Scott Sumner  

Economic theory, but only when it's convenient

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A few weeks ago, I did a post pointing to an inconsistency in progressive thought. Progressives worry a lot about low wages in Mexico stealing jobs form Texas, but not at all about a $7.25 minimum wage in Texas stealing jobs from California, where the minimum wage will gradually be increased to $15/hour.

A few days ago, a commenter provided another example, echoing the common progressive complaint that the Earned Income Tax Credit might be viewed as a subsidy to Walmart, allowing them to pay even lower wages. I'm glad to see people applying economic reasoning, but I wish they would follow through with the implications. Here are a few examples:

For the same reason that Walmart might react to an EITC with lower wages, almost all of the data that has ever been provided by progressives on income inequality is essentially worthless. The simple fact is that economists do not know how to measure the tax incidence of either the personal or the corporate income taxes. And in the case of the personal income tax, many of them don't even know that they don't know.

For instance, suppose that becoming a brain surgeon is such an onerous procedure (lots of schooling and residency) that their salaries need to be four times higher than the average salary of an accountant. Say $400,000 instead of $100,000. But which salary, before or after tax? Presumably people care about after tax salaries. Thus if there is a high income tax rate on people making $400,000, reducing their after-tax salary, then fewer people will want to enter the field. That will push up the cost of brain surgery, until the four to one ratio is restored. The cost of that "income tax" will be passed on to consumers of medical services.

Now of course the preceding example is oversimplified, and in the real world not all of the tax is passed on in higher prices. Unfortunately, we don't know how much is passed along. But the same is true of Walmart and the EITC. Not all of it will be offset by lower wages at Walmart, and we don't know how much will be.

Here's another example. Progressives often favor laws mandating that companies provide certain benefits, such as vacation days, or overtime pay for work that exceeds 40 hours/week. At first glance, it would seem that those sorts of benefits would help workers, but the Walmart/EITC example suggests just the opposite. Companies will react to the extra benefits by reducing pay.

At this point you might think it's a wash, lower pay offset by more benefits. But it's even worse. If workers valued the extra benefits at more than the foregone wages, then companies and workers would already have struck a deal to provide the extra benefits. Thus suppose workers valued a smoke-free environment at $1100 per worker, and it only cost the company $1000/worker (in lost workers who quit due to a smoking ban). In that case, the company would have an incentive to ban smoking without any government regulations. They could hire their workforce more cheaply. On the other hand, if the regulation produces only $900 in benefits, then it actually hurts, workers, by leading to $1000 in lower wages. The regulations that government forces down the throat of companies could just as easily be viewed as regulations being forced down the throat of workers. Employment mandates hurt workers.

[Of course there's also the issue of benefits that are back door increases in the minimum wages, which are even less efficient than the already inefficient minimum wage.)

In summary, I like it when progressives actually try use economic theory---I wish they'd do it more often. Of course another entire article could be written about blind spots on the right. The right is concerned about "burdensome government regulations that don't pass the cost-benefits test", except when they provide a way to discourage minority voters from going to the polls, or involve expelling millions of productive workers from the country, or ban pot smoking. That sort of thing.

PS. Don Boudreaux and Liya Palagashvili have a study showing how the Obama administration's new overtime regulations actually hurt workers.

PPS. This Market Urbanist blog has coined the term "supply and demand denialism" (SDD) which seems increasingly common on the left.


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CATEGORIES: Labor Market , Regulation , Taxation




COMMENTS (19 to date)
Andrew_FL writes:

Market Urbanist compares people they disagree with to Holocaust Deniers and you applaud them. Nice.

Quick way to tell someone knows exactly nothing, indeed less than nothing about climate change: they use the term "climate change denier."

I wish you'd stop insulting our intelligence by claiming to be a free market guy instead of a pick and choose what kind of socialism you like guy.

The Original CC writes:
This suppose workers valued a smoke-free environment at $1100 per worker, and it only cost the company $1000/worker (in lost workers who quit due to a smoking ban). In that case, the company would have an incentive to ban smoking without any government regulations.
How well do you think employers can assess these costs & benefits?

The reason I ask is that in NYC they banned smoking in restaurants in bars, and advocates for the policy claim that it didn't hurt. (I think they claim that it improved business, esp. b/c nonsmokers like going out now that they don't have to breathe smoke the whole time.)

One might ask why the owners didn't do it on their own. Or at least, you should ask why *some* of them didn't try this on their own years ago. Why wasn't it the case that 10% of restaurants were 100% smoke-free? I have no idea.

This has always puzzled me.

entirelyuseless writes:

The situation is actually even more complicated, for the following reason:

Economic reasoning would suggest removing all such regulations, any kind of minimum wage, and so on. The overall outcome should be best for everyone.

However, people do not generally understand this reasoning, and supporting the minimum wage and other regulations makes them feel like they care about people.

You can respond that "feeling like you care about people" is different from actually caring about people, and if you are actually harming them rather than helping them, you are not even doing what you supposedly want to do.

