Seattle Proves Economics is not Physics
The ongoing fight about min wage in Seattle magnifies some of the things wrong with mainstream economics. In 2014 the city council voted to phase in a $15 wage over the next few years and in 2015 increased the wage floor from $11 to $13 per hour. Recently, the University of Washington conducted a study that showed the increase caused low-wage workers’ annual pay to go down and overall low-wage jobs to also shrink.
Keep in mind that mainstream economists cling to their gods, guns and economic models because, as they insist, math makes economics a science like physics. Yet with all of the veneration of the math and statistics, I have seen no econometric study such as this one change anyone’s mind or change mainstream economics in my 40 years of watching the game. The usual suspects in economics greeted the study in the same old way they have met with similar studies for the past half century: the right (free market) celebrated and the left (socialists) poo-pooed it.
No one sees such behavior in the truly math oriented sciences such as physics. There aren’t five schools of physics that dispute gravity or the speed of light as there are five different schools of macroeconomics. But why aren’t the econometric analyses of economic data more convincing? The problem lies with the subject matter. Physics is child’s play compared to economics because gravity and light and electrons always act the same way under similar circumstances. Humans, the subject of economics, don’t. And the number of relevant variables in a physics problem is small compared to those in economics, not to mention the complex interactions.
Because historical data is so vast, complex and contradictory, economists can find support for any crackpot idea in data and everyone knows that. For example, Fortune magazine complained that the researchers in the University of Washington study ignored much of the low wage population:
The research has significant flaws—most glaringly that its data excludes 40% of the Seattle workforce. It also stands in contrast to a massive trove of actually credible studies showing that raising the minimum wage is a boon for working class families and the communities they live in.
However, even if the study excluded 40% of the workforce, that doesn’t invalidate the study. At the least it means that the study found negative results in the 60% of the workforce that it surveyed and it’s likely the results can be extrapolated to the remaining 40%. At the worst it merely doesn’t apply to the 40%. But the Fortune writer is probably wrong. If I could make an appeal to authority, the National Bureau of Economic Research published the paper and they’re not typically sloppy. The paper states,
This paper examines the impact of a minimum wage increase for employment across all categories of low-wage employees, spanning all industries and worker demographics.” [emphasis in the original]
How Fortune Magazine could construe all as 60% I’m not sure. I would encourage viewers to read the paper and make up their own mind about its credibility. Also, it points out the bad methodology of the papers that Fortune lauds.
Credibility is in the eye of the beholder in economics. Usually, any study that supports free markets gets trashed by socialists, like the writer of the Fortune article. The reasons for rejecting a study are innumerable: the researchers ignored the relevant population or time period; they failed to include the right variables or included the wrong ones. The math is almost always pristine.
Is there any way to sort the good from the bad research? Mises taught the only method. He wrote that historical data is so deep, complex and contradictory that it’s impossible to make sense of it without a theory to sort it out. All historians approach history with a theory of how societies work whether they admit it or not. Economists are no different. They need to apply sound theory to the data.
The theoretical problem with the studies that show the min wage has no effect or actually benefits low wage workers is that they contradict the most fundamental principle of economics – the law of demand. That principle says people buy less of a product or service as prices rise, all else being equal, or ceteris paribus. If ceteris paribus holds and people buy more of something at a higher price, they are irrational. So if we see someone buying more of something at a higher price, it’s safer to assume ceteris paribus doesn’t hold than to assume people are irrational. People can be irrational, but on something as simple as wages it’s not likely for profit-seeking businessmen to be so irrational.
When ceteris paribus holds, the demand curve remains fixed in position on the graph and as prices change the quantity demanded moves up and down the demand line, which demonstrates the principle that the quantity demanded falls as prices rise. But when we see people buying more of something at a higher price we know that ceteris paribus no longer is true and something besides price is impacting the quantity bought. Dozens of things can affect sales other than price. They can include changes in taste, supply, income, weather, seasons, quality, population and many other things.
So how does this shed light on min wage research? It’s simple. If the min wage rises then ceteris paribus employers will buy less labor in the form of fewer employees or employees working fewer hours. If the data doesn’t show that happening then something else is going on. Keep in mind that the laws of supply and demand states that the quantity demanded will fall only if the price is above the price that a free market would determine. If the min wage is at or below or only slightly above the free market rate then it will have no impact at all on employment.
That is what I think is happening with the min wage studies. Researchers find no effect on employment because politicians are setting the min wage at or below the market rate. Politicians do that so that they can appease their socialist base but not hurt the economy. Their base is gullible enough to drink the Kool-Aid. Let them try a min wage of $25 per hour and I can guarantee you those same socialist economists who haven’t found a min wage effect for decades will suddenly discover a herd of elephants.
Another serious problem with all of the studies is the fixation on the short run. In the long run, which all good economists should consider, min wages above the market rate will discourage new businesses from entering the market, but that will never show up in a short term study. Nor will one show the theft of property that happens when a small business owner is stuck with a firm that can’t make a profit because of the higher min wages. He can’t sell the business. His only option is to close the business and lose all of the wealth he had worked so hard for over decades.
Don’t be fooled by socialists armed with econometric studies. Humans are generally rational where profits are concerned and that means min wages always hurt workers and impoverish societies in the long run. Even the theologians at the University of Salamanca in the 16th century understood that. Denying it takes a great deal of socialist brainwashing.
Originally published on ABCT Investing.
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