Quote of the Day

This is the first comment from a post at Econlog:

…More evil has been done by poor logicians than by evil men intentionally doing evil.

Policies that were created with good intentions are not good enough. Policies need to be rooted in sound economic theory for an economy to continue functioning at a healthy and productive level.

Steven

Ch 1: The Lesson

I am reading through Economics in One Lesson by Hazlitt and my goal is to annotate as I go through the book via this blog. I think that it is an incredible resource for developing good intuition about economic phenomena for a new student of economics. I also think that it is a classic that still yields rewards when revisited.

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups. (pg. 17)

This is an undeniably simple, yet forgotten art. Good economics is keen awareness. The skill of an economist is detecting and explaining the tradeoffs and consequences of actions in the economy. Since economics is a study of humans and their acting and interacting, things can be quite complex because humans are complex.

One thing is striking to me when I read this chapter, though. When the emphasis turned from the long-run to the short-run, the incentives of public policy drastically changed, too.

Legislators are responsible to the people that elected them; they speak on behalf of their constituency. If they do not like their representative/senator anymore, then they have the freedom to vote them out. Assuming that the congressman/woman would like to get re-elected, then the incentive is to appease the people that elected him/her. What better way to gain the favor of constituents than to shower them with short-term benefits? From then on, any competitor who speaks of restraint is at a disadvantage, especially once the benefits become commonplace.

It is no wonder why good economic analysis is forfeited so many times in policy decision-making; temptation to obfuscate the truth in order to gain short-term benefits is strong and persistent.

It is often sadly remarked that the bad economists present their errors to the public better than the good economists present their truths. … But the basic reason of this ought not to be mysterious. The reason is that the demagogues and bad economists are presenting half-truths. They are speaking only of the immediate effects of a proposed policy or its effect upon a single group. (pg. 18)

Steven

The Effectiveness of (Raising) the Minimum Wage

This post will mostly be a response to three recent posts which argue that the minimum wage:

– Would be a net benefit to people it targets (low-wage hourly workers)
– Helps other policies acheive their objective, particularly the Earned Income Tax Credit (EITC)
– Or some combination of the two

The three posts are:

Jared Bernstein’s February 14th, 2013 post titled “Raising the Minimum Wage: The Debate Begins…Again”
Mike Konczal’s February 15th, 2013 post titled “Interview with Dube; EITC and Minimum Wage as Complements”
Paul Krugman’s February 16th, 2013 blog post titled “Minimum Wage Economics”

It will also include some musings about minimum wage and the Keynesian view of the business cycle.

The (Negative) Effects of Minimum Wage

It follows from classical economic theory that the minimum wage is an example of a price floor: the government enforces a minimum hourly wage (price) at which employees (potential suppliers of labor) and employers (potential sellers of labor) make their trade.

It is possible (and probable) that an employee and an employer can agree on a trade for a range of hourly wages. That is, the value of the employee’s labor to the employer, and the minimum price the employee is willing to work for, may not be the same value.

Following this logic, it is entirely possible that a minimum wage has no effect on whether a trade happens or not; even if it is binding at a certain price that two agents would agree on, it may not be binding at a higher price that they both agree on as well. Extending this to the overall market, it is possible that a minimum wage has no effect on the volume of labor services traded whatsoever. However, given the variety of employers and employees, this seems unlikely.

So, what’s the empirical observation? A 2007 economic literature review by UC Irvine’s David Neumark and the Fed’s William Wauscher concludes:

A sizable majority of the studies surveyed in this monograph give a relatively consistent (although not always statistically significant) indication of negative employment effects of minimum wages. In addition, among the papers we view as providing the most credible evidence, almost all point to negative employment effects, both for the United States as well as for many other countries.

So it would seem that the economic literature as a whole agrees with the conclusions of classical economics that we should expect the minimum wage to cause unemployment. However, it is worth noting there are significant exceptions: a literature review published this month by John Schmitt concludes:

The weight of that evidence points to little or no employment response to modest increases in the minimum wage.