But the fact is that human beings don't like being hypocrites. So e.g. if you think that you care about Peter, you will be more likely to do something good for Peter, than if you think that you do not care about him.

This implies that there is an additional effect of such regulations: people get to feel that they care about other people, and this may actually get them to do good things for other people in real ways. We have no way to measure this effect.

Mark writes:

Regarding your point at the end, on deportation and marijuana I understand and agree, but on voter ID laws I don't see the analogy. What exactly is the cost benefit analysis of that law? I don't see much in way of economic implications there, it seems to be more about other things like the principle of citizenship. I also think the complaint that it is designed to keep minorities from voting because minorities are less likely to have IDs disingenuous at best. By that logic, every progressive policy ever conceived to help the poor may be called racist against white people because they are less likely to be poor. Besides, im pretty sure voter ID laws are genuinely geared toward keeping illegal immigrants from voting, not an underhanded way to circumvent the 15th amendment.

Philo writes:

Regarding conservative blindspots: Drug regulations and immigration regulations, OK. But who has done a cost-benefit analysis on various different rules ("regulations") about who gets to vote? I must have overlooked it.

Nathan F writes:

Its the job of economists to present the costs/benefits of any policy. If, knowing the full costs and benefits, voters decide to go through with the policy, than public choice theory says that the policy was worth the costs.

I support a minimum wage for one reason - I'd rather have workers who add value below that wage sit at home and collect a small welfare check. Fast food joints can add more machines and maybe hire workers that are semi literate.

In pure econ theory there will be a job for everyone at each wage point. The reality is that those permanently making near minimum wage are fairly unintelligent and incompetent enough that dealing with them is a chore.

Scott Sumner writes:

Andrew, You said:

"Market Urbanist compares people they disagree with to Holocaust Deniers and you applaud them. Nice."

Actually, they did not make that comparison, and I did not applaud them.

And believing in climate change does not imply one is a socialist. But if someone thinks that believing in climate change implies socialism, then that person is unlikely to make a honest judgment about climate change.

CC, You asked:

"How well do you think employers can assess these costs & benefits?"

I'm not sure, but almost certainly better than regulators.

Entirelyuseless, You said:

"However, people do not generally understand this reasoning, and supporting the minimum wage and other regulations makes them feel like they care about people."

In that case this blog will help the public, by educating them about what actually helps and hurts workers.

Philo, I read studies that suggest vote fraud is not a problem, hence I'm inclined to believe the regulation is not cost effective. But that's obviously a relatively uninformed opinion, and if there is evidence that vote fraud is a significant problem, then I would change my view.

Aaron McNay writes:

Scott,

While I agree with your points, one of the responses that I usually hear from people on the left who support these policies is that there are information asymmetries and other collective action problems between employees and employers. As a result, markets breakdown when each employer tries to provide some non-monetary benefit on their own. As a result, government action that requires all employers to provide a non-monetary benefit may be overall welfare improving.

I would appreciate your thoughts with regards to this justification used by some progressives for

"regulations that government forces down the throat of companies."

Thank you.

Jack PQ writes:

@Andrew_FL, @Scott,

I think the point is that it is very unfortunate that people label opponents "deniers" (whether of CC or S&D), because there is an obvious connotation. It is disingenuous to claim one is unaware of the subtext, although I would not go as far as does Andrew_FL.

More interesting to me is the inconsistency shown by most people in this context. Many people on the left believe in human-caused CC because the theory is clear, and they downplay the very mixed empirical evidence. That's fine--but then, they take the opposite stance regarding minimum wages. They put all their faith in (some) empirical studies such as Card-Krueger, and they downplay the unambiguous prediction of economic theory. And to be fair, we see the opposite for people on the right.

It is this "selective anti-science" stance that I worry about. But maybe it's better than being consistently anti-science!

Jay writes:
discourage minority voters from going to the polls

I agree they have many blind spots, but is this really one of them? Especially given today's court ruling.

MikeP writes:

Its the job of economists to present the costs/benefits of any policy. If, knowing the full costs and benefits, voters decide to go through with the policy, than public choice theory says that the policy was worth the costs.

Public choice theory says pretty much exactly the opposite.

Voters vote based on many, many things -- with one particular policy being only one of those things. Furthermore, there is no way that anywhere close to a twentieth of the voters actually are educated enough on economists' presentations of the costs and benefits of one particular policy to be informed enough to make a reliable decision based on it. Finally, whether or not the voters elected an official based on one policy, the official and his appointees are free to do whatever they want with regard to that policy once in office.

Gordon writes:

"Many people on the left believe in human-caused CC because the theory is clear, and they downplay the very mixed empirical evidence."

Well said! I'm a person who believes that theory needs to be backed up by empirical evidence. It was disheartening to see that satellite and weather balloon temperature data was "corrected" to conform to the hypothesis that almost all of the warming was due to CO2 rather than raising questions about whether the hypothesis was correct. And there was the solar physicist who conducted an experiment to show that the solar wind could have a greater impact on climate variation than what was previously believed. He immediately came under personal attack from climatologists after publishing his results.

