The Empirical Reality of the Minimum Wage (Donald J. Boudreaux)

From the American Institute for Economic Research:

The Current Consensus

So what, really, is the state of modern empirical research into minimum wages? Let’s start with an unambiguous statement: Paul Krugman is factually mistaken. Plenty of recent evidence indicates that raising the minimum wage costs jobs. As long-time minimum-wage researcher David Neumark concluded in a December 2015 article for the Federal Reserve Bank of San Francisco:

Coupled with critiques of the [econometric] methods that generate little evidence of job loss, the overall body of recent evidence suggests that the most credible conclusion is a higher minimum wage results in some job loss for the least-skilled workers — with possibly larger adverse effects than earlier research suggested.

 

My own extensive reading of minimum-wage research confirms Neumark’s conclusion.

That said, it is also the case that quite a few, although not a majority, of the empirical studies of minimum-wage hikes find no evidence that these hikes destroy jobs. What explains these conflicting research results?

One reason for these inconsistent conclusions is simply the differences in skill and meticulousness that separate some researchers from others. Economic studies vary greatly in quality and reliability. Not every piece of published work by Ph.D. economists is trustworthy. Far from it.

But even after excluding all shoddily done studies of minimum wages, we’re still left with conflict in the conclusions. Fortunately, economic theory itself supplies clues as to why.

Clue #1: While the destruction of jobs for some low-wage workers is the banner prediction elementary economics makes about minimum wages, it’s not the only prediction. Employers and workers can adjust to minimum-wage hikes in other ways. For example, the value of fringe benefits can be reduced, as when restaurants no longer let their employees eat free of charge and when retailers stop offering their merchandise to employees at discount prices.

Similarly, employers can work their low-wage employees harder or become less tolerant of these employees’ showing up for work late, leaving work early, or texting and making personal phone calls while on company time.

To the extent that employers and employees adjust to hikes in minimum wages in these ways, the incentive for employers to reduce the number of low-wage workers they employ is muted. Hence the number of workers cast into unemployment by minimum-wage hikes is diminished.

Clue #2: Employers can adjust to higher minimum wages not only by reducing the number of low-skilled workers they employ, but by reducing the number of hours they employ each of these workers. Indeed, because minimum-wage legislation is written in terms of hourly wages, the most precise description of the banner prediction that elementary economics makes about minimum wages is that these legislative mandates reduce the number of hours of low-skilled labor that employers wish to hire (rather than the number of such workers themselves).

Therefore, empirical studies that count the number of workers employed, rather than the number of hours workers work, count the wrong variable. While it’s true that the most obvious way, and often the easiest way, for employers to reduce the number of hours of labor they employ is to employ fewer workers, empirical studies that find that minimum wages cause no reduction in the number of people employed do nothing to cast doubt on the elementary case against minimum wages because an alternative way is to employ the same number of workers but at fewer hours.

Even if no workers lose jobs because of minimum wages, minimum wages harm these workers if some of them are thereby unable to work as many hours as they would work absent minimum wages.

Clue #3: Employers in countries in which minimum wages have existed for many years have adjusted their business plans not only to the existence of minimum wages, but also to the likelihood that minimum wages will rise. In the United States, the current national minimum wage was first imposed in 1938 by the Fair Labor Standards Act. Starting off at $0.25 per hour, it has since been raised 22 times, an average of once every 44 months. This minimum wage is now $7.25 per hour.

Because this minimum wage has been around, without pause, for 80 years, because it is routinely increased, and because there is no realistic prospect of its being repealed, employers make their business plans accordingly. No firm today in the United States uses a production process as heavily reliant on low-skilled workers as some of these processes would be absent a minimum wage. Knowing of the existence both of the minimum wage and of the likelihood that it will be raised in the not-too-distant future, employers use more labor-saving machinery and fewer low-skilled workers than they would use otherwise.

So it’s no surprise that some researchers fail to detect any resulting decrease in employment whenever the minimum wage is increased. The negative employment effects of the minimum wage were already built into the structure of the American economy. Indeed, when this undeniably correct prediction of economics is understood, it is not too much to say that the most surprising fact about the many modern empirical studies of minimum wages is that any of them find that hikes in minimum wages continue to have statistically significant negative employment effects.

