Water rights and markets

Why have the percentage estimates of job losses been so low? The simple answer is the labor markets for low-skilled workers are highly competitive, which explains the low wages paid workers with limited skills in the first place. Many employers of low-skilled workers would love to be able to pay their workers more, but they have to face a market reality: if they paid more, then their competitors would have a cost advantage in pricing their products.
When Congress forces employers to pay more in money wages, it also forces them to pay less in other forms, most notably in fringe benefits. If there are few fringes to take away, the employers can always increase work demands.
Why would employers curb benefits and increase work demands? There are three reasons:
15 For reviews of the minimum-wage literature, see Charles Brown, Curtis Gilroy, and Andrew Kohen, “The Effect of the Minimum Wage on Employment and Unemployment,” Journal of Economic Literature, vol. 20 (1982), pp. 487-528; and Charles Brown, “Minimum Wage Laws: Are They Overrated?” Journal of Economic Perspectives, vol. 2 (1988), pp. 133-147. In more recent studies in the 1990s, the reported employment effects among teenagers continue to be relatively small [Richard V. Burkhauser and David Whittenberg, “A Reassessment of the New Economics of the Minimum Wage Literature Using Monthly Data from the SIPP and CPS” (Syracuse, N.Y.: Center for Policy Research, Syracuse University, 1998).
16 These estimates of the responsiveness of labor markets to minimum wage hikes are independent of the tightness of labor markets. If the country’s labor markets remain relatively tight over the next year or so, the number of low-skill workers covered by the minimum wage can be expected to fall as market-determined wage rates for low-skill workers rise past the proposed new levels for the minimum wage. (Currently, only about 4 million Americans work at the federal minimum wage.) Hence, while the percentage reduction in the number of minimum wage jobs may remain more or less in line with past studies, it stands to reason that the actual number of minimum wage jobs will fall as the count of covered workers shrinks.
17 Victor R. Fuchs, Alan B. Krueger, and James M. Poterba, “Economists’ Views about Parameters, Values, and Policies: Survey Results in Labor and Public Economics,” Journal of Economic Literature, vol. 36 (September 1998), pp. 1387-1425.
First, they can do it, given that the minimum-wage hike will attract a greater number of workers (and workers who are more productive) and cause some employers to conclude that they cannot hire as many workers --unless adjustments are made. Hence, given the tightness of the labor market, the forced wage hike necessarily strengthens the bargaining position of employers, given that the employers can tell prospective workers, “If you don’t like it, I can hire someone else. Your replacements are lined up at my personnel office door.”18 Employers will make the adjustments for an offensive reason, to improve their profits (or curb losses).
Second, and perhaps more importantly, employers of covered workers must (to decrease costs) cut fringes and/or increase work demands or face the threat of losing their market positions as their competitors cut fringes and increase work demands. Employers will, in other words, make adjustments for defensive reasons, to prevent their market rivals from taking a portion of their markets and causing their profits to fall (or losses to mount).
Third, if employers don’t cut fringes and/or increase work demands, the value of the company’s stock will suffer on the market, leaving open profitable opportunities for investors to buy the firm, change the firm’s benefit/work demand policies, improve the firms profitability, and then sell the firm at a higher market value. Employers -- either the original or new owners -- will make the adjustments for financial reasons, to maximize share values.19
The net effect of the adjustments in fringes and work demands is that the cost impact of the minimum-wage hike will be largely neutralized. For example, when the minimum wage is raised by $1, the cost of labor may, on balance, rise by only 5 cents. Such an adjustment explains why the Card and Krueger studies and more than a hundred other statistical studies on the minimum wage have found that minimum-wage hikes have caused a small (if not negligible) percentage drop in jobs even among that group of workers – teenagers working at fast food restaurants – whose jobs are most likely to be cut.20
18 Tight labor markets, like the ones in the United States in 1999, can cause wages and fringe benefits to rise, even for low-skill workers, and can cause the number of workers affected by any minimum wage hike to fall. However, the point that minimum wage hikes increase the relative bargaining power of employers still holds for those workers remaining at the minimum wage. Moreover, if employers have responded to their tight labor markets by increasing their workers’ fringe benefits, then there will be more benefits for employers to take away when faced with a hike in the mandated money wage rate.
