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.