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Simple Rules for a Complex World

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My Mercatus Center colleague Keith Hall discusses, in the pages of U.S. News & World Report, minimum-wage legislation. [2]  A slice:

This is an important fact to consider, since raising the minimum wage from $7.25 to $10.10 would be a huge 39 percent increase in hourly wage costs for employers. Common sense dictates that raising the cost of hiring the least skilled workers will prompt employers to reduce employee hours, cut back on staff or replace employees with updated technology such as automated scanners. Further, despite what supporters of a higher minimum wage have said, there is a significant amount of economic research that finds raising the minimum wage by a much more modest amount than what is being proposed only benefits some workers at the expense of jobs for others – particularly the least skilled and experienced workers such as these.

I also refer readers again to Bob Murphy’s superb new EconLib essay on the minimum wage [3].  In a part of his essay, Bob explains that even if all the revisionist analyses of the employment effects of minimum-wage hikes are correct on their own terms, those analyses fail to account for – and much less attempt to quantify – several likely negative effects (beyond any effects on the number of workers employed) of minimum-wage legislation.

The general proposition upon which the classic economic case against the minimum wage rests is the law of demand.  The higher the cost of performing action A, the fewer will be the instances of A that are performed.  It’s a general proposition.  It applies to goods, “bads,” services; in applies in the private sector no less and no more than it applies in the “public” sector; it applies in America and Armenia no less and no more than it applies in Zimbabwe and New Zealand.  It applies in 2014 A.D. no less and no more than it applied in 2014 B.C. and in 20,140 B.C.

Moreover, everyone accepts this reality.  Whenever some tweedy economics professor or some deep-green environmentalist discovers what he or she thinks to be a harmful pollutant being discharged excessively into the air or water, that professor or that environmentalist immediately proposes to reduce the pollution by making the discharge of this pollutant more costly to the polluters.  The higher cost might be imposed in the form of a tax (or tax hike) on the pollution discharge, or it might be in the form of a command – backed by the promise of punitive action in the event of failure to comply – to reduce the discharge to a lower (perhaps zero) level.  The intervention here reflects a proper understanding of law of demand.

Or when a parent wants to discourage a toddler from misbehaving, the parent inflicts some punishment – some cost on the toddler – with the natural understanding that even small children will alter their behavior predictably in response to changes in the costs of behaving in various ways.

Indeed, our world is infused throughout with applications of the understanding of the operation of the law of demand.  We use this law in our private lives – even in the rearing of our children and, indeed, also in our romances; we use this law in our business dealings; we use this law in government settings.  We use our understanding of the reality of the law of demand incessantly.  Recognition of the reality of the law of demand is ubiquitous.

In almost all cases, expressions or actions contrary to our understanding of the reality of the law of demand are, or would be, regarded as signs of cluelessness if not of dementia.  If, for example, a state governor announced that his administration was cracking down on the plague of drunk-driving accidents by reducing the penalties for driving while intoxicated, he or she would be thought mad (or intoxicated).  Or if, wanting to sell your house and finding no buyers at its currently listed price, you raised the list price, your real-estate agent would think you mad (or intoxicated).

Yes, yes – a clever person can easily spin out scenarios in which the governor’s proposal or the house-seller’s pricing policy might actually bring about the effects allegedly desired by the governor or the house seller.  Ceteris is not always paribus, or relatively rare quirks might exist that cause the law of demand to be overridden by other effects.  But no one of any sense would propose that, as a general rule, a good way to reduce drunk-drivng accidents is to lower the penalties suffered by persons convicted of driving while drunk.  No one would propose that, as a general rule, a good way to sell a home that currently has no buyers is to raise the asking price for the home.

One great exception to this widespread understanding of the workings of the law of demand involves the demand for low-skilled labor.  Lots of ‘men-in-the-street’ – their untutored economic notions supported today by several professional economists – mysteriously think that employers, when deciding how many hours of low-skilled work-effort to employ, somehow and for some reason do not generally respond predictably to higher costs.

Men-in-the-street can be forgiven for such poor and inconsistent reasoning.  It’s harder to forgive the several economists who fuel this particular men-in-the-streetism.  It’s difficult to overlook the unjustified leaping to conclusions by such economists – leaps allegedly justified by the sophistication of the empirical tests that are said to show that the demanders of low-skilled labor do not predictably respond to incentives as predicted by the law of demand.

Do these economists really believe that the market for low-skilled workers is so consistently – across time and space – shot-through with monopsony power that minimum-wage legislation is justified (legislation that, if such monopsony power turns out not to exist, will harm the very workers it is trumpeted as helping)?  Or do these economists, for some reason, believe that low-skilled labor is one of the very few, perhaps the only, commodity that is not governed by the law of demand?  Or is there some third, X hypothesis that these economists have about the market for low-skilled workers that makes it uniquely devoid of the operation of the law of demand?

When one accounts for the many different ways that employers can react to minimize their exposure to higher minimum wages – only one of which is firing low-skilled workers (or hiring fewer such workers) – and when one realizes that the empirical studies that allegedly justify minimum-wage legislation do not begin to take account of all of these ways – one must conclude that it is the height of unscience to believe that minimum-wage legislation might not harm many of the very workers that it is ostensibly designed to help.  One must conclude that such economists, although they fancy themselves to be dispassionate devotees of ‘the facts,’ are especially blind to a reality that most of us other economists are well aware of – namely, the many different margins of adjustments that are, in fact, exploited by employers, responding to minimum wages, in ways that harm low-skilled workers.

Reality is far more complicated and rich than the pro-minimum-wage crowd makes it out to be.  And reality is far more complicated and rich than the pro-minimum-wage studies have managed to capture.  We are confident of this fact – even though in principle we must concede that it can be shown to be inapplicable here – because we understand that the law of demand applies generally.  To abandon this understanding for no reason other than the counter-intuitive and counter basic economics findings of the much-contested and highly stylized empirical studies that are purported to show that the law of demand is suspended in the market for low-skilled workers would be quite unscientific.