DRI-265 for week of 2-23-14: False Confession Under Torture: The So-Called Re-Evaluation of the Minimum Wage

An Access Advertising EconBrief:

False Confession Under Torture: The So-Called Re-Evaluation of the Minimum Wage

For many years, the public pictured an economist as a vacillator. That image dated back to President Harry Truman’s quoted wish for a “one-armed economist,” unable to hedge every utterance with “on the one hand…on the other hand.”

Surveys of economists belied this perception. The profession has remained predominantly left-wing in political orientation, but its support for the fundamental logic of markets has been strong. Economists have backed free international trade overwhelmingly. They have opposed rent control – which socialist economist Assar Lindbeck deemed the second-best way to destroy a city, ranking behind only bombing. And economists have denounced the minimum wage with only slightly less force.

Now, for the first time, this united front has begun to break up. Recently a gaggle of some 600 economists, including seven Nobel Laureates, has spoken up in favor of a 40% increase in the minimum wage. The minimum wage has always retained public support. But what could possibly account for this seeming about-face by the economics profession?

The CBO Study

This week, the Congressional Budget Office (CBO) released a study that was hailed by both proponents and opponents of the minimum wage. The CBO study tried to estimate the effects of raising the current minimum of $7.25 per hour to $9 and $10.10, respectively. It provided an interval estimate of the job loss resulting from President Obama’s State of the Union suggestion of a $10.10 minimum wage. The interval stretched from roughly zero to one million. It took the midpoint of this interval – 500,000 jobs – as “the” estimate of job loss because… because…well, because 500,000 is halfway between zero and 1,000,000, that’s why. Averages seem to have a mystical attraction to statisticians as well as to the general public.

Economists looking for signs of orthodox economic logic in the CBO study could find them. “Some jobs for low-wage workers would probably be eliminated, the income of most workers who became jobless would fall substantially, and the share of low-wage workers who were employed would probably fall slightly.” The minimum wage is a poorly-targeted means of increasing the incomes of the poor because “many low-income workers are not members of low-income families.” And when an employer chooses which low-wage workers to retain and which to cut loose after a minimum-wage hike, he will likely retain the upper-class employee with good education and social skills and lay off the first-time entrant into the labor force who is poor in income, wealth and human capital. These are traditional sentiments.

On the other hand, the Obama administration’s hired gun at the Council of Economic Advisers (CEA), Chairman Jason Furman, looked inside the glass surrounding the minimum wage and found it half-full. He characterized the CBO’s job-loss conclusion as a “0.3% decrease in employment” that “could be essentially zero.” Furman cited the CBO estimate that 16.5 million workers would receive an increase in income as a result of the minimum-wage increase. Net benefits to those whose incomes currently fall below the so-called poverty line are estimated at $5 billion. The overall effect on real income – what economists would call the general equilibrium result of the change – is estimated to be a $2 billion increase in real income.

The petitioning economists, the CBO and the CEA clearly are all not viewing the minimum wage through the traditional textbook prism. What caused this new outlook?

The “New Learning” and the Old-Time Religion on the Minimum Wage

The impetus to this eye-opening change has ostensibly been new research. Bloomberg Businessweek devoted a lead article to the supposed re-evaluation of the minimum wage. Author Peter Coy declares that “the argument that a wage floor kills jobs has been weakened by careful research over the past 20 years.” Not surprisingly, Coy locates the watershed event as the Card-Krueger comparative study of fast-food restaurants in New Jersey and Pennsylvania in 1994. This study not only made names for its authors, it began the campaign to make the minimum wage respectable in academic economic circles.

“The Card-Krueger study touched off an econometric arms race as labor economists on opposite sides of the argument topped one another with increasingly sophisticated analyses,” Coy relates. “The net result has been to soften the economics profession’s traditional skepticism about minimum wages.” If true, this would be sign of softening brains, not skepticism. The arguments advanced by the re-evaluation of the minimum wage have been around for decades. Peter Coy is saying that, somehow, new studies done in the last 20 years have produced different results than those done for the previous fifty years, and those different results justify a turnabout by the economics profession.

That stance is, quite simply, hooey. Traditional economic opposition to the minimum wage was never based on empirical research. It was based on the economic logic of choice in markets, which argues unequivocally against the minimum wage. Setting a wage above the market-determined wage will create a surplus of low-skilled labor; e.g., unemployment. Thus, any gains accruing to the workers who retain their jobs will come at the expense of workers who lose their jobs. The public supports the minimum wage on the misapprehension that the gains come at the expense of employers. This is true only transitorily, during the period in which some firms go out of business, prices rise and workers are laid off. During this short-run transition period, the gains of still-employed workers come at the expense of business owners and laid-off workers. But once the adjustments occur, the business owners who survive the transition are once again earning a “normal” (competitive) rate of profit, as they were before the minimum wage went up. Now, and indefinitely going forward, the gains of still-employed workers come at the expense of laid-off workers and consumers who pay higher prices for the smaller supply of goods and services produced by low-skilled workers.

