Winner of the New Statesman SPERI Prize in Political Economy 2016

New! Lecture on 23rd May at Bush House, 44-46 Aldwych on my book 'The Lies We Were Told' with discussion from Rachel Shabi and Aeron Davis. Book here.

Friday, 19 April 2019

Views on the minimum wage show economics to be an inexact science


.The hallmark of a science is not just having refutable hypotheses, but also changing its view when data shows the theory is wrong. Economics is often accused of not being a science. A good test case to see if that is true is the minimum wage. Basic economic theory suggests if you fix wages at above their level in the market, employment will fall as less workers are employed. However a number of empirical studies, the most well known of which was written by Card and Krueger in 1994, have suggested that employment shows no noticeable decline when a minimum wage is imposed or modestly increased. My reading is that the most convincing studies do show this result, but not all do, so the picture is not completely clear.

This illustrates a problem for economics (and all social sciences) that outsides often fail to appreciate. Measurements and econometric studies are often not conclusive, and even in the case of austerity you can find one or two empirical studies which says something different to all the rest. As a result, it is more difficult to use data to show a hypothesis is conclusively wrong in the way the natural sciences can. My own view is that the balance of studies clearly shows a modest minimum wage has no noticeable impact on employment, but others would disagree.

Here is a question from the IGM survey.of around 50 top US economists on the minimum wage


Academic economists appear evenly divided, and few hold a strong opinion on the issue. A similar survey of UK economists, asked about the 2016 increase in the minimum wage, was also divided but lent more towards no effect. In contrast, most German economists appear to have been opposed to the recent introduction of a minimum wage.

If you were cynical you might say that all this shows is that the views of economists just reflect their political opinions, and I would indeed expect there would be a clear correlation to support that with the minimum wage. However when either theory or evidence are pretty clear, economists do not divide by political opinion. The same survey in 2012 and 2014 showed economists largely agreeing that the Obama stimulus reduced unemployment and was beneficial, even though the political right was strongly opposed to it. The reason is that economic theory and nearly all evidence shows that fiscal expansion when interest rates are stuck at their lower bound is expansionary.

Equally standard microeconomic theory is just as clear that the minimum wage will reduce employment, and I suspect that had this survey been done in the early 1990s most academics would have agreed with this, whatever their political persuasion. What has changed is the evidence. This example clearly shows a good number of academics responding to empirical results that conflict with standard theory.

Furthermore some economists have done what good scientists should do and produced new theories which can explain the empirical results that the minimum wage does not reduce employment. In that sense economists have been behaving as a science should. But because there are some contrary studies, that allows two things that distinguish economics from physical sciences. The first thing is a temptation to hold on to basic theory even though the balance of evidence is against it, something that is not totally absent in the physical science either (Kuhn, Lakatos etc). The second is to allow ideological influences to help decide what should be a scientific judgement. These are the senses in which economics is an inexact science.


For those interested in economic methodology, and excellent place to start is here, the title of which I am abusing in this post. However it is also worth reading this for sources on the new 'empirical turn' in economics. On the impact of ideology on economics a great place to start is this thread from Beatrice Cherrier. On the introduction and history of the minimum wage in the UK, including initial political resistance to it, see here.






10 comments:

  1. What if unemployment is the wrong measure? affirm like Amazon or McDonald's may be able to absorb a higher wage to the detriment of small businesses that cannot survive .

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  2. Surely only ideologues expect Social Sciences to produce cast-iron results conforming to theoretical predictions: there appears to be nothing wrong with the basic assumptions, they simply fail (and those failures are fairly obvious) to quantify other major variables affecting the principal variable.
    Since replicable experiments to determine the values concerned are almost invariably unacceptable (pace: Josef Mengele) this situation is not likely to change until very large natural data sets are available and analysed.
    Meanwhile we do ourselves a favour by acknowledging the role our own political inclinations play in determining attitudes to everything.

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  3. You say, correctly: "But because there are some contrary studies, that allows two things that distinguish economics from physical sciences."

    You then go on to identify those two things, both of which appear to expose weaknesses in those who practise economics rather than the 'science' itself. But surely it is exactly the possibility, even likelihood, that two equally rigorous and well-designed studies can produce divergent results that distinguishes economics from 'hard' sciences. Another way of putting it might be that replicability, a - if not the - cornerstone of the scientific method, cannot be assured in economics.

    The result is that the goal of demonstrating the 'hardness' of economics is doomed to failure, at least until we are able to set up comparable universes, with identical participants, to test alternate theories. This has driven 'higher' economic theory into the intellectual bottleneck (I hesitate to say dead end) of a branch of mathematically founded logic. Hence the desire to define ever more precisely the assumptions on which theories - and predictions - are based at the expense of real-world validity.

    It's a bit like theories of child-raising: we know that extremes (of physical discipline or complete complaisance) are unlikely to turn out well but any theory to guide us to the appropriate 'sweet spot' is more likely to reflect our own prejudices and preferences than to be informed by 'objective' reality.

