprettydifficulttointerpret,however,theytendtomatchupasa
substantialmajorityofthestudiesinthemonographrelativelyconsistentlyconcludethatthe
lowwage labor market can be reasonably approximated by the neoclassical model,
reinforcing the idea that minimum wages reduce employment of lowskilled workers.
(p.166)Moreover,theconsensusemploymentelasticitywassetinarangefrom0.1to0.3
(i.e.a10%increaseinMGleadstoadditionalemploymentof1to3%)suggestingthateven
though MW cause unemployment among lowskilled workers, the effects are relatively
modest.(p.163)
However, right after this study was published, Fairris and Bujanda (2008) examined the
impactoftheLosAngeleswagepolicyandfoundempiricalevidenceofanotherperverse
effectofMWonthelabormarket.Tocompensateforwageincrease,employerstendcut
downhoursthenumberofhoursand/orovertimehoursduringwhichemployeescanbepaid.
Theresultisadecreaseinweeklywages.Therefore,evenifworkersareluckyenoughnotto
befiredafterMWareinstituted;theymayactuallynotbemuchbetteroff.Hence,whenthe
living wage was implemented in Santa Fe, workweeks were shortened by 1.6 hours on
averageandeven3.5hoursforthosewith12yearsofeducationorless(Yelowitz,2005in
Karabegovic&Veldhuis,2011,p.8)

University of St. Gallen

VW 75
Spring Semester 2014

13

Whatsmore,theNewYorkStatehasratherrecentlysubstantiallyincreasedtheamountof
theStatesMWandtheeffectsofthatraisehavebeeninvestigatedbyBurkhauseretal.
(2012).TheirresultsprovidessomepersuasiveindicationsthatgenerousMWincreasescan
actuallyhaveconsiderableadverseeffectsforthemostvulnerablepartoftheworkforce,with
elasticitiesfarfromtheconsensusrangeof0.1to0.3.(p.372)
Indeed,bycreatingauniquesetofcircumstancesenablingthemtoisolatetheeffectofaMW
hikeonyounger,lesseducated,lowerskilledindividuals,Burkhauseretal.(2012)found
robustevidencethatraisingtheNewYorkMWfrom$5.15to$6.75perhoursignificantly
reducedemploymentratesoflowskilledNewYorkerworkers.Theirestimationsshowthat
theemploymentratesofthe16to29yearsolduneducatedworkersmovedfrom20.2to21.8
%,implyinganelasticityofaround0.7!(p.372)
Atlast,theeffectsofthemostrecentglobalcrisisonunemploymentarealsoilluminatingfor
neoclassicaleconomists.Ofcourse,MWlawsarenttheonlyelementtoaffectemployment
andthelabormarket.Therefore,theydontdeterminealonethelivingconditionsofpoor
workers.Anappropriateanalysiswouldhavetobemuchbroader.Nevertheless,toseethat
Spain,partlybecauseofitsinflexiblelaborlaws,hastodealwithunemploymentrateofover
25%whiletheUS,consideredtohaveamoreflexiblelabormarket,aredoingfourtimes
betterwithhasanunemploymentrateofunder7%isnosurpriseforneoclassicaleconomists.
Thats without mentioning the extremely low unemployment rates of countries, like
Switzerland,withnoMWandthereforeveryflexiblemarkets
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-

University of St. Gallen

VW 75
Spring Semester 2014

14

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.

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.

University of St. Gallen

VW 75
Spring Semester 2014

15

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 doesnt 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.
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 cant 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, doesnt 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

University of St. Gallen

VW 75
Spring Semester 2014

16

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).
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 countrys 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 cant be the result of

University of St. Gallen

VW 75
Spring Semester 2014

17

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

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 L S 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 arent
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)

University of St. Gallen

VW 75
Spring Semester 2014

18

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 W b 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 arent 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
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
cant 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. Postkeynesians believe that if wages are pushed up, aggregate demand and business volume will

University of St. Gallen

VW 75
Spring Semester 2014

19

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 dont want to go bankrupt, firms faced with high wages
are forced to quickly and massively invest in advanced equipment and eliminate all
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 arent 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

University of St. Gallen

VW 75
Spring Semester 2014

20

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 postkeynesians. 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
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.

University of St. Gallen

VW 75
Spring Semester 2014

21

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 dont 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.

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 didnt
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 Krugers 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 cant 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

University of St. Gallen

VW 75
Spring Semester 2014

22

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 dont argue that instituting such legislations would be the panacea to resolve
all of the countrys problems. However, according to professor Huis researches (2013),
because of the countrys 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
would reduce dependence on foreign labor, while state financial assistance to poor workers
would drop. Most importantly, MW laws would help increase Singapores 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 Indonesias lowskilled 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 countrys real problem
is a lack of aggregate demand because of a demand-constrained economy, where firms arent
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 economys long-term potential, by dragging down

University of St. Gallen

VW 75
Spring Semester 2014

23

investment and employment, is the countrys 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),

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 doesnt 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.