The still-employed workers are by no means all “poor,” despite the face that they earn the minimum wage. Some are teenagers in middle- or upper-class households, whose good educations and social skills preserved their jobs after the minimum-wage hike. Some are older workers whose superior discipline and work skills made them irreplaceable. The workers who rate to lose their jobs are the poorest and least able to cope – namely, first-time job holders and those with the fewest cognitive and social skills. The minimum wage transfers income from the poor to the non-poor. What a victory for social justice! That is why even the left-wing economists like Alan Blinder formerly pooh-poohed the minimum wage as a means of helping the poor. (While he was Chairman of the CEA under President Clinton, Blinder was embarrassed when the arguments against the minimum wage in his economics textbook were juxtaposed alongside the administration’s support of a minimum-wage increase.)

This does not complete the roster of the minimum wage’s defects. Government price-setting has mirror-image effects on both above-market prices and below-market prices. By creating a surplus of low-skilled labor, the minimum wage makes it costless for employers to discriminate against a class of workers they find objectionable – black, female, politically or theologically incorrect, etc. Black-market employment of illegal workers – immigrants or off-the-books employees – can now gain a foothold. Business owners are encouraged to substitute machines for workers and have done so throughout the history of the minimum wage. In cases such as elevator operators, this has caused whole categories of workers to vanish. This expanded range of drawbacks somehow never finds its way into popular discussions of the minimum wage, which are invariably confined to the effects on employment and income distribution.

“If there are negative effects on total employment, the most recent studies show, they appear to be small,” according to Bloomberg Businessweek.  The trouble is that the focus of the minimum wage is not properly on total employment. The minimum wage itself applies only to the market for low-skilled labor, comprising roughly 20 million Americans. There are certainly effects on other labor and product markets. But it is difficult enough to estimate the quantitative effect of the minimum wage on the one market directly affected, let alone to gauge the secondary impact on the other markets comprising the remaining 300 million people. The Obama administration, the vocal economists, the Bloomberg Businessweek and the political Left are ostensibly concerned with the poor. Why, then, do they insist on couching employment effects only in total terms?

It is clear that the same reasons why economists have traditionally chosen not to confuse the issue by dragging in total employment are also the reasons why economists now choose precisely to do so. They want to confuse the issue, to disguise the full magnitude of the adverse effects on low-skilled workers by hiding them inside the much smaller percentage effect on total employment. That is what allows CEA Chairman Jason Furman to brag that the “CBO’s central estimate…leads to a 0.3% decrease in employment… [that] could be essentially zero.” 500,000 is not 0.3% of 20 million (that would be 60,000) but rather 0.3% of the larger total work force of around 170 million. 0.3% sounds like such a small number. That’s almost zero, isn’t it? Surely that isn’t such a high price to pay for paying people what they’re worth – or what a bunch of economists think they’re worth, anyway.

But we digress. Just what is it that causes those “apparently small” effects on total employment, anyway? “Higher wages reduce turnover by reducing job satisfaction, so at any given moment there are fewer unfilled openings. Within reasonable ranges of a minimum wage, the churn-reducing effect seems to offset whatever staff reductions occur because of higher labor costs. Also, some businesses manage to pass along the costs to customers without harming sales.”

This is mostly warmed-over sociology, imported by economists for cosmetic purposes. American industry is pockmarked with industries plagued by high turnover, such as trucking. If higher wages were a panacea for this problem, it would have been solved long since. Today, we have a minimum wage. We also have a gigantic mismatch of unfilled jobs and discouraged workers. The shibboleth of businesses “passing along” costs to consumers with impunity was a cherished figment imagined in books by John Kenneth Galbraith in the 1950s and 60s, but neither Galbraith nor today’s economists can explain what hypnotic power businesses exert over consumers to accomplish this feat.

The magic word never mentioned by Peter Coy or the 600 economists or Jason Furman is productivity. Competitive markets enforce a strict link between market wages and productivity – specifically, between the wage and the discounted marginal value product of the marginal worker’s labor. Once that link is severed, the tether to economic logic has been cut and the discussion drifts along in never-never land. The political Left maunders on about the “dignity of human labor” and “a living wage” and “the worth of a human being” – nebulous concepts that have no objective meaning but allow the user to attach their own without fear of being proven wrong.

Bloomberg Businessweek‘s cover features a young baggage handler holding a sign identifying his job and duties, with a caption reading “How Much Is He Worth?” Inside the magazine, a page is taken up with workers posing for pictures showing their jobs and their own estimation of their “worth.” These emotive exercises may or may not sell magazines, but they prove and solve nothing. Asking a low-skilled worker to evaluate their own worth is like asking a cancer victim what caused their disease. Broadcast journalists do it all the time, but if that were really valuable, we would have cured cancer long ago. If a low-skilled worker were an expert on valuing labor, he or she would qualify as an entrepreneur – and would be set up to make some real money.

