Down With The Living Wage

Tuesday, September 3, 2013

A recent opinion piece in the New York Times by Alex Rosenberg and Tyler Curtain, both trained as philosophers of science, asks the intriguing question: “What is Economics Good For?” “Not much” is their largely skeptical answer. They argue that economics is a second-rate science, while the physical and biological sciences sport more impressive credentials. For all its use of fancy mathematics, they argue that “the trouble with economics is that it lacks the most important of science’s characteristics—a record of improvement in predictive range and accuracy.” Unfortunately, this increasingly fashionable view that economics is not a science too often leads people to endorse unwise regulatory policies.

Illustration by Barbara Kelley

Their column sparked a reply by the Harvard Nobel Prize–winning economist, Eric Maskin, who argued that even if economics fails the test of prediction, it offers explanations of phenomena just as the other sciences do. Maskin was chastised by a number of readers who denied, with good reason, any distinction between explanation and prediction. A theory that purports to explain something but predicts nothing is, intellectually, not very compelling.

So what, then, is economics good for?

Economics as a Guide to Politics

Rosenberg and Curtain’s argument misses the point. The purpose of economics is not to shape social institutions; it is to solve some of the tough and important problems of daily life, like how society can allocate resources efficiently. In this regard, it is not unlike physics. Physics has serious trouble probing the secrets of dark matter, or even predicting the next time an asteroid will crash into planet earth. But it does well building bridges and designing supercomputers. Ultimately, Rosenberg and Curtain’s emphasis on big economics leads us astray both analytically and politically, distracting us from what economics can really do.

Analytical Issues

Analytically, the correct response to Rosenberg and Curtain is that social scientists can make real progress in understanding the economic system by confining their attention to problems big enough to matter, yet small enough to generate sensible predictions. Rosenberg and Curtain eventually gravitate to that position by ending the article with this critical aside: “Fixing bad economic and political institutions (concentrations of power, collusions and monopolies), improving good ones (like the Fed’s open-market operations), designing new ones (like electromagnetic bandwidth auctions), in the private and public sectors, are all attainable tasks of economic theory.” Thankfully, much of economics, especially at the applied level, is devoted to just those issues.

These midlevel systems can be studied and understood even if grand economic theories are sorely wanting. Rosenberg and Curtain observe that economic theory assumes that all social interactions are “determined from the choices of a large number of ‘atomic’ individuals,” whose behaviors can be represented by a set of complex mathematical models.

This is not strictly true. One of the central tenets of modern biology is the principle of “inclusive fitness” which, with some exaggeration, states that individuals are not built to maximize their own happiness, but rather to safeguard the welfare of all the people to whom they are genetically related. No one could sensibly examine family behaviors without taking into account the strong bonds that bind parents to their children and, to a somewhat lesser extent, children to each other.

Yet, all these elements drop out of the equation in addressing the mass phenomena that Rosenberg and Curtain identify. Whether the topic turns to monopoly, pollution, or separation of powers, a rigorous analysis starts with the assumption that each person acts atomistically toward strangers in these macro settings. Once those outcomes are determined, each person then separately tends to allocate his or her gains and losses with other family members by taking ample account of inclusive fitness.

Modern behavioral economics delights in identifying heuristics and biases by which ordinary individuals deviate from the standard atomistic model. These errors in reasoning surely come up in many social situations. But in my career as a practicing lawyer, I have never seen a high stakes struggle where these reasoning errors played more than a peripheral role in shaping the litigation or legislative strategies of the contending behemoths on all sides of any dispute.

To put it otherwise, I could not think of any sensible approach to monopoly or pollution that flips over because of insights derived from either biology or behavioral economics. Letting standard economic models provide intelligent and tractable recommendations for these midrange phenomena is no cause for a generalized pessimism about economics. Just pick the problems that are amenable to these models, and then hope, usually with good result, that no mysterious macroeconomic trend or behavioral anomaly will falsify the basic conclusions.