The paper makes some other conclusions about how employment responds to the minimum wage besides changing the quantity of employees. I won’t directly deal with those other conclusions in this post.

To me, the conclusions of both of these literature reviews are consistent with the classical model; because it says that the minimum wage might not be binding, and might not affect whether a trade happens even if it is binding to a single price, we should expect it could be possible that it either creates a surplus of labor (unemployment) or has no effect. I am not asserting that the classical model is an excellent one for the study of labor markets as a whole; I think labor in general behaves differently from other goods. However, we don’t seem to have found anything that would refute the classical model’s conclusions about price controls.

The (Normative) Question of Minimum Wage

Conclusion 1: The minimum wage has no empirical effect on the quantity of employment, therefore we should expect it to help poor hourly workers independently.

This is the conclusion that seems most puzzling to me. Only Bernstein makes it; Krugman and Konczal may or may not support it, but do not specify in their posts.

1) It’s very easy to imagine negative effects of a price floor besides surpluses. I can think of two:

– The policy would cost resources to enforce. Even if we already had minimum wage enacted, businesses would use resources adjusting to a change in the price floor, regardless of the effect on employment. We would spend time and resources changing the legal code even if no new enforcers of the law (police, inspectors, IRS agents) were required.

– The policy would lend itself to rigid nominal prices regardless of the quantity of trade. The New Keynesian view of business cycles holds that depressions persist because prices are “sticky.” A minimum wage would reinforce price stickiness, especially if labor costs are a large share of the total cost of production.

2) There are other programs that have proven very empirically effective at helping the working poor.

– The Earned Income Tax Credit (EITC) is one of these. It maintains an incentive to work (you need to be employed to qualify), lowers taxes on the working poor, and is means-tested, meaning it’s very effective at reaching the people it intends to help. Bernstein agrees with this conclusion.

– Education is one of the oldest ideas in the book for increasing the productivity of workers. With higher productivity, employers will value the same person’s labor more highly, potentially increasing wages.

– The Temporary Assistance for Needy Families (TANF) Act, passed by Clinton in 1997, is time-correlated with both a reduction in the number of Americans in poverty and the reduction of the number of Americans qualifying for means-tested assistance.

If our objective is to help the working poor, I don’t think price controls are a very effective way of doing it. In particular, because we have a limited amount of political capital for enacting such reforms, we can’t always “come back for seconds” if our initial methods don’t work – we should focus on what’s effective in the first place.

Conclusion 2: The minimum wage has no empirical effect on the quantity of employment, and therefore it will help other programs such as the Earned Income Tax Credit (EITC) achieve it’s goals.

Krugman, Konczal, and Bernstein all come to this conclusion.

This conclusion doesn’t seem to hold water to me because of the economic logic behind minimum wage “helping” the Earned Income Tax Credit achieve it’s goals. Konczal points to a paper by Jesse Rothstein of Princeton University that concludes:

With my preferred parameters the [Earned Income Tax Credit] increases after-tax incomes by $0.73 per dollar spent, while the [Negative Income Tax] yields $1.39.

Konczal doesn’t focus on the conclusions about the effectiveness of a negative income tax, but he claims that:

Jesse Rothstein did an estimate finding that for every dollar of EITC, a worker’s wage only goes up 73 cents. That’s a big capture by employers.

He correctly mentions that we should only expect the EITC to grant 100% of it’s benefits to employees if we assume the demand for wages in low-income markets is perfectly elastic. He then suggests that minimum wage is an effective law at getting more of the EITC to go to worker’s wages. Bernstein comes to the same conclusion.

Since when is it commonplace for economists to advocate legal codes against economic truths such as elasticity? I don’t understand why we would think a legal requirement would increase the elasticity of demand for low-wage workers.

Konczal provides a citation of a paper by David Lee and Emmanuel Saez that concludes that a binding price floor prevents the lowering of wages as a result of government transfers like the EITC; but from classical logic, we would expect this to increase the unemployment associated with a binding price floor!