Despite some commentary to the contrary, empirical studies of the employment effects of minimum wages do not come close to proving that minimum wages don’t harm many of the people most minimum-wage supporters wish to help: low-skilled workers.

Markets are the worst system…

…except for all the others that have been tried.

Markets Fail. Use Markets.

Among Arnold’s themes that I especially like is this one: “Markets fail. Use markets.” The idea is the vital one that the case for markets does not depend on markets being perfect—or to use economists’ terms, the case for markets doesn’t collapse simply because of the existence of some “market failures.”

First, the concept “market failure” is notoriously slippery. The absence, say, of more light-rail transportation in Little Rock might plausibly be seen by Jones as evidence of market failure but also might plausibly be seen by Smith as evidence of the prohibitively high cost of expanding such transportation in Little Rock. Social and economic reality being what it is, there are simply no tests available to settle this question with the sort of certainty that is often achieved by tests of physical matter.

Importantly, Jones’s assessment might be correct. Perhaps investors and entrepreneurs really are underestimating the demand for—or overestimating the costs of building and operating—more light-rail lines in Little Rock. Arnold wisely advises friends of free markets to recognize and to publicly concede that markets can and do fail, even though such failure might never be provable in the way that the earth’s elliptical rotation around the sun is provable.

To reject Arnold’s advice is inadvertently to strengthen the hand of those who insist that instances of market failure are sufficient justification for government intervention. It is (at least to appear) to concede that if and when markets should fail, government should intervene to correct the failure.

But in reality markets aren’t perfect. They’re just not. Markets do sometimes fail because of (bear with me as I parade before you a band of fancy economics terms) “asymmetric information,” “moral hazard,” “time inconsistency,” “free-rider problems,” “opportunism,” “strategic behavior,” “empty cores,” “lumpiness,” “transaction costs,” “bounded rationality,” and other features of reality that prevent markets from performing ideally.

These sources of market imperfections are themselves a second reason to take seriously Arnold’s advice to use markets even though markets sometimes fail. Too many people—including economists—remain stubbornly unaware that even the proven existence of a “market failure” is only a necessary condition to justify government intervention; market failure is not a sufficient condition.

Voters and government officials don’t become more godlike simply by acting in the domain of politics. So voters and government officials are at least as likely as are investors, consumers, and other private-market participants to be poorly informed, to let their emotions block their rational faculties, and to suffer each of the other decision-making quirks that can lead to market failure.

But this fact suggests only that political outcomes are likely to be as imperfect as market outcomes. It does not suggest that political outcomes are likely to be worse than market outcomes. So why the strong advice to “use markets”?

The answer is that market institutions are better than political institutions at minimizing the frequency, intensity, and ill consequences of uninformed, emotion-ridden, and otherwise fallible decision-making.

The competition among businesses for consumers’ dollars, being never-ending, is more continuous than is the intermittent competition among politicians for citizens’ votes.

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Yet another feature of government that causes its outcomes to be less desirable than those of the market is “lumpiness.” When Congress and the president agree on an annual appropriation for the U.S. military, every American is party to that specific annual appropriation. I—a dove—don’t get to have a lower appropriation than does my neighbor the war hawk. Government’s provision of national defense comes in a largely indivisible lump.

Not so in markets. If I prefer wine to beer, I get to have more wine than beer while my neighbor with opposite preferences gets to have more beer than wine. And all the while the teetotaling couple down the block chooses—and receives—a third, alcohol-free bundle of consumption goods.

Arnold Kling endorses free markets not because they are foolproof or flawless. They aren’t. Arnold supports them because the alternative is generally much worse: an especially flawed institution that fosters unusual amounts of foolishness.