A Fine-Tuned Minimum Wage

Into the valley of brain death rode the 600 economists who supported a minimum wage of $10.10 per hour. Their ammunition consisted of fine-tuning based on econometrics. Let us hear from Paul Osterman, labor economist of MIT. “To jump from $7.25 to $15 would be a long haul. That would in my view be a shock to the system.” Mr. Osterman, exercising his finely-honed powers of insight denied to the rabble, is able to peer into the econometric mists and discern that $10.10 would be …somehow… just right – barely felt by 320 million people generating $16 trillion in goods and services, but $15 – no, that would shock the system. In other words, that first 40% increase would be hardly a tickle, but the subsequent 38% would be a bridge too far.

In any other context, it would be quite a surprise to the economics profession to discover that the study of econometrics had advanced this far. (The phrase “science of econometrics” was avoided advisedly.) For decades, graduate students in economics were taught a form of logical positivism originally outlined by John Neville Keynes (father of John Maynard Keynes) and developed by Milton Friedman. Economic theory was advanced by developing hypotheses couched in the form of conditional predictions. These were then tested in order to evaluate their worth. The tests ranged from simple observation to more complex tests of statistical inference. Hypotheses meeting the tests were retained; those failing to do so were discarded.

Simple and attractive though that may sound, this philosophy has failed utterly in practice. The tests have failed to convince anybody; it is axiomatic that no economic theory was ever accepted or rejected on the basis of econometric evidence. And the econometric tools themselves have been the subject of increasing skepticism by economists themselves as well as the outside world. One of the ablest and most respected practitioners, Edward Leamer, titled a famous 1983 article, “Let’s Take the Con Out of Econometrics.”

The time period pictured by Peter Coy as an “econometric arms race” employing “increasingly sophisticated” tools and models overlapped with a steadily growing scandal enveloping the practice of econometrics – or, more precisely, statistical practice across both the natural and social sciences. Within economics alone, it concerned the continuing failure of the leading economists and economic journals to correctly enforce the proper interpretation of the term “statistical significance.” This failure has placed the quantitative value of most of the econometric work done in the last 30 years in question.

The general public’s exposure to the term has encouraged it to regard a “statistically significant” variable or event as one that is quantitatively large or important. In fact, that might or might not be true; there is no necessary connection between statistical significance and quantitative importance. The statistician needs to take measures apart from ascertaining statistical significance in order to gauge quantitative importance, such as calculating a loss function. In practice, this has been honored more in the breach than the observance. Two leading economic historians, Deirdre McCloskey and Steven Ziliak, have conducted a two-decade crusade to reform the statistical practice of their fellow scientists. Their story is not unlike that of the legendary Dr. Simmelweis, who sacrificed his career in order to wipe out childbed fever among women by establishing doctors’ failure to wash their hands as the transmitter of the disease.

This scandal could not be more relevant to the current rehabilitation of the minimum wage. The entire basis for that rehabilitation is supposedly the new, improved econometric work done beginning in 1994 – the very time when the misuse and overemphasis of statistical significance was in full swing. The culprits included many of the leading economists in the profession – including Drs. Card and Krueger and their famous 1994 study, which was one of dozens of offending econometric studies identified by McCloskey and Ziliak. And the claim made by today’s minimum-wage proponents is that their superior command of econometrics allows them to gauge the quantitative effects of different minimum-wages so well that they can fine-tune the choice of a minimum wage, picking a minimum wage that will benefit the poor without causing much loss of jobs and real income. But judging the quantitative effect of dependent variables is exactly what econometrics has done badly from the 1980s to the present, owing to its preoccupation with statistical significance. The last thing in the world that the lay public should do is take the quantitative pretensions of these economists on faith.

This doesn’t sound like a profession possessing the tools and professional integrity necessary to fine-tune a minimum wage to maximize social justice – whatever that might mean. In fact, there is no reason to take recent pronouncements by economists on the minimum wage at face value. This is not professional judgment talking. It is political partisanship masquerading as analytical economics.

The Wall Street Journal pointed out that the $2 billion net gain in real income projected by the CBO if the minimum wage were to rise to $10.10 is a minute percentage gain compared to the size of a $16 trillion GDP. (It is slightly over 0.001%.) The notion of risking a job loss of one million for a gain of that size is quixotic. Even more to the point, the belief that economists can predict gains or losses of that tiny magnitude in a general equilibrium context using econometrics is absurd. The CEA and the CBO are allowing themselves to be used for political purposes and, in the process, allowing the discipline of economics to be prostituted.

The increasing politicization of economics is beginning to produce the same effects that subservience to political orthodoxy produced on Russian science under Stalin. The Russian scientist Lysenko became immortal not because of his scientific achievements but because of his willingness to distort science to comport with Communist doctrine. The late, great economist Ronald Coase once characterized the economics profession’s obsession with econometrics as a determination to “torture the data until it confesses.” Those confessions are now taking on the hue of Soviet-style confessions from the 1930s, exacted under torture from political dissidents who wouldn’t previously knuckle under to the regime. Today, politically partisan economists torture recalcitrant data on the minimum wage in order to extract results favorable to their cause.

The CBO and the CEA should have new stationery printed. Its logo should be an image of Lubyanka Prison in old Soviet Russia.

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