University of St. Gallen

VW 75
Spring Semester 2014

24

4. Conclusion
Nowthatthetwocontrastingmodelsofthelabormarkethavebeenanalyzed,onerealizesthat
wedonthave,ononeside,thegreedyneoclassicaleconomistswhobelievethattheonly
socialresponsibilityofbusinessistoincreaseitsprofits(MiltonFriedman,1970)andthat
lowwagesarejustawayofalwaysmaximizingprofits,andexploitvulnerable,unskilled,
workers;andontheotherthepostKeynesianswhoargueinfavorofhighMW,since,even
thoughtheymightbealittledisconnectedfromtherealityofthelabormarket,pursuethe
noblegoalofmakingsurethatcompaniesdonttakeadvantageoftheiremployeesandthe
lackofregulations.
No,infact,wehavetwodifferentschoolsofthoughtsbasingtheirrationalargumentontwo
different economic models linking individuals to society as a whole in opposing ways.
Thereforethedifferencesbetweenthetwoviewpointsarefarmorecomplex,interestingand
deeperthanonecouldthinkatfirst.
Eventhoughonemodelmightbemoreappropriatethantheotherdependingonthecontext,I
have tried to remain as neutral as possible and do not wish to take position since until
additionalfruitfulresearchiscarriedout,noone(yet)canofferdefinitiveevidence.
Atlast,Idliketohighlight,thatinadditiontoalltheinsightIgainedonthefascinatingMW
problematic,IalsolearnedthatinourManichaeanworld,wherewealwaystrytosetclear

University of St. Gallen

VW 75
Spring Semester 2014

25

boardersseparatingblackfromwhite,goodfrombad,rightfromwrong,inrealitythingsare
sometimes(often)morecomplex.Therefore,thispaperhasremindedmethatinacademic
studies, as well as in life, there are usually more than one conventional way to look at
political,sociological,ecological,oreconomicalissues;andthereforemorethanonepossible
response.

5. Declaration of Authorship
I hereby declare
- that I have written this work on my own without other peoples 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

University of St. Gallen

VW 75
Spring Semester 2014

26

6. Bibliography:
Anonymous (1999), Minimum wage for British workers, The Worklife Report, 11 (4): p.18
Adams, S. (2013), Forbes: The Minimum Wage Debate: Who's Right? Retrieved from
http://www.forbes.com/sites/susanadams/2013/11/11/the-minimum-wage-debate-whos-right/
Appelbaum, E. (1979), Post-Keynesian Theory: The Labor Market. Challenge, 21(6):
39-47
Asia monitor (2010), Minimum Wage Will Likely Lead To Job Losses. CHINA & NORTH
EAST ASIA, September 2010. Retrieved from http://www.asiamonitor.com/file/92705/macroeconomic-forecast-hong-kong.html
Burkhauser, R.V., Hansen B. & Sabia, J. J. (2012), Are the Effects of Minimum Wage
Increases Always Small? New Evidence from a Case Study of New York State. Industrial and
Labor Relations Review, 65 (2): 350-376
Breedon F., Miles D. & Scott A. (2012), Macroeconomics, Understanding the global economy
(3rd ed.). West Sussex, UK. John Wiley & Sons Ltd.
Card, D. & Krueger, A. B. (1994), Minimum Wages and Employment: A Case Study of the
Fast-Food Industry in New Jersey and Pennsylvania. American Economic Review, 84 (4):
772-793
Chowdhury, A. and Islam, I. (2011), A Critique of the Orthodox Approach to Indonesia's
Growth and Employment Problems and Post Keynesian Alternatives. American Journal of
Economics and Sociology, 70: 269299. DOI: 10.1111/j.1536-7150.2010.00771.x
Galbraith, J.K (1978). On Post Keynesian Economics: Journal of Post Keynesian Economics,
1(1): 8-11.
Holt, R. P. F. (2007), Empirical Post Keynesian Economics: Looking at the Real World.
Armonk, NY: M.E Sharpe, Inc.
Holt, R. P. F. & Pressman, S. (2001), A New Guide to Post-Keynesian Economics. London,
England : Routledge.