So in the end, I agree with those who hold the "luke warm" climate change view. Yes, some of the increase in temperatures is highly likely due to the increase in man made carbon dioxide. But I'm very doubtful that the investigation of how much of the change is due to this cause has been conducted with the utmost scientific honesty.

Charles Clarke writes:

"Progressives often favor laws mandating that companies provide certain benefits, such as vacation days, or overtime pay for work that exceeds 40 hours/week. At first glance, it would seem that those sorts of benefits would help workers, but the Walmart/EITC example suggests just the opposite. Companies will react to the extra benefits by reducing pay."

I'm not sure you got this right. The EITC argument has to go through the monopsony power of low wage workers. Otherwise, McDonalds has to outbid Walmart to attract EITC worker and no one captures the EITC. Without monopsony EITC is a win. But the same monopsony argument can make the other policies a win too.

I think it's a mistake to view the economy as mostly described my firm's monopsony power, but it's hard to argue it isn't a consistent progressive viewpoint. Under that worldview, combining these two beliefs seems coherent.

James writes:

Nathan F writes,"I support a minimum wage for one reason - I'd rather have workers who add value below that wage sit at home and collect a small welfare check."

Why would you want that? Why should your wants be a reason for the law to constrain the peaceful options of others?

I am asking these questions theoretically. In the US, it is legal to pay workers less than the minimum wage in many situations. If a low productivity individual wants to take a job at less than the minimum wage, the law permits that to happen. You probably see people employed at less than the minimum wage fairly regularly. Now that you know minimum wages are not effective at achieving the "one reason" you gave to favor them, I believe you have zero reasons remaining.

Tim Worstall writes:

It was Bryan of this parish who made the point that the EITC is potentially a subsidy to employers (as it is only paid if you are in work) while other welfare, like the SNAP, Section 8 stuff, is an anti-subsidy, raising the reservation wage. Because you get it whether you are in work or not, it's based purely on income.

I've seen around and about the statement that empirically about 30% of the EITC does flow to employers as a subsidy.

But the net effect of all welfare is to be an anti-subsidy.

Scott Sumner writes:

Aaron, I'm not sure I understand that argument. Why would collective action be required for businesses to provide benefits that can be delivered more cheaply than higher salary?

Jack, Just to be clear, would you say the same about adding "gate" to a scandal? I'm not trying to be disingenuous, but I honestly don't think adding "gate" to a scandal is an attempt to equate it to "Watergate" --at least in degree of seriousness. Maybe others see things differently.

Having said that, the term "denier" could be viewed as an insult, a sort of shorthand for saying "you are stupid." (In contrast, I view Holocaust denial as more of a moral issue.)

What interested me about the link was not the same as Andrew assumed, but the fact that a blogger was crossing ideolological lines. He was saying (in my view) "OK, you leftists are always talking about climate deniers, but why isn't a rejection of econ 101 an example of "S&D denial." That's why I said I didn't agree with Andrew's interpretation that I was approving of insults. As far as I recall, I've never used denialism except as pushback to denialism on the other side of the ideological divide (but of course my memory may be faulty.)

I agree with the rest of your comment.

Jay, It's pretty clear to me that one goal of these laws is to reduce minority turnout.

Charles, I think you misunderstood. The Walmart example applied to all firms, and thus is consistent with perfect competition. Draw a S&D for labor and add a subsidy. Wages costs fall for employers, even under prefect comp.

Tim, I'm no expert here, but the 30% figure sounds plausible.

Aaron McNay writes:

Soctt,

I am sorry that I did not provide enough clarification and supporting information for my question.

Below is a link to a paper by Alan Krueger where he talks about some of the reasons that can be used for justifying government mandated benefits provided by employers.

In the paper (Pg. 4 - 5), he says "The no-firing rule is a stylized example, but there are other situations where, because of adverse selection, certain benefits that all firms would like to provide to workers are not provided because it is not profitable for any firm to offer the benefit individually. In this situation, total welfare may be higher if all firms are required to provide the benefit."

It is this type of justification that I was hoping you would provide your insight on, as it would seem to indicate that there may be some non-monetary benefits that are not being provided even though their costs to the employer are less than the foregone wages incurred by the employee. At least, that is my reading of what he is saying.

http://harris.princeton.edu/pubs/pdfs/323.pdf

Thank you.

SD writes:

I was interested in this part:

The simple fact is that economists do not know how to measure the tax incidence of either the personal or the corporate income taxes. And in the case of the personal income tax, many of them don't even know that they don't know.

I live in a country where a government-subsidised internship scheme causes huge controversy as it is viewed by 90% of people as a subsidy to corporations. I suspect this is only partially true as it depends on the relative elasticities of labour demand and supply.

Can someone point me toward any useful research about the incidence of corporate tax, income tax, and also EITC-type subsidies too?

Benjamin Cole writes:

Yes, minimum wages are bad for economic results.

Property zoning is arguably worse. Case study: California. It boomed when it had higher minimum wages than now, but is obviously suffocating now from tight property zoning.

Why is the topic always the minimum wage?

Property zoning is ubiquitous also.

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