By James Kwak
My new book—Economism: Bad Economics and the Rise of Inequality—is coming out on January 10 (although, of course, you can pre-order it from your local monopoly now). If you’d like more information about the book, the book website is now up at economism.net. (I used Medium instead of WordPress.com this time.) The post below, which is also the top story on the book website, summarizes the main themes of the book.
Income inequality is at levels not seen for a century. Many working families are struggling to get by, only kept afloat by Medicaid and food stamps. The federal minimum wage is just $7.25 per hour—below the poverty line even for a family of two. The bright outlook for corporate profits has driven the S&P 500 to record levels. Surely it makes sense to raise the minimum wage, forcing companies to dip into those profits to pay their workers a bit more.
But that’s not what you learn in Economics 101. The impact of a minimum wage is blissfully easy to model using the supply-and-demand diagram that dominates first-year economics courses.
A price floor in the labor market—that’s what a minimum wage is—causes demand to exceed supply. The difference is unemployment, and the reduction in the employment level represents value lost by society. People who want the minimum wage are well-meaning but muddle-headed do-gooders who don’t understand economics. As Milton Friedman wrote in Capitalism and Freedom, “minimum wage laws are about as clear a case as one can find of a measure the effects of which are precisely the opposite of those intended by the men of good will who support it.”
That’s what Economics 101 teaches you—but it’s not what many economists actually think.
Economists polled by the Chicago Booth School of Business are evenly split on whether an increase in the minimum wage to $9—or even $15—would significantly increase unemployment. Professional opinion is divided exists because detailed empirical research is inconclusive, with several recent studies (e.g., Dube, Lester, and Reich 2010 and 2014) and meta-studies (Doucouliagos and Stanley, Belman and Wolfson) showing no significant impact on employment.
In policy debates and public relations campaigns, however, what you are more likely to hear is that a minimum wage must increase unemployment—because that’s what the model says. This conviction that the world must behave the way it does on the blackboard is what I call economism. This style of thinking is influential because it is clear and logical, reducing complex issues to simple, pseudo-mathematical axioms. But it is not simply an innocent mistake made by inattentive undergraduates. Economism is Economics 101 transformed into an ideology—an ideology that is particularly persuasive because it poses as a neutral means of understanding the world.
In the case of low-skilled labor, it’s clear who benefits from a low minimum wage: the restaurant and hotel industries. In their PR campaigns, however, these corporations can hardly come out and say they like their labor as cheap as possible. Instead, armed with the logic of supply and demand, they argue that raising the minimum wage will only increase unemployment and poverty. Similarly, megabanks argue that regulating derivatives will starve the real economy of capital; multinational manufacturing companies argue that new trade agreements will benefit everyone; and the wealthy argue that lower taxes will increase savings and investment, unleashing economic growth.
In each case, economism allows a private interest to pretend that its preferred policies will really benefit society as a whole. The usual result is to increase inequality or to legitimize the widening gulf between rich and poor in contemporary society.
I became aware of the subtle power of economism during the 2009–2010 financial reform debate, when bank lobbyists invoked economic logic to protect their clients’ profits from new regulations. As far as I can recall, I first wrote about it in a 2011 blog post titled “The Smugness of Unintended Consequences.” My new book, Economism: Bad Economics and the Rise of Inequality, offers an intellectual history of the rise of economism in the late twentieth century, case studies of its impact in several different policy domains, and—I hope—the tools to enable readers to understand both the merits and the limitations of arguments based on Economics 101. Because the first step in overcoming an ideology is understanding how it works.
The Baseline Scenario 
The election year malarkey-factor has reached a culmination point that has obscured logic to a confusing degree. Most notably, there are still those who will write entire articles on the dire state of wages and employment yet without mentioning immigration. But over a million immigrants per year are allowed to increase the supply of labor when the demand has been waning for half a century. To make these matters even worse, there are an additional 10 million or so illegal immigrants living openly among us, and if this additional supply of labor gets mentioned in an article such as this one, that impact on wages is justified somehow, and as if there is a contest to see who can ignore the highest number of variables.
In this election cycle however, there has been some push-back in regards to illegal immigration. Legal immigration is still being ignored, and we are frequently reminded that immigrants are what made this country ‘great’, and so on. Of course, these claims ignore the fact that our infrastructure is overwhelmed; and… that the impact of immigrants in the distant past, and the impact of immigrants now, are two entirely different matters in regards to the demand for labor, and insofar as opportunities exist, but so it goes.
More than anything else though, the subject of ‘inequality’ has turned logic upside down of late. Most Americans are now thoroughly convinced that inequality is like a creeping plague on society. The actual truth being…that inequality can in fact occur with those in the lower-classes gaining ground right along with those in the upper-classes. And on a global level, this is what has been happening. Globally, extreme poverty has declined form 40% in 1981, to 10% in 2015 (World Bank), but inequality worsened even though this was an unprecedented decline in extreme poverty.
Take for example an imaginary rich guy who makes $1,000. on day #1. A poor guy then earns $2.. On day #2, rich-guy’s earns $1,010., while poor-guy makes $4. ‘Inequality’ has worsened by $8, but…the poor guy’s income has doubled while the rich guy’s earnings have changed little. On day #3, the rich guy makes $1,030., the poor guy earns $8., inequality worsens again, but the poor guy now makes 4 times more than he did on day #1. And the rich guy ‘could’ be paying more in taxes. Anyway, ‘inequality’ can be a misleading indicator of how things are, or how things could be..
it’s clear who benefits from a low minimum wage: the restaurant and hotel industries.
Pricing in the restaurant and hotel industries is not set by costs, it is set by competitor pricing. The beneficiaries are the consumers.
Hey, I’m not even an economist. I’m simply a seismologist who sometimes watches the oil market.
Hey Jon,
Welcome to the world of Econ-blogging and other foolishness. Now, consider how higher wages might affect those restaurateurs, and hoteliers, who you, by implication, claim… not to benefit no matter what, does all this mean then that higher wages, once those have caused higher prices for the consumers thereto, will then require employers to operate at a loss due to a presumable loss of business? This all based on the presumption that “the restaurant and hotel industries” were ‘all’ breaking even in accordance with your assertion.
The way to measure income inequality is not by the difference in incomes but by the ratio of incomes. At least to a first approximation.
Hey Min,
Glad to see that you are still at it.
Your comment however leaves me wondering if my comment is lacking enough in regards to my intended criticism of those who oversimplify ‘inequality’. I maybe should have included that I’ve been bouncing around the internet and trying to better understand how we got to where we are. And as you may know, the blogosphere has become a strange place with lots of strange comments and conclusions.
Naturally, the election chatter has caused unusual confusion, even for an election year. And so, it seems that if one doesn’t believe that ISIS is about to overrun our shores, and that offshoring and free-trade are the primary reasons for job-loss and etc, and that inequality may soon destroy civilization as we know it, well, then one must be a ‘troll’ of some sort or another.
In fact, I’ve been called more names, of the negative variety, in the last couple of months than during the entirety of my long life, lol. Oddly too, as it turns out, if one is able to construct a sentence without solecisms, or if one refers to a ‘bankster