19 Indeed, it may be interesting to note that, at least conceptually, minimum-wage workers might contemplate the prospects of buying their firms, if their firms did not make compensation and work adjustments and if they, the minimum-wage workers, could make the purchase. The point here is that even worker groups can see the financial benefits of adjusting fringe benefits and work demands in light of a minimum-wage increase.
20 Even the Employment Policies Institute study cited above (Macpherson, “The Effects of the 1999-2000 Washington Minimum-Wage Increase”), which is likely to contain estimates of the employment losses that are on the high side of the expected range, shows a reduction in Washington’s total employment (2.7 million workers) of less than three tenths of one percent for a proposed 26 percent increase in the state’s minimum wage. However, it can be noted that if Washington has the average percentage of minimum
This line of argument can also help us understand why workers who retain their jobs are unlikely to be any better off. They get more money, but they also get fewer fringes and have to work harder for their pay. We know the covered workers who retain their jobs will be worse off, at least marginally so, because the only reason an employer intent on making as much profit as possible would offer the fringes and reduced work in the first place is that the workers valued the fringes and lax work demands more highly than they valued the money wages that they had to give up in order to get the fringes or lax work demands. Further, profit-maximizing employers aren’t about to offer workers anything that’s costly unless they get something in return, like greater output per hour or a lower wage bill.
If a firm offers costly benefits that do not lower wages or fail to offer benefits that could lower wages, then that firm should be subject to takeover. Some savvy investor can be expected to buy the firm, change its benefit policies, lower wages by more than the rise in other costs rise, improving the firm’s profitability in the process, and then sell the firm for a higher price.
Make no mistake about it, profit-maximizing firms do not “give” fringes to their workers; they require their workers to pay for the fringes through wage-rate reductions. The wage rate reductions can be expected because, if workers value the fringes, the supply of workers will go up, forcing the money wage rate down.
It follows that competitive market pressures will force firms to do what is right by their bottom lines and their workers. This means that when the minimum wage is raised, the value of the resulting lost fringes and reduced work demands to the workers will be greater than the value of the additional money income.
Put another way, the workers who retain their jobs are made worse off (perhaps, marginally so) in spite of the money-wage increase. Employment in low-skill jobs may go down (albeit ever so slightly) in the face of minimum-wage increases not so much because the employers don’t want to offer the jobs (as traditionally argued), but because not as many workers want the minimum-wage jobs that are offered.21
Available Empirical Evidence
Have the expected effects been seen in empirical studies? The most compelling evidence is captured in the many studies already cited that indicate that job losses from a minimum-wage increase tend to be small, even within the worker groups are most likely to be adversely affected. However, there have been other studies over the past two
wage workers, 8.8 percent, then the EPI study suggests that each 10 percent increase in the minimum wage lowers the employment of covered workers by, at most, 1.2 percent.
21 Granted, not all low skill workers have many fringe benefits that can be taken away, and some minimum wage workers may be working very hard. The argument that is being developed suggests that the negative employment effects of a minimum wage increase will be concentrated among this group of particularly disadvantaged workers.
decades that have attempted to assess directly the impact of minimum-wage increases on fringes and work demands, as well as the overall value of jobs.
• Writing in the American Economic Review, Masanori Hashimoto found that under the 1967 minimum-wage hike, workers gained 32 cents in money income but lost 41 cents per hour in training -- a net loss of 9 cents an hour in full-income compensation.22
• Linda Leighton and Jacob Mincer concluded that increases in the minimum wage reduce on-the-job training -- and, as a result, dampen growth in the real long-run income of covered workers. 23
• Walter Wessels found that the minimum wage caused retail establishments in New York to increase work demands. In response to a minimum-wage increase, only 714 of the surveyed stores cut back store hours, but 4827 stores reduced the number of workers and/or their employees’ hours worked. Thus, in most stores, fewer workers were given fewer hours to do the same work as before.24
• The research of Belton Fleisher, 25 William Alpert,26 and L.F. Dunn27 shows that minimum-wage increases lead to large reductions in fringe benefits and to worsening of working conditions.

