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Prices Are Not Arbitrary

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This morning two different e-mails greeted me yet again with the accusation that my opposition to minimum-wage legislation is (as one correspondent complains) “sophomoric.”  Both correspondents accuse me of “dogmatically” ignoring facts in order to “defend … a pet theory that works better in textbooks for freshmen than it works for real people in real life.”

Sigh.

I can hardly say here anything that differs from – or that adds substantively to – what I’ve said in many earlier posts.  And I will not here try even to summarize, much less to repeat in any comprehensive way, the many reasons why I believe that accusations such as this one are, well, sophomoric.  Instead – before reprising a relevant post from 2013 (below) – I say only that one reason for my refusal to leave the minimum-wage issue alone is that those economists who defend the minimum wage on the grounds that the data allegedly cast doubt upon the theory do a grave disservice to economic science – and I seem to be constitutionally unable to ignore such battering of the core of a discipline that I dearly love and admire for its ability to make visible so much that is invisible to those who do not think like economists.

One of the greatest services that economics offers to humankind is the demonstration that prices set on markets are not arbitrary dictates.  Instead, prices (1) reflect underlying realities and, in doing so, (2) inform producers and consumers about how best to coordinate their actions with each other and (3) give incentives to countless producers and consumers to adjust their actions to each other in coordinating ways.  In short, prices reflect, inform, and incentivize.  (I hate the word “incentivize,” but I now give up trying to buck the trend that has made its use widely acceptable.)

To understand these facts about prices is to deepen your understanding of economic reality.  To understand the formation and role of prices is to take what is perhaps the single biggest step toward understanding the core logic of a market economy.  To understand prices is to take what is perhaps the single biggest step toward understanding how today billions of strangers, spread around the globe and speaking dozens of different languages and each looking out chiefly for the welfare of his or her own family, choose and act in ways that make modern prosperity possible – to make possible the reliable presence on store shelves of fresh meats, bread, beer, eggs, and blueberries (year round!).  To make the lights go on when our fingers flick or the voices of loved ones come through the little slabs held in our hands when we press a few buttons – none of this happens without competitively set prices.  And none of this would happen if prices were, as too many non-economists naively believe, arbitrary extractions imposed by sellers on buyers (or, sometimes, arbitrary offers of gifts to sellers by buyers).

Microeconomic theory is indispensable for understanding and explaining the formation and function of prices.  (An old-fashioned name for microeconomics is “price theory” – a name that is quite appropriate.)  So, for me it is extraordinarily disturbing to find so many economists bending over backwards to justify a policy – minimum-wage legislation – that cannot be justified (save in the most unrealistic of circumstances: the presence of monopsony power) given what economists confidently know about the logic of the workings of the economy.  For me, it is deeply annoying that any economist lends credence to the man-in-the-street myth that prices are arbitrary dictates that can be changed at whim without unleashing consequences that the man-in-the-street himself would unhesitatingly reckon to be undesirable.

….

Economists who support minimum-wage legislation because they judge the resulting higher wages paid to some workers to be worth the resulting greater unemployment and other burdens imposed on other workers [2] are, of course, free to make that value judgment – although it is a value judgment that I do not share.  But this basis for supporting minimum-wage legislation has nothing to do with being an economist. No economist is any better than any non-economist at judging the relative merits of a government policy that makes some people artificially richer by making other people artificially poorer.  But although I do not share the value judgments of those economists who support minimum-wage legislation because they ethically weigh the downsides of minimum-wage legislation to be sufficiently ‘small,’ I am not disturbed by their economics – for they do not deny or attempt to contradict the basic economic theory of minimum-wage legislation.  They admit that the wages of some workers cannot be arbitrarily raised without causing harm to others in the economy, and most likely harm to other workers.  I have no objection to the economics of the economist who, for example, says “I think that the resulting harms inflicted on poor black workers by minimum-wage legislation are not large enough to offset the gains that such legislation gives, in the form of higher pay, to rich white teens and to high-wage labor-union members.”  I object mightily to this economist’s value system, but I cannot object to his economics – because his economics is correct.

….

Here’s a post from March 2013 that is relevant [3].

