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Rules Should Rule

Comes this e-mail today from Josh Terrence (whom I do not know but who kindly gives me permission to post here, under his name, the germane parts of his e-mail); it’s written in response to this earlier post:

Professor Boudreaux,

Your extreme hostility to minimum wage laws has me shaking my head.  It’s silly as you imply for government to set all prices.  This doesn’t mean that it’s silly for government to set some prices like wages for low paid workers.  [DBx: By “set,” Mr. Terrence here means a government policy that either caps or floors prices and wages.]….

You make yourself look silly by your stridency and failing to realize that setting a subset of prices is entirely different from setting all prices.

As regular Cafe patrons know, I make frequent use of reductio ad absurdums.  I believe such exercises to be especially effective at exposing and challenging the implicit theories that people often employ to justify this government regulation or that government tax.  And I stand by the reductio that I used in my open letter to Labor Sec. Perez.

The implicit theory sported by most proponents of minimum-wage legislation is that prices – at least within some relatively modest range (which apparently includes changes of up to at least 39 percent) – are rather arbitrary figures that government can successfully command to change without sparking any regrettable counter-reactions or offsetting ill-consequences.  This implicit theory – while widely held by the general public – is lousy economics.  My main purpose in arguing as frequently as I do against minimum-wage legislation is to do my modest part in trying to inoculate (especially the younger) readers of this blog against this particular fallacy.

Of course it’s true that an omniscient god could at any time glance down at the existing pattern of market-determined prices and identify tens of thousands, perhaps millions, of them that at the moment are ‘wrong’ – market prices, therefore, that could be set better by the commands of an all-knowing, all-powerful, and benevolent god.  And god’s angels toiling away in the academy could, with equal success, develop and share with us mere mortals theories and models that reveal the logic of god’s economic interventions and explain just how these interventions improve the economy and make life better for nearly everyone.

But contrary to much popular and academic opinion, no such market-intervening god exists.  Therefore, we imperfect humans – we ignorant, error-prone, and self-interested mortals – must rely upon rules to govern our economy.

One darn good rule – darn good in theory and darn good as evidenced by long experience – is that voluntarily chosen terms of exchange, including monetary prices and wages, are the best available guides to economic activity.  Only if there is clear and convincing evidence that such prices are the result, in one or more instances, of genuine monopoly or monopsony power does a practical exception to this rule even begin to arise.  Absent such real (not hypothesized) monopoly or monopsony power, the best that we can do is to follow steadfastly the rule that whatever prices exist at the moment are the best possible prices that can exist at the moment.

By this advice I emphatically do not mean that we should presume that in fact every price and wage rate at the moment is theoretically ideal.  Again, I have zero doubt that at any moment in time countless market-determined prices and wages are either too high or too low.  But no one can know with sufficient certainty which of these prices and wages are ‘correct’ and which are ‘incorrect.’  We mortals, therefore, must presume that any particular price or wage that we encounter is indeed ‘correct.’

The only people who have any business challenging the presumed correctness of the existing pattern of market-determined prices are people who put their money and their actions where their suspicions are.  Entrepreneurs, investors, non-special-privileged business people – people who, suspecting that profit can be made by entering this market, by exiting that market, by buying more of this commodity or by selling this other commodity short – these people each and every day speculate against the correctness of large numbers of existing prices (or price trends).  In doing so they tend to make the pattern of relative prices more ‘correct’ than it would be otherwise.

Many of these speculations are mistaken – but the costs of such mistake-based actions are borne by the individuals who make them.  And because of the decentralized and competitive nature of markets, if Smith has a different assessment than does Jones of the correctness of current prices, Jones puts his money where his mouth is by ‘betting’ (say) that the current price of kumquats is too high while Smith puts his money where his mouth is by ‘betting’ that the current price of kumquats is too low or is just right.  Neither Jones nor Smith knows ahead of time if his or her assessment will prove to be correct, but time – and competition – will tell.

Not only are the bulk of the costs of any price-assessment mistakes ‘internalized’ on those who make these mistakes, but the ability of people with differing assessments to compete against each other ensures that not all of the economy’s ‘bets’ are wagered on one assessment or another.  As such, not only is the probability of sustained and on-going error minimized, also minimized are the depth and extensiveness of the many errors that are routinely committed.  People who put their own money, time, reputations, and effort on the line when betting that this output price is too high or that wage rate is too low do not make such ‘bets’ lightly.  People who put their own money where their mouths are when making assessments of the correctness or ‘erroneousness’ of current market prices do not avail themselves of the luxury so beloved by too many academics, pundits, and government officials to make cost-free pronouncements about the ‘incorrectness’ or ‘correctness’ of prices and wages.

So unless and until we reliably identify a god-like creature in our midst, the best we can do is to follow simple rules for our complex world.  And again, one of the best simple rules is to rely only upon competitive market activities of individuals – acting as entrepreneurs, investors, consumers, workers – each putting his or her own money, time, and reputation where his or her mouth is.

Put in the context of the minimum-wage debate, I see absolutely no reason to suppose that the market-determined wage rates of low-skilled workers are better able than are any other prices to be second-guessed by academics and politicians who stake nothing personal when announcing, god-like, their dissatisfaction with the current level of wages.  Said differently, if it were true that academics or government officials had reliable-enough power to correctly second-guess market-determined wages, then I see no reason to believe that they would not have reliable-enough power to correctly second-guess all market-determined prices.