If the minimum wage does not cause employers to make substantial reductions in nonmoney benefits, then increases in the minimum wage should cause (1) an increase in the labor-force participation rates of covered workers (because workers would be moving up their supply-of-labor curves), (2) a reduction in the rate at which covered workers quit their jobs (because their jobs would then be more attractive), and (3) a significant increase in prices of production processes heavily dependent on covered minimum-wage workers. However, Wessels found little empirical support for such conclusions drawn from conventional theory. Indeed, in general, he found that minimum-wage increases had the exact opposite effect: (1) participation rates went down, (2) quit rates went up, and (3) prices did not rise appreciably -- findings consistent only with the view that
22Masanori Hashimoto, “Minimum Wage Effect on Training to the Job,” American Economic Review, vol. 70 (December 1982), pp. 1070-87.23Linda Leighton and Jacob Mincer, “Effects of Minimum Wage on Human Capital Formation,” in The Economics of Legal Minimum Wages,” ed. Simon Rothenberg (Washington, D.C.: American Enterprise Institute, 1981).24Walter J. Wessels, “Minimum Wages: Are Workers Really Better Off?” (Paper prepared for presentation at a conference on minimum wages, Washington, D.C., National Chamber Foundation, July 29, 1987). For more details, see Walter J. Wessels, Minimum Wages, Fringe Benefits, and Working Conditions (Washington, D.C.: American Enterprise Institute, 1980). 25Belton M. Fleisher, Minimum Wage Regulation in Retail Trade (Washington, D.C.: American Enterprise Institute, 1981).26 William T. Alpert, The Minimum Wage in the Restaurant Industry (New York: Praeger, 1986).
27 L.F. Dunn, “Nonpecuniary Job Preferences and Welfare Losses among Migrant Agriculture Workers,” American Journal of Agriculture Economics 67 (May 1985), pp. 257-65.
minimum-wage increases make workers worse off.28 With regard to quit rates, Wessels writes,
I could find no industry which had a significant decrease in their quit rates. Two industries had a significant increase in their quit rates.... These results are only consistent with a lower full compensation. I also found that quit rates went up more in those industries with the average lowest wages, the more full compensation is reduced. I also found that in the long run, several industries experienced a significantly large increase in the quit rate: a result only possible if minimum wages reduce full compensation.29
Seen from this perspective, Herbert’s cited figures on the added income received by 10 million workers are grossly misleading because the figures suggest that the affected workers are “better off,” which is not likely to be the case, given their loss of fringe benefits and increased work demands. The fact that the Card and Krueger studies also found, supposedly, no loss of jobs suggests that the market may have forced non-wage adjustments on the fast food restaurants studied.
Granted, economists might speculate, as they have, that the job reductions have been small because the low-skill labor market exhibits a “low elasticity of demand” (or low responsiveness among employers to a wage hike), but such an explanation is hardly compelling. The demand elasticity for anything, including labor, is related to the number of substitutes the good (or labor) has: the greater the number of substitutes, the greater the ability of buyers (employers) to move away from the good (labor) when the price (wage rate) is raised, and hence, the greater the responsiveness of buyers (employers), or elasticity of demand. The problem with the explanation is that there is no labor group that has more substitutes than low-skill (minimum-wage) workers, especially now that firms have so much flexibility to automate jobs out of existence or to replace domestic workers with foreign workers by way of imports. The elasticity of demand for low-skill labor must be relatively high. Hence, the relatively small decline in the number of low-skill workers in response to a minimum-wage hike points to a conclusion central to this: the mandated wage hike is likely offset in large measure by other adjustments in the affected workers’ compensation package.