How Legal Activism Stopped the Market from Abolishing Segregation – Foundation for Economic Education – Working for a free and prosperous world

Source: How Legal Activism Stopped the Market from Abolishing Segregation – Foundation for Economic Education – Working for a free and prosperous world

The Untold Story

What is often lost in the short history-class-version of this case is the effort by the company to comply and remove the segregation law. This may appear counterintuitive to some, but the market reality made segregation expensive. Looking at the requirements of the law (see above) makes it clear why securing separate accommodations, either by car or partition, is costly, and when you are in the business of selling seats, increasing the likelihood of empty seats works against that interest.

In the 1950’s the economist Gary Becker at the University of Chicago began to write about the economics of discrimination. His writing was contemporaneous to the Brown case which was decided in 1954. Becker’s book, titled The Economics of Discrimination and released in 1957, began a discussion on discrimination in the market which has yielded counterintuitive results in many instances.

Using economic assumptions to describe discriminatory behavior, Becker observed two basic features of discrimination. First, that discrimination may depress the wages and employment opportunities of those discriminated against and conversely that the discriminator may pay higher wages to avoid hiring a minority.

If for example, a white worker gets paid $2 more an hour than an African American worker, the employer is paying a $2 an hour penalty to maintain his discriminatory preferences. Over time, this is a difficult practice to maintain in a competitive environment. The result is parity when comparing equal, similarly situated people. Most employers or businesses are not willing to pay that penalty in the long run.

Since Becker’s book, others have also observed the impact of discrimination in markets and the tendency to move away from discrimination unless the base is sufficiently broad and the taste for discrimination is rather strong. However, in this scenario discrimination is highly likely to arise via democratic mechanisms as well, as it did in the South unless there is a constitutional constraint to prevent discriminatory democratic results.

Additionally, when faced with strong preferences for discrimination those discriminated against are likely to move to geographic areas with more equal outcomes, much like the movement to the north of about six million African-Americans during The Great Migration, which was certainly exacerbated by Jim Crow.

The Free Market Is the Great Equalizer

What Plessy illustrates is that even in a place willing to legalize discrimination (meaning the democratic taste for it was sufficient to be legislated, even if it failed to reach a true majority due to potential disenfranchisement), the market was pushing toward more equal market outcomes and had to be artificially constrained. Essentially, the Plessy verdict granted a special interest group their preference and arrested the development of the market preventing it from moving away from discriminatory practices.

With the hindsight of Becker and others like him, we see how Plessy set the stage for years of subsidized discriminatory behavior. In practice, the schools and other segregated venues behaved as cartels with the ability to impose costs on an industry and essentially remove it as a matter of competition for certain services. If all market actors faced the same imposed costs, there is no incentive to compete to remove that cost.

The Plessy verdict prevented the market from removing discriminatory behavior and it also created a rent-seeking incentive. With the Plessy verdict, racists and segregationists learned they could implement their preference of a segregated society by diffusing the costs among the population at large. Until Brown, these rent-seekers were able to implement their market preferences and it is no surprise that after Plessy Jim Crow continued to grow throughout the South.

There is also a political reason why markets should be preferred over legislation to remove discrimination. Markets tend to work quietly in the background; there is no grand political movement, no sweeping legislation, and very little reactive backlash against those politics that ingrain, often unintentionally, discriminatory views.

In contrast, the doux commerce thesis suggests markets are institutions that bring about desired social change, peace and cordiality, and anti-discrimination becomes a byproduct of this thesis. Two of the most recent advocates of this view have been Deirdre McCloskey in her Bourgeoise trilogy, and Nathan Oman in his book, The Dignity of Commerce. Markets create more peaceful, less discriminatory communities simply because they penalize discrimination and introduce personal interactions within the market.

The lessons of Plessy, often overlooked, are two-fold. The market removes discrimination in a more peaceful manner if we allow it to do so but the desire to intervene on behalf of one group or another is very alluring (an argument to restrict, maybe chain, democratic governments may be merited to some degree based on this observation).

When we take the stance that intervention is necessary we increase the risk of a less peaceful outcome and increase the incentive for rent-seeking behavior, even when discrimination is not the underlying impetus. Understanding the history of this pivotal Supreme Court case teaches how markets provide more favorable outcomes and dispels the myth that free markets are tools of oppression.