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  4. Economics has not been conducted in the manner of a science, but rather as a branch of philosophy -- rigorous reasoning from a set of assumptions. Keynes wrote in the 'General Theory', "..if orthodox economics is at fault, the error is to be found not in the superstructure, which has been erected with great care for logical consistency, but in a lack of clearness and consistency in the premises". He always saw economics as a system of logic and was sceptical about the application of mathematics and econometrics to it; one could cite many other economists who would support that view.

    So if economist A and economist B come to different conclusions on a particular question, assuming no logical errors in their reasoning, it's simply because they differ in their starting assumptions. But where do the assumptions come from? Friedman famously said when challenged about the 'unrealism' of many of the assumptions of neoclassical economics that the realism of the assumptions wasn't important it was the results that counted -- this has been termed Friedman's instrumentalism. So, far from being a science, economics reduces to a belief system.

    In the case of the minimum wage, economists who believe that labour is just a commodity whose quantity is determined by price will believe that a minimum wage will reduce employment, other economists who believe that price is only one of many determinants of the level of employment are likely to disagree.

    All this could still change, in Keynes's day there was very little data and no computers, an empirical basis to economics was hard to imagine; but now, talk of an 'empirical turn' encourages me to think that a science of economics is still a possibility.

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  5. Hi! I feel like one argument might be, to explain why unemployment does not go down, is that most markets are oligopolies. Oligpolies can therefore absorb the rise in costs by cutting down on their profits, and they have an incentive to do so, so that they do noto spark price wars. Profits might also not go down by much (which will mean there is likely to be growth for large companies), because labour now takes less of a proportion of a firm's costs, given so many parts are automated. This is tied into empiricism, as I'm looking at economic outcomes under the current context, but there is some theory to explain, I think. Any thoughts?

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  6. Odd, in that there is an obvious alternative hypothesis that wage bargaining between low-skilled would-be workers and employers is marked by such large asymmetries of knowledge and leverage that the result can be wages set below the market equilibrium. The third hypothesis is market collusion between employers to achieve the same result, facilitated by the much greater ease of organizing between employers than between poor workers. Why should economists assume that the real world markets are always closer to efficiency than to one of the many modes of failure?

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  7. Hi Simon,

    Can you write a blog on the Job Guarantee concept spend side auto-stabiliser

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  8. The questions economists never seem to ask:

    Do businesses want their customers to have higher income or lower incomes?

    Which businesses want customers to have lower incomes?

    Which want more higher income customers?

    Dollar stores, payday lenders, etc probably want wages cut for lots of workers to increase their business.

    Luxury car and homes need their customer incomes to go up a lot. Eg, they want a college graduate to earn over $50, probably $100 an hour including benefits, not $10 an hour as food server or even $15 an hour packing and delivering for Amazon.

    The same can be said about living costs. Should living costs in a US State move toward the living costs of rural Africa or toward the living costs of urban US east and west coasts? If lower kiving costs spur growth, why is rural America losing population while population in California increasing. And Texas has higher living costs than the places most Texas immigrants came from: most Texas immigrants come from lower cost Mexico or rural plains and midwest States.

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  9. FWIW :-)

    Scenario: Bottom 40% earners double wages (on average) through collective bargaining (some 50% more, most 100%, some 150%). Bottom 40% labor averages 15% of production costs. Doubling wages adds 15% to consumer prices – which bites off 15% of sales – before we factor in new sales from the newly flush 40%.

    Common sense dictates that bottom 40ers spend proportionately more of their income buying bottom 40er made products – and (what I call) the mid 59% spend proportionately less on 40er prods. Let’s make that spread 20/10%. (We won’t concern ourselves with the top 1% here.)

    85% of previous sales retained. Extra 10% sales from the doubled half of wages (with 15% fewer jobs) adds 8.5%. Sales retained = 93.5%. (Sales actually cascade up a bit from there as added jobs add jobs – but just a bit of eighth-grade math mind candy.)

    To make sure we are not picking a sweet spot scenario:
    -- 10% sales lost to higher prices – 20/10% spending spread – 90% + 9% = 99% sales retained.
    -- 15% sales lost to higher prices – 40/20% spending spread – 85% + 17% = 102% sales retained.
    -- 10% sales lost to higher prices – 40/20% spending spread – 90% + 18% = 108% sales retained. (Thinking Card and Krueger anyone?)

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  10. "[T]he most well known of which was written by Card and Krueger in 1994, have suggested that employment shows no noticeable decline when a minimum wage is imposed or modestly increased"

    The problem with your statement is you don't define "modest". Krueger himself was on the record that $15 was not a modest increase for the entire U.S. The above picture might reflect some politics, but it is not so clear cut as you suggest.

    "Research suggests that a minimum wage set as high as $12 an hour will do more good than harm for low-wage workers, but a $15-an-hour national minimum wage would put us in uncharted waters, and risk undesirable and unintended consequences."

    Alan Krueger

    https://www.nytimes.com/2015/10/11/opinion/sunday/the-minimum-wage-how-much-is-too-much.html

    Note that Krueger made that statement 2015 which was the same year the survey you cite was given.

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