Minimum-Wage Consequences over Time
This line of argument does not lead to the conclusion that minimum-wage increases of given amounts should always have the exact employment effect no matter when they are legislated. Looking back at Figure 4.7, we might reason that as the real minimum wage rose between 1938 and 1968, employers did what they were pressed to do to moderate their labor cost increases: take away progressively more fringe benefits and add progressively more work demands (compared to what they would have done). Hence, as time went by, we might expect the employment effects of a given minimum wage
28Wessels, “Minimum Wages: Are Workers Really Better Off?” 29Ibid., p. 13.
increase to go up as 1968 was approached. As time passed, there simply were fewer ways for employers to adjust to the wage hike.
However, as the minimum wage has fallen irregularly since 1968, we might expect employers to respond by gradually adding back more fringe benefits and relaxing their work demands (a trend that has likely been accelerated with growing tightness in labor markets in the late 1990s). The result should be that in the 1990s, employers should have had more ways to adjust to a minimum-wage hike than they had in, say, the late 1960s. As a consequence, we should not be surprised that Card and Krueger found little or no employment effect in the early 1990s, whereas other studies in the 1960s found larger effects.30 We should not be surprised if future studies of the impact of any 1999 increase in the minimum wage show similarly negligible negative employment effects.
* * * * *
Members of Congress and the president need to recognize a simple fact of modern economics: You can’t fool the market as much as imagined, at least not all the time. Politicians simply do not have as much power to manipulate markets as they may think they have. Markets can be expected to outsmart the smartest of politicians in the next round of minimum-wage hikes. We can anticipate that, once again, the chosen increase in the minimum wage will have minimum employment consequences for two reasons: First, members of Congress will choose a fairly small increase in the minimum wage because of political groups working against the proposed minimum-wage bill. Second, market forces will largely neutralize the potential negative employment effects of whatever wage increase is legislated.
Concluding Comments
The market system can perform the very valuable service of rationing scarce resources among those who want them. It alleviates the congestion that develops when resources, goods, and services are rationed by other means. Markets, however, are not always permitted to operate unobstructed. Government has objectives of its own, objectives that are determined collectively rather than individually. We have seen how government can use its power to tax, to raise government revenues, or reallocate market demand.
30 The implication of the theory that a minimum-wage hike will have a greater impact on employment when the minimum wage is high, compared to when it is low, has not been rigorously tested to date. However, it is interesting to note that through the 1950s 1960s, and early 1970s, the editors at the New York Times were staunchly for increases in the minimum wage, mainly because the evidence on the negative employment effect was not strong, to say the least. However, as the evidence in the 1960s mounted that minimum-wage hikes had a negative employment effect, especially among minority teenagers, the editors began to shift their editorial stance. By the mid-1980s, they came out in favor of a minimum wage of “$0.00.” They have since shifted their editorial stance back to support for minimum-wage hikes, mainly because the negative employment effects have been shown to be nil in recent studies. See Richard B, Mckenzie, Times Change: The Minimum Wage and the New York Times (San Francisco: Pacific Research Institute, 1994).
Government power can also be used to eliminate externalities or reduce monopoly power. Whether the use of such controls is considered good or bad depends to a significant extent on one’s personal values and circumstances. In a free market system, price controls and consumer protection will always be controversial.
In the case of minimum wage hikes, it appears that policy makers and economists alike have failed to grasp an important lesson: The hikes do not destroy competition, only redirect its force. They also give managers an incentives to find ways of reducing their impact on employment – and the net benefits of the hikes to the workers.
Review Questions
1 Is a tax on margarine efficient in the economic sense of the term? Why would margarine producers prefer to have an excise tax imposed on both butter and margarine? Would such a tax be more or less efficient than a tax on margarine alone?
2 If punishment for crime is a kind of tax on those who engage in illegal activity, what effect would the legalization of marijuana have on its supply and demand? What would happen to the market price? The quantity sold? Illustrate with supply and demand curves.
3 If in a competitive market, prices are held below market equilibrium by government controls, what will be the effect on output? How might managers be expected to react to the laws?
4 Why might some managers want price controls? Why don’t they get together and control prices themselves (if it were legal)?
5 How would price controls affect a firm’s incentive to innovate? Explain.
6 “If prices are controlled in only one competitive industry, the resulting shortage will be greater than if prices were controlled in all industries.” Do you agree? Explain.