Debunking Minimum Wage Myths — Radical Capitalist

In the United States, I have noticed increasing amounts of local municipalities instituting minimum wage laws. This is happening in many states across America, with many people supporting it in the hopes of bettering workers’ wages. Unfortunately, minimum wage is economically dysfunctional and unethical, yet so many people who lack economic or ethical knowledge are […]

via Debunking Minimum Wage Myths — Radical Capitalist

Twelve Economic Concepts Everyone Should Know – Foundation for Economic Education – Working for a free and prosperous world

Source: Twelve Economic Concepts Everyone Should Know – Foundation for Economic Education – Working for a free and prosperous world

1. Gains from trade: In any economic exchange, freely chosen, both parties benefit–at least in their own minds.

2. Subjective value: The value of any good or service is determined by the individual human mind.

3. Opportunity cost: Nothing is free, and the cost of anything is what you give up to get it.

4. Spontaneous order: Society emerges not from top-down intention or planning but from individuals’ actions that result in unplanned outcomes for the whole.

5. Incentives: Individuals act to maximize their own reward.

6. Comparative advantage: Cooperation between individuals creates value when a seller can produce a given item or service at a lower cost than the buyer would spend to produce it himself.

7. Knowledge problem: No one person or group knows enough to plan (and force) social outcomes, because information necessary for social order is distributed among its members and revealed only in human choice.

8. Seen and Unseen: In addition to the tangible and quantifiable effects, there are quite often invisible costs and unmet opportunities to any action or policy.

9. Rules matter: Institutions influence the decisions individuals make. For example, property rights extend from the reality of scarcity which demands that ownership must be vested in individuals and not a collective.

10. Action is purposeful: Each person makes choices with the intention of improving his or her condition.

11. Civil society: Voluntary association permits people of all backgrounds to interact peaceably, create value, cultivate personal character, and build mutual trust.

12. Entrepreneurship: Acting on an opportunity to gather underused, misused, or undiscovered resources and ideas to create value for others.

Boudreaux on the Progressive Mentality, Bryan Caplan | EconLog | Library of Economics and Liberty

Source: Boudreaux on the Progressive Mentality, Bryan Caplan | EconLog | Library of Economics and Liberty

It’s been my observation that the Left dismisses the notion of spontaneous order in markets (hence, free markets are rejected), while the Right dismisses the notion of spontaneous order in biology (hence, evolution is rejected). Apparently there are those who believe the Left’s rejection of spontaneous order is more widespread than just markets.

Bryan Caplan would disabuse them of this notion.

But ultimately, I think resentment of markets has little to do with incomprehension of “spontaneous order.”  Key point: As Hayek emphasizes, markets are only one form of spontaneous order.  Others include language, science, fashion, manners, and even informal hiking paths.  In each case, individuals pursue their own plans with no central direction, yet a tolerably well-functioning social order emerges.  And leftists rarely express resentment – or even worries – about the social value of any of these.  So how can spontaneous order be the crux of the issue?

My preferred story is much simpler: Leftists look at the world of business and see greedy people leading and prospering.  This upsets people of almost every ideology if they dwell on it.  On an emotional level, human beings want people with noble intentions in charge.  Who then are leftists?  They’re the sub-set of humans who feel these emotions with exceptional intensity and durability – and accept a group identity that reinforces such emotions.  Why is a power-hungry politician who bullies strangers with big plans and pompous speeches more “nobly intentioned” than a greedy businessman who woos strangers with fine wares and low prices?  I don’t know, but clearly I’m in the minority here.

People Before Profits – Foundation for Economic Education – Working for a free and prosperous world

Now go read “Person or Principle” over on Sarah Hoyt’s blog.

 

Source: People Before Profits – Foundation for Economic Education – Working for a free and prosperous world

Whether it’s Nation of Islam Minister Louis Farrakhan leading the Million-Man March, anti-WTO (World Trade Organization) protesters, or AIDS activists, we’re frequently treated to the chant demanding “People Before Profits.” Since profit demagoguery is a deceptively appealing tool used by scoundrels everywhere, let’s demystify the concept of profits.