University of St. Gallen

VW 75
Spring Semester 2014

27

Hui, W. T. (2013), Croissance conomique et ingalits Singapour: plaidoyer pour un salaire

minimum. Revue internationale du Travail, 152: 117134. DOI: 10.1111/j.15649121.2013.00172.x

Karabegovi A. & Veldhuis N. (2011), The economic impacts of living wage policies, Fraser
Forum, January/February 2011: 7-9. Retrieved from
http://www.fraserinstitute.org/uploadedFiles/fraser-ca/Content/researchnews/research/articles/economic-impact-of-living-wage-policies.pdf
Kaufman, B.E. (2010), Institutional Economics and the Minimum Wage: Broadening the
Theoretical and Policy Debate: Industrial and Labor Relations Review, 63 (3): 427-453
Keita, L. D. (1992), Science, Rationality, and Neoclassical Economics. Newark, Delaware:
University of Delaware Press
Krasniqi, M. (2007): Changing Attitudes towards Minimum Wage Debate: How is The
Neoclassical Economic Theory holding in the face of a New Era of Minimum Wage Studies?
New Voices In Public Policy, 2(1): 1-15
Lavoie, M. (2010), A Comparative Analysis of the Post-Keynesian Theory of Employment
Retrieved from http://aix1.uottawa.ca/~robinson/english/a/a_10_mexico.htm
Levinson S. (2014), Elite Daily: Wall Street Bonuses Are Worth More Than The Annual
Earnings Of Everyone On Minimum Wage Combined. Retrieved from
http://elitedaily.com/news/business/wall-street-bonuses-are-worth-more-than-the-annualearnings-of-everyone-on-minimum-wage-combined/
Neumark D., Wascher W. L. (2007), Minimum wages and employment. Foundations and
Trends in Microeconomics, 3 (1-2): 1-182. DOI: 10.1561/0700000015
Neumark D., Wascher W. L. (2008), Minimum Wages. Boston, Massaschusetts : MIT Press.
Nielsen, R. (2012), The Advantage Of The Minimum Wage. Retrieved from
http://robertnielsen21.wordpress.com/2012/07/27/the-advantage-of-the-minimum-wage/
Nguyen, C. V. (2013), The impact of minimum wages on employment of low-wage workers.
Economics of Transition, 21(3): 583615. DOI: 10.1111/ecot.12022
Pally T. I. (2004) From Keynesianism to Neo-liberalism: Shifting Paradigms in Economics. In
Johnston D. and Saad-Filho A. (eds.), Neo-liberalism: A Critical Reader. (pp. 1-9). London,
England: Pluto Press.
Prasch R. (1996), In Defense of the Minimum Wage. Journal of Economic Issues, 30(2): 391397
Resnick, S. A. & Wolff R. D. (2012), Contending Economic Theories: Neoclassical,
Keynesian, and Marxian. Boston, Massaschusetts: MIT Press.

University of St. Gallen

VW 75
Spring Semester 2014

28

Rivera R. (1999), Rethinking the Minimum Wage and Welfare Policy symposium. Nations
restaurant News, July 5, 1998, 26/58
Root, G. N. (2014), Minimum Wage: Pros & Cons. Retrieved from
http://smallbusiness.chron.com/minimum-wage-pros-cons-2765.html
Sapsford, D., Bradley, S., Elliott, C. and Millington, J. (1999), The European economy: labour
market efficiency, privatisation and minimum wages. Industrial Relations Journal,
30(4): 291312. DOI:10.1111/1468-2338.00127
Seccareccia, M. (1991), Salaire minimum, emploi et productivit dans une perspective postkeynsienne. L'Actualit conomique, 67(2) :166-191. DOI : 10.7202/602032ar
Solow, R. M. (1980), On Theories of Unemployment. The American Economic Review,
70(1): 1-11
Sowell, T. (2014), Facing Minimum-Wage Truth. Retrieved from
http://www.nationalreview.com/article/369072/facing-minimum-wage-truth-thomas-sowell
Stiglitz J.E & Walsh C.E (2006), Principles of Microeconomics (4th ed.). New
York, NY : W. W. Norton & Company, Inc
The Economist (2001), Debating the minimum wage. Retrieved from
http://www.economist.com/node/494922
Worstall T. (2011), Forbes : Alan Krueger's Mistake on the Minimum Wage.
Retrieved from http://www.forbes.com/sites/timworstall/2011/08/31/alankruegers-mistake-on-the-minimum-wage/

7. Figures
Figure 1:
Anonymous (2013). ECONOMICS BLOG POST ASSIGNMENT #2 (Price
Control / Minimum Wage). Retrieved from
http://blogs.yis.ac.jp/14webbk/2013/01/13/economics-blog-postassignment-2-price-control-minimum-wage/
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 productivit dans une perspective postkeynsienne. L'Actualit conomique, 67(2) :166-191. DOI : 10.7202/602032ar. Page 183

University of St. Gallen

VW 75
Spring Semester 2014

29