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.

Microfoundations and the values of policymakers

For economists

This post started an interesting discussion, directed largely by Beatrice Cherrier‏ (@Undercoverhist), about how economists are increasingly tending to hide the value judgements they make. By value judgement I do not mean the trivial, like why did you get interested in this area rather than others, but more serious issues like what values are assumed as part of their analysis. (The distinction between the two was the point of my original post.)

It occurred to me that microfounded macro has an issue that is related to that discussion. It is in fact discussed in my OXREP paper, but used there as an example of where microfoundations had gone one step backwards, with only the prospect of going forwards in the future. The example is the derivation of a benevolent policy maker’s preferences from the utility function of the representative consumer assumed as part of the model, a line of research initiated by Michael Woodford.

Before getting on to the values point, let me note that it is a good example of the primacy of internal consistency in microfoundations rather than the Lucas critique. Before Woodford’s work, microfoundations macroeconomists were embarrassed that they typically assumed an ad hoc objective function for the policy maker choosing between the bads of deviations in inflation from target or deviations of output from its natural rate. Typically, results were presented with alternative values for the policy maker’s preferences between the two. But if the policy maker was benevolent and the model is internally consistent, shouldn’t this objective function reflect the utility function of the representative consumer in the model? What Woodford showed was how this could be done, and better still how it implied the form of objective function, quadratic, that had previously been used on an ad hoc basis. The preference between output and inflation deviations was now an implication of the model.

It was, it is important to admit, an exciting breakthrough. We could now tell policymakers that, if this is the utility function of the representative consumer, and the model was a good representation of reality (yes, I know), this is how you should be trading off output and inflation losses. It was a literature I participated in with colleagues. The derivations were hard and tedious to do, and could take pages of algebra, but within a year every macro paper of this kind had switched from ad hoc objective functions to derived objective functions. If you were doing macro and wanted the paper published in a good journal, this is what you had to do. 

There was only one problem. The simple version of a New Keynesian model that most researchers used implied that inflation deviations were much more important than output deviations. This was very different from the adhoc objective functions that had been used before, where equal weights were commonly used. It also appeared unrealistic: not only did policy makers not act as if inflation was all important in reality, but consumers in happiness studies tended to rate unemployment as more important than inflation. That was the step backwards that I mentioned earlier.

But what it also did, I think, was to make less transparent the value judgements that the researcher was implicitly making. Everyone, including policymakers, know that macro models are huge simplifications, but to get interpretable results that is what you have to do. Yet they also have some idea of their preferences between excess output and inflation. But if the policymaker’s preferences were now endogenised, they would generally get welfare results presented to them with no choice to make involving their own preferences.

Researchers were not hiding anything. The utility function of the representative agent was there to see, and most papers would show the derived objective function with a low relative weight on output deviations. But what was often not shown was how the results would differ under alternative objective functions: why would you as a modeller committed to microfoundations, as to use any other weights than those implied by the model was internally inconsistent. Thus internal consistency took a value judgement away from policy makers.