7 “Price controls can be more effective in the short run than in the long run.” Explain.
8 Why would some firms want the minimum wage to be increased? Why would some managers who believe that workers “deserve” higher wages cut fringe benefits or increase worker demands in response to a hike in the minimum wage?

READING: Water Rights and Water Markets
Terry L. Anderson, Montana State University
Mark Twain wrote, “Whiskey is for drinkin’—water is for fightin’.” In the American West, water has always been a matter of survival. It was the cause of many frontier skirmishes, and it may provoke conflict again. Newsweek warned recently that “drought, waste, and pollution threaten a water shortage whose impact may rival the energy crisis.” And former Secretary of the Interior James Watt said, “The energy crisis will seem like a Sunday picnic when compared to the water crisis.”
Unless Americans change their ways, a water crisis is inevitable. In economic terms, the quantity of water demanded is greater than the quantity available, and there is little time to adjust either amount. The
reason for the imbalance is that the government has been keeping prices below market-clearing levels. In most places in the United States, water is cheaper than dirt. Nowhere in the nation do water prices reflect the true scarcity of the resource.
In Southern California, for example, water is in short supply. Yet Los Angeles residents pay only
0.60 per thousand gallons—a quantity that costs the residents of Frankfurt, Germany, $2.80. It is not surprising, therefore, that each person in the United States consumers an average of 180 gallons a day, compared with 37 gallons in Germany. Water prices are actually lowest in the arid Southwest, where residents of El Paso and Albuquerque pay $0.53 and $0.59, respectively, per thousand gallons, compared with $1.78 in Philadelphia. In many U.S. cities the real price of water has fallen in recent decades, despite the threat of shortages.
Agricultural users, who consume over 80 percent of the water in western states, enjoy extremely low prices. Throughout the nation the price of irrigation water ranges from about $0.009 to $0.09 per thousand gallons. In 1981, the average price of covering one acre of land in California’s Central Valley with one foot of water was $5.00, or less than $0.02 per thousand gallons. Supplying that amount of water cost the government as much as $325. According to a 1980 study by the Department of the Interior, government subsidies covered between 57 and 97 percent of the cost of water projects.
Pricing water at market rates could help to solve the water crisis. Water consumption—whether for industrial, municipal, or agricultural use—is highly responsive to price changes. For example, the quantity of water used in industrial processes varies considerably around the world, depending on prices. Where water is expensive, electric power is produced using as little 1.32 gallons per kilowatt-hour. Where water is cheap, production requires as many as 170 gallons per kilowatt-hour. One study of urban water consumption showed that a 10 percent increase in the price of water decreased the quantity of water demanded about 4 to 13 percent.
Pricing water more realistically will require changes in the laws governing water use, as well as the creation of an effective water market. Like any market, a water market will depend on well-defined, well-enforced property rights. If water rights are secure and people can trace them, prices will quickly come to reflect the true scarcity of the resource. During the late nineteenth century, such a system evolved in the American West. Rights were defined on a first-come, first served basis, and institutions arose through which owners of rights could seek out the highest and best use of the resource. The system offered incentives that encouraged some people to deliver water wherever it was demanded. Thousands of miles of ditches were constructed, and millions of acres blossomed, as a result of entrepreneurial efforts to deliver water. Over time, however, legislators, bureaucrats, and judges have tinkered with the system. Legal restrictions now limit the transfer of water, and its use is determined by politicians, not by the market.
One place where a water market might encourage more efficient water use is the Imperial Irrigation District (IID) in Southern California. The IID receives its water from the U.S. Bureau of Reclamation, at subsidized rates. Its water could be conserved if ditches were lined, wastewater recovered, and the timing of irrigation changed. All those measures would be costly to farmers, however. And at present low prices, farmers have little incentive to invest in conservation. Recently, the Municipal Water District (MWD) of Southern California, thwarted in its effort to obtain water from Northern California, has begun negotiating for water from the IID. The MWD is willing to fund improvements in farmers’ irrigation systems in return for the water those improvements would save. If such a trade could be accomplished, everyone would be better off.

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