Let’s first get its definition out of the way. Profits represent the residual claim earned by entrepreneurs. It’s what’s left after all other costs—wages, rent, interest—have been paid. The entrepreneur is generally seen as the person who takes risks, innovates, and makes decisions. It’s important to recognize that profits are a cost of business just as are payments to labor, land, and capital. If wages, rent, and interest are not paid, labor, land, and capital will not be offered; similarly, if profit is not paid, entrepreneurs won’t be seen either.

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Here’s Williams’s law: whenever the profit incentive is missing, the probability that people’s wants can be safely ignored is the greatest.

Quotation of the Day… – Cafe Hayek

Source: Quotation of the Day… – Cafe Hayek

The first lesson to be taught is that when we run across a situation we don’t like – “outrageous exploitation of sick people,” for example – we should start by asking how the situation came about and why it persists.  What’s actually going on here?  That’s an extremely important lesson: for the dinner table, the conference room, the legislative hall, and the faculty lounge as well as the economics classroom.  We all have a tendency, especially when we’re filled with indignation, to begin with the conclusions and subsequently to choose the facts that will enable us to reach our preestablished results.  That does little to promote understanding; it merely hardens opinions already held.  It does not lead to learning.  And it fosters debate rather than discussion.  Doesn’t it make far more sense to ask why, if the situation is as intolerable as it seems to be, it continues to exist?  Social phenomena are not facts of nature, like mountains.  They emerge from the choices individuals make in response to the situations they encounter, situations that are in turn largely created by the choices other people make.  If we want to change society, we must first understand it.  The first step toward understanding how markets work, and the beginning, I would say, of all social understanding, is the recognition that social phenomena are the product of particular choices in response to particular incentives.  Incentives matter!  To fix any social problem, we must alter the incentives.  To do that, we must first discover what they are.

You Can’t Deny that Venezuela is a Socialist Calamity – Foundation for Economic Education – Working for a free and prosperous world

Source: You Can’t Deny that Venezuela is a Socialist Calamity – Foundation for Economic Education – Working for a free and prosperous world

 

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Economists have long understood the dynamic at work here. Marx and other socialists thought that those in charge of the planning process, and for Marx that was the whole community, could rationally determine what to produce and how best to produce it in the absence of markets, exchange, and prices. Since Mises’s famous essay in 1920, however, we have known that doing so is not possible.

Genuine market prices are necessary for people be able to make determinations of value in anything larger than a household. Without prices, there is no way to know, not just what people value but (more importantly) how to make what they value using the least valuable resources possible.

In other words, rational production decisions are impossible without market prices, and market prices can’t exist without exchange and therefore there has to be private ownership, especially of the means of production.

But what happens when those given the power to make such decisions realize they cannot achieve their perhaps well-intentioned goals? The power does not go away. More often than not, the first reaction is precisely what we’ve seen in Venezuela: crack down harder on producers for not living up to impossible demands and ration goods to punish consumers for “hoarding.” And when that doesn’t work, go to more draconian authoritarianism, and do whatever it takes to hold on to power.

After a while, these exercises of brute power have consequences. They attract those with a comparative advantage in exercising such power (and perhaps those who have a high consumption value for doing so) into positions of power. Marxism is not Stalinism, but the inability of Marxian socialism to live up to its promises creates the conditions that make Stalinism possible and likely. In other words, Stalinism is an unintended consequence of Marxian socialism.

In addition, as state control becomes more clearly ineffective, people start to work around it by establishing distorted forms of market exchange. Bribery of politicians and bureaucrats, threats to producers, cronyism, and nepotism all become the ways of getting things done. Scarce resources have to be allocated somehow, and markets are like weeds in that they will grow in the cracks left by the failures of planning.

Intellectual Negligence

To the outside world, corruption and poor implementation caused socialism to fail. But that gets matters completely backward: corruption and ineffective political actors are not the cause of socialism’s failure, but a result of that failure. When you make real markets illegal and when your attempts at planning inevitably fail, what you get is the bribery and corruption of black markets. Once again, these are not what Marxism intends, but they are an inevitable unintended consequence.