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Quotation of the Day…

… is from Greg Mankiw’s August 29, 2006, blog post titled “How are wages and productivity related?“:

Economic theory says that the wage a worker earns, measured in units of output, equals the amount of output the worker can produce.  Otherwise, competitive firms would have an incentive to alter the number of workers they hire, and these adjustments would bring wages and productivity in line.  If the wage were below productivity, firms would find it profitable to hire more workers.  This would put upward pressure on wages and, because of diminishing returns, downward pressure on productivity.  Conversely, if the wage were above productivity, firms would find it profitable to shed labor, putting downward pressure on wages and upward pressure on productivity.  The equilibrium requires the wage of a worker equaling what that worker can produce.

DBx: A point repeated often here at Cafe Hayek is that economists are at their most productive – for society – when they ask probing questions.  Yet to productively ask probing questions requires a good sense of baselines: warranted presumptions about what we ‘should’ expect to observe in reality against which we can compare that which we observe or think that we observe.

My favorite example of a probing question premised on a poor baseline is “What causes poverty?”  As I long ago heard the late Peter Bauer somewhere point out, “Poverty has no causes.  Wealth has causes.”  Poverty is humanity’s default mode.  If we do nothing, we are poor.  Nothing must occur to cause poverty.  So asking “What causes poverty?” is to slip in the presumption that wealth – widespread prosperity – is somehow more natural than is poverty and that, therefore, poverty must be the result of some cause – that if only we can identify that ’cause’ and eliminate it, then poverty would disappear.

While I don’t deny that the question “What causes poverty?” can be bundled with accompanying explanations to make that question genuinely meaningful and useful, I nevertheless believe that the better question is always “What causes wealth?”  To ask this latter question is to start with a baseline more appropriate to human reality.

And so it is with questions of lesser grandeur in economics, such as “What determines wage rates?”  The appropriate question, for the economist, is not “Why do observed wages track worker productivity?”  Instead, the appropriate question is “Why might observed wages not track worker productivity?”  (In the link above, Mankiw offers some answers to this latter question.)

The above distinction isn’t academic.  Among the seemingly intelligent games played by people who know only something about economics (as opposed actually to knowing economics) – and by some poor economists – is the childish sport of pointing out that reality differs from theory and then immediately and triumphantly leaping to the conclusion that economic theory is a useless, or even misleading, guide to reality.  I am the first to admit that economics has its share of misleading theories, but neither this fact nor the reality that no theory is a description of any reality justifies the rejection of economic theory as a guide to reality.  Without a solid grasp of good economic theory – by which I mean largely the insights learned in a good undergraduate curriculum in economics – economic reality cannot be usefully understood.

And among the unsung benefits of a solid grasp of economic theory is that such a grasp supplies the wisdom to distinguish appropriate from inappropriate baselines against which observed reality is to be judged.