The following is part of an e-mail that I opened earlier today from Aaron the Aaron.  Mr. Aaron remains unusually perturbed at Russ and me for suggesting that minimum-wage legislation might have some ill, unintended consequences that escape empirical detection:

You [Boudreaux] and Russ … are too anxious to substitute your own theorizing for measured, verifiable data.  I do not trust your and Russ’s theorizing any more than I trust anybody else’s theorizing….  Your way of going about economics is cheating….

You would both be taken more seriously by people who matter if you both take empirical work more seriously.

Neither this forum nor this economist is properly equipped to launch into a lengthy discussion of scientific method.  But I can’t resist writing a few words here in response.

First, I do take empirical work – including, by the way, non-quantitative history – very seriously.  I emphatically do not believe that reality can be divined merely from armchair, a priori theorizing.  (I’m sure that the same holds true for Russ, but I’ll speak here formally only for myself.)  But to take empirical work seriously is not at all the same practice as naively swallowing asserted ‘facts’ and quantitative relationships whole and uncritically.  Quite the opposite is true.  To take empirical work seriously requires thinking seriously about methodology and epistemology – a practice that leads to mature evaluation of empirical claims.  In turn, a mature evaluation of empirical claims often leads to a rejection of many such claims (for a variety of possible reasons).  Such rejections of empirical claims reflect not a rejection of the importance of empirical information but, rather, a recognition of the inescapability of evaluating any and all empirical claims through theoretical lenses.

Second, the nature of economics and other social sciences means that the proper role of abstract theory in these sciences is greater even than it is in the ‘natural’ sciences.  Not only is ceteris almost never paribus in social and economic reality, but many of the ‘predicted’ effects of postulated causes are often too fine and too small to detect with any practically useable tools of observation and measurement – even when ceteris is paribus.

Here’s an example, one that I first used, back in 2006, in another context [4]: Suppose you’re standing beside a swimming pool that’s 1,000 times larger than an Olympic-sized swimming pool.  This gigantic pool is full of water.  The surface of the pool is calm.  You drop into the pool a grain of sand.  Question: what happens, as a result of dropping the grain of sand into the pool, to the pool’s water level?

Answer: it has risen.  (Or, more precisely, the water level of the pool with the grain of sand in it is higher than that level would have been had you not dropped the grain of sand into the pool.)  How do we know this fact?  Reason tells us.  By “reason” I mean here only – and perhaps in a way annoying to professional philosophers – that amalgam of human thought processes made up of experience with basic, everyday physical relationships as well as of ‘common-sense’ logic.

But no practical method for empirically measuring this pool’s water level will detect that that level has risen in response to your dropping into the pool a single grain of sand.  Surely, though, you would be justified in dismissing as mistaken some sophomore who, standing beside you, insists that because the pool’s measured water level is unchanged, you are engaged in unjustified and anti-empirical theorizing when you conclude that the grain of sand dropped into pool actually raised the water level.  Likewise if some empirical study found that, after the grain of sand was dropped into the pool, the water level fell.

The sophomore, believing only what is empirically detectable, concludes that the dropping of grains of sand, one by one, into a huge pool does not raise the pool’s water level (or that it actually causes the water level to fall).  You – not rejecting empirical studies but also not rejecting what you know reasonably well about cause and effect – reach a conclusion opposite to that reached by the sophomore.  And no protestations by the sophomore about your alleged scientific Neanderthalism and his or her devotion only to ‘the facts’ will, or should, change your mind.

Who, in this case, is the better scientist?  You or the sophomore?

My pool example is intentionally extreme.  But it’s perfectly valid for justifying why those of us who insist that a higher legislated minimum-wage will have some negative effect on low-skilled-workers’ employment options continue to accept this proposition despite failures of some measurement attempts to detect those effects.

Of course, like all such scientific propositions, the one defended here – about the inevitable negative consequences of a modest legislated minimum wage – must be held not as a dogma but, rather, as a scientific proposition that is the result of theoretical and empirical analysis.  The possibility that this proposition is mistaken must never be forgotten.  But because the case against the validity of this proposition challenges the very foundations of well-accepted economic science, the burden of proof borne by those who would have us reject this proposition is enormously heavy.  A few empirical studies that find no negative consequences, or that find positive consequences, hardly suffice to meet this burden.

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