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Friday, November 3, 2006

Economists Against Economics

Five economists who either won the Nobel Prize in economics or who served as president of the American Economic Association — and three who did both — recently joined over 600 other economists in urging the federal government to increase the minimum wage (pdf). The signatures were gathered by the union-backed Economic Policy Institute (EPI), which unsurprisingly supports substantial government intervention in the economy.

I guess this is supposed to make us think more of the minimum wage. Instead, it makes me think less of the Nobel Prize in economics and the American Economic Association.

Observe what these economists claim.

[The minimum wage] is based on the principle of valuing work by establishing an hourly wage floor beneath which employers cannot pay their workers.

That's gibberish. Legislating a wage floor is not a principle of valuing work. We value work according to the utility it produces. No law can change that. All the minimum wage does is decree: If you are going to buy labor services (a big if), you can't pay less than the law mandates.

In a free market a wage is agreed on through bargaining between an employer, who wants to pay as little as he must to obtain the labor's expected value, and a potential employee, who wants to be paid as much as he can get for his services. What they are willing to offer and accept depends on their expectations and other options. An unskilled worker's options can be expanded through the acquisition of skills, but also through competition for his present services.

Ultimately, an employer's ability to pay the wage depends on consumers' willingness to buy the good that emerges from the production process at a price that covers the (opportunity) costs of making it. If the market price of the good doesn't cover all the costs, no wages will be paid for long.

A wage, then, is the result of a transaction. If competition is free of political impediments, wages tend to reveal the discounted marginal value of particular labor services in the market. Indeed, competitive bidding is the only way to discover that value, which has meaning only through the market process. There is no external standard against which a market-set wage can be judged. Moreover, if the parties are (politically) free, that is, the system is void of physical force, the outcome satisfies the criteria of justice and fairness.

True, we don't have a fully free market, but the proper response should be to repeal the subsidies, taxes, regulations, and other privileges that suppress competition, capital investment, and hence the demand for labor. Replacing the rotten school system with a competitive education market would also help. Tinkering with the minimum wage distracts us from the real task at hand.

If there is no floor beneath which skills can fall, there can't be a floor beneath which hourly wages can fall — unless you want forced unemployment. You'd expect economists to know that.

[T]he minimum wage helps to equalize the imbalance in bargaining power that low-wage workers face in the labor market.

But it doesn't do that for workers who are dismissed because their productivity is perceived to be below the mandated wage. For the same reason, the minimum wage cannot be, as the statement claims, an important tool in fighting poverty. Economic theory demonstrates — and endless studies illustrate — that if you raise the price of something, other things equal, less of it will be bought; in economists' lingo, demand curves slope downward. When anti-smoking advocates want people to buy fewer cigarettes, they call for higher taxes so tobacco will cost more. How can demand curves slope downward for everything but unskilled labor?

The value of the 1997 increase in the federal minimum wage has been fully eroded. The real value of today’s federal minimum wage is less than it has been since 1951.

If the value of the current minimum had not been eroded by inflation — government expansion of money — unemployment among unskilled workers would be higher than it is today. Is such unemployment too low for these economists, not to mention EPI's union backers, who demand a minimum-wage increase although none of their members earns anything near the minimum?

We believe that a modest increase in the minimum wage would improve the well-being of low-wage workers and would not have the adverse effects that critics have claimed.

The adverse effects referred to are job losses by unskilled workers and less entry-level job creation. Other adverse effects are possible. A firm may cut other costs in order to pay the higher minimum, but that cost-cutting may make things less pleasant for workers. For example, hours may be cut back or on-the-job-training could be cancelled. The 650 economists might think the costs are worth the benefits, but should they be making that decision? What will they do personally to help those who actually bear the costs?

What Controversy?

In particular, we share the view the Council of Economic Advisors expressed in the 1999 Economic Report of the President that the weight of the evidence suggests that modest increases in the minimum wage have had very little or no effect on employment. While controversy about the precise employment effects of the minimum wage continues, research has shown that most of the beneficiaries are adults, most are female, and the vast majority are members of low-income working families.

What controversy? Over the slope of the demand curve for unskilled labor? As noted, the adverse effects have been amply demonstrated. The economists might point to a single study, by David Card and Alan Krueger, which purported to show that after the minimum wage was increased in New Jersey a dozen years ago, fast-food restaurants there hired more people than fast-food restaurants in Pennsylvania, where the minimum was not raised. (Curiously, neither Card's nor Krueger's name appears in the EPI statement.) The study was criticized for its method, but Freeman columnist David Henderson, writing in the Wall Street Journal in August, noted something that EPI is not likely to talk about:

Based on criticism of their data from David Neumark and economist William Wascher of the Federal Reserve Board, Messrs. Card and Krueger moderated their findings, later concluding that fast-food jobs grew no more slowly, rather than more quickly, in New Jersey than in Pennsylvania. But they never answered a more fundamental criticism, namely that the standard economists' minimum-wage analysis makes no predictions about narrowly defined industries. As Donald Deere and Finis Welch of Texas Aamp;M University, and Kevin M. Murphy of the University of Chicago, pointed out, an increased minimum wage help expand jobs at franchised fast-food outlets by hobbling competition from local pizza places and sandwich shops. This could explain, in fact, why Messrs. Card and Krueger found fast food prices rising more quickly in New Jersey than in Pennsylvania, a fact that they were unable to explain.


As economists who are concerned about the problems facing low-wage workers, we believe the Fair Minimum Wage Act of 2005′s proposed phased-in increase in the federal minimum wage to $7.25 falls well within the range of options where the benefits to the labor market, workers, and the overall economy would be positive.

But why do they believe it? What's their theory? And why not $8.25 — or $82.50?

Or is this wishful thinking driven by notions of fairness? If so, these economists are not thinking like economists. One also suspects they have guessed at the net effect of an increase. If that's so, their method is flawed. Since we're dealing with subjective and incommensurable human well-being, no way exists to compare the benefits to some (if they exist) with the harm to others in order to see which is greater. Even if a worker gets the two-buck-ten-cent-an-hour raise, does that offset another worker's job loss?

In the end it's hard to know what to say to economists who don't acknowledge that the market has regularities that occur whether or not we wish to recognize them. Even an economist armed with a Nobel Prize can't accomplish what King Canute's couriers thought he could do.

At the official banquet held the night before he was presented the 1974 Nobel Prize in economics, F. A. Hayek expressed his gratitude for the honor, then added:

I must confess that if I had been consulted whether to establish a Nobel Prize in economics, I should have decidedly advised against it. . . . [T]he Nobel Prize confers on an individual an authority which in economics no man ought to possess. . . . [T]he influence of the economist that mainly matters is an influence over laymen: politicians, journalists, civil servants and the public generally. There is no reason why a man who has made a distinctive contribution to economic science should be omnicompetent on all problems of society — as the press tends to treat him till in the end he may himself be persuaded to believe. One is even made to feel it a public duty to pronounce on problems to which one may not have devoted special attention. I am not sure that it is desirable to strengthen the influence of a few individual economists by such a ceremonial and eye-catching recognition of achievements, perhaps of the distant past. I am therefore almost inclined to suggest that you require from your laureates an oath of humility, a sort of hippocratic oath, never to exceed in public pronouncements the limits of their competence.


As in so many things, Hayek was right.

  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.