This seems like a terrible conclusion on the part of these two economists, especially considering the EITC and other programs have proven very effective on their own.

Minimum Wage and (Effective) Keynesian Policy

An idea I touched on earlier is that minimum wage might help exacerbate depressions because it contributes to nominal wage “stickiness” or inflexibility, increasing the time it takes prices to adjust in response to phenomena that happen extremely quickly (like banking crises).

However, if we consider the idea that lower-income workers have a higher marginal propensity to consume, then we can talk about some possible counter-cyclical effects of an increase in the minimum wage, or the enactment of a new minimum wage policy, given that we make two assumptions:

1) Minimum wage laws are effective at increasing the discretionary (after-tax) income of poor-income workers.

2) Minimum wage laws have no overall net effect on the quantity of employment.

The first assumption is incredibly dubious; minimum wage laws contribute to phenomena like inflation, and may have other effects on the income of workers besides increasing their hourly wage rate. However, let’s assume it’s valid for now.

Given the empirical tests, the second assumption seems like it might be reasonable in some cases, such as when we increase minimum wage only a small amount.

If we consider the idea that minimum wage laws increase the discretionary income of poor workers without decreasing overall quantity of employment, we come to the conclusion that it might be significantly expansionary, because the income gained from an increase will be used to purchase goods and services and thus create higher expectations of inflation.

However, I would expect this policy to be extremely ineffective as a counter-cyclical policy for a few reasons:

1) An increase in income would work similarly to a tax cut; even for low-income workers, part of that money might be saved or used to pay down debt. We would expect the multiplier (the increase in the velocity of money) to therefore be lower than if the government simply spend the money itself on things like infrastructure projects.

2) The magnitude of the policy matters. Adam Ozimek agrees that minimum wage is ineffective compared to the EITC.

3) An increase in minimum wage that significantly increased discretionary low-incomes would probably be extremely disruptive and affect much of the hourly labor market.

Conclusion

The minimum wage might have no negative effects on the quantity of employment, but it seems economically unreasonable to assume it has no negative effects whatsoever.

For the objective of increasing the incomes of poor families, the minimum wage is ineffective.

The minimum wage would be very ineffective as Keynesian policy even given extremely questionable assumptions.

– Thomas C.

Why Can’t We All Agree?

After reading about President Obama’s ambitious plan to raise the minimum wage to $9, I began to wonder why there is not a general consensus among trained economists about the effects of minimum wage increases on unemployment.

I do believe there is a consensus if we take the extreme cases. If we raise the minimum wage to $50 or $100 or maybe $500, then yeah, economists are going to agree that there would be serious negative consequences for such actions. So the trouble is in magnitudes, not in the general theory. How high can the price floor be set and avoid the negative consequences on employment? 

I ran across this article at the Washington Post today discussing the same question, why can’t economist agree on this? The reporter, Brad Plumer, cites a paper from the Center of Economic Policy and Research in which the researcher tries to find the reasons that minimum wage increases do not always have noticeable effects on unemployment.

The waters are murky when the minimum wage increases by a relatively small amount. We wouldn’t expect much to happen if the minimum wage increased by one cent, and we would expect serious consequences if it increases by $100. So again, magnitude is key.

A firm may decide to try and make the increased wage work so that negative consequences do not have to be realized. From the paper, this can take the form of delaying bonuses to more productive workers in order to pay for the higher minimum wage. It can also manifest itself through higher retail prices as the cost is pushed to the consumer.

The point is that the general theory is correct. Because the revenue and savings of a firm is finite, it can only pay unproductive workers so much before a manager has to lay them off. But what is the threshold of that decision? What level does the minimum wage have to reach for that to occur? That is a firm-specific question. It will be different for each firm and so we will see different firms make different decisions that may or may not square with the understood theory. With these different results, we have different opinions about the effects of the higher wages.

Steven

Walt Williams – Good Intentions Part 1

In honor of Black History Month, here’s Walt Williams from 1982 talking about how government programs aimed at helping the poor and minorities (his focus is black Americans) ended up negatively affecting them in huge and enduring ways. It seems pretty clear that the Great Society has failed and the attempt to create utopia via mass legislating has led to chaotic outcomes.