Political Implications

Once the analytical issues are squared away, the political dangers of this learned skepticism come more sharply into view. Nothing is more common in this populist age than a constant procession of situations where outraged activists denounce conventional economic theory in order to neutralize any possible deference given to those who know something about the subject. Instead, that supposed weakness of conventional economics is said to leave the field of public debate wide open for those who think that “other values,” such as human dignity and social justice, could bolster the claim for some new statutory program, like the “living wage.”

The dangers here need not be left to idle speculation. A recent New York Times editorial “Labor, Then and Nowunwisely uses the fiftieth anniversary of the March on Washington to renew its plea for a whole host of restrictions on the labor market, including adopting a $15-per-hour minimum wage, which would be an increase from the so-called “miserly” $7.25-per-hour minimum wage of today—a figure that is lower in real terms than $1.15 minimum wage in effect when the march took place.

Similarly, New York Democratic mayoral front-runner Bill de Blasio has made enormous headway in his current mayoral bid, clearly eclipsing the stolid Christine Quinn, with his unabashed call for a “progressive agenda” that includes a sharp rise in the minimum wage. De Blasio will try to survive on a minimum wage to show how insufficient it is. 

What is characteristic about these and other similar attempts is how little effort they make to understand anything about the underlying principle. For example, de Blasio’s stunt makes it appear that the test of a good minimum wage law is whether people can live on that salary. In so doing, he ignores all the non-pecuniary benefits that a job can give people: exposure to business, professional skills, networking, and the like. College seniors are eagerly seeking unpaid internships to gain experience in the work force. Why deny that opportunity to those from less privileged backgrounds who must contend with unemployment rates of 41.6 percent in the case of black teenagers aged 16 to 19?

Living wage proponents do not acknowledge these numbers, nor do they address the downsides, especially for marginal workers, of a massive government intervention in labor markets. In this instance, the empirical data are well explained by a midlevel economic theory often derided by progressives. That theory explains why it is difficult to make any generalization of the effects of a minimum wage on market behavior without first knowing both the market clearing wage and the proposed minimum wage. If those wages lie above the actual minimum wage, the statutory imposition will not, at least in the short run, reduce employment levels or alter the terms on the employment contract.

Even then, however, the minimum wage is a bad idea for two reasons. First, it requires setting up a major bureaucracy with extensive compliance powers that impose a net drain on society. Second, if market wages drop (as happened with teenage wages after the 2006 increase in the minimum wage), the minimum wage can come into play to reduce employment levels.

The typical minimum wage law is meant to alter market behavior, so that its immediate effects are of real social concern. The size of those effects on labor markets depends critically on the gap between the market wage and the minimum wage, so it is not possible to determine in the abstract how large those effects will be.

Exact predictions of the sort that Rosenberg and Curtain call for are hard to obtain. But that uncertainty does not undercut the case for rejecting the dramatic proposals of the Times editorial board and de Blasio. As Mark Wilson of the Cato Institute has argued, the stark unemployment statistics offered by the Bureau of Labor Statistics make it highly unlikely that there is any credible scenario where increases in minimum wages will improve either social welfare or the position of the intended beneficiaries of the law. That is a powerful prediction, even if no one can pinpoint with exactitude which persons will be helped or hurt by the law.

Theoretically, it is idle to predict that the only effect of a “living wage” will be to increase the wages of all people earning less. The real challenge is to figure out the effects that the law has on job formation, consumer prices, educational attainment, crime rates, and a host of other issues. No serious discussion of the topic can ignore the simple economic truth that under universal conditions of scarcity, people respond to incentives in ways that benefit themselves and their families—and not some abstract social ideal. That one point should dim the mindless optimism behind new regulations, and hopefully encourage people to think about deregulation as a way to reduce administrative costs and improve incentives for productive behavior.

This move to smaller government is not confined to the minimum wage, but covers the grab bag of political proposals for strong unions, free pre-K education, fail-safe financial institutions, and the like. There is a reason that New York state ranks dead last on a scale that measures the outmigration of personal income between the years 2000 and 2010. Each of its new initiatives has a seductive tone, but their cumulative effect stifles economic growth and sends productive people running to other states. It is high time to reverse that flow.