Steven

Diary of a Capitalist – Day 1

Damn I love being a salesman.

Today was my first day training to become a stockbroker at one of the biggest banks in the world.  I’m pretty sure I got the job because during the interview I said that I loved sales, and that I was good at it too.

But this has not always been the case; growing up in the US, I was pretty sure that people were being exploited by the economic system.  Somebody was being ripped off, I could feel it.  I spent my time in high school volunteering at a local soup kitchen, and once I even took a trip to the Dominican Republic to help rebuild a bridge after a particularly destructive hurricane.  Helping others has always been at the forefront of my thoughts, this is likely due to growing up Roman Catholic with all the self-deprecating guilt-laden baggage that entails.  Perhaps thinking of myself once in a while would lead to a more healthy and balanced life, but that will have to wait, because today I chose capitalism.

There was a sea change within economics that took place in the 1870’s.  Although many historians disregard Karl Marx’s role in the change, I believe he was instrumental.  I believe that Das Kapital demonstrated once and forever that all objective theories of value are absurd.  It was only after this reductio ad absurdum of Marx that the subjective theory of value could begin to take root within the economics profession.  Balmes argued for the subjective theory of value in Spain decades earlier, but as the Spanish say, “no puedes mojar el agua.”  The presence of the labor theory of value precluded the growth of the subjective theory.

I wouldn’t be so bold as to say that all economists hold value to be subjective; economics is too stymied and backward for there to even be consensus on axioms or scope.  I leave it to the reader to ponder whether the worth of a thing is more akin to its length or its beauty.  Do we impose value on a thing through our desire of it, or does value exist outside of our minds within the thing itself?

If it is true that only the subjective theory of value can adequately explain the ultimate cause of exchange, then the consequences are most profound.  If value truly lies in the eye of the beholder, then when two people enter into an exchange, in the abscenece of force or fraud, they both expect to be richer afterward.  And they both can be.  If entrepreneurial error isn’t too great, believe it or not, they both are richer than before.  It couldn’t be any other way.  If value is subjective, no one can choose to impoverish themselves; that’s just what the word choice means, to prefer one over another.

When two people come together to engage in a voluntary transaction, they create wealth.  There is exploitation in this world, of that I have no doubt, but it is not to be found in consensual exchange.

When I discovered this, I realized that I had been going about the business of helping others all wrong.  Serving fried chicken to heroin addicts at the soup kitchen was an alright place to start, but by giving them a hot meal, the only result was that they would sell their food stamp balance for cash to buy more heroin.  The people in the Dominican Republic were living a material quality of life of about the same level as my grandparents.  My grandparents didn’t consider themselves in need of charity, and to a certain extent, neither did the people I met in the Dominican Republic.  In fact, in the fifteen years since I was there, they have engaged in quite a bit of capital accumulation and have improved their own material quality of life enormously.  The nun who organized the trip did so not to help the impoverished poor, but to teach a bunch of spoiled, affluent youth a few hard lessons, most of which I am probably still ignorant.

Damn I love being a salesman.

With every financial product I sell, I get to make somebody better off than they were before.  I get to take some of the scary uncertainty out of their future, and remove some dread from their lives.  When I’m done, they’ll be able to sleep more soundly at night, their marriages might have less squabbling over the future, and they might spend less time worrying and more time enjoying leisure with their children.  Not only that, but they are thankful enough for my service to pay me for it.  The heroin addicts never thanked me for giving them a wooden spoon handle to bite on while they were overdosing in the parking lot.  They might even have been angry that I had the audacity to try and interfere with their lethargic suicides.

Schumpeter argued that capitalism fails because there is nobody left to defend it.  The captains of industry donate their money to colleges where idle professors teach their children to hate and to destroy the capitalism that allowed their donation in the first place.  Well, I for one choose to be a capitalist.  I choose it because it is the best way I know to help the people I care most about, all of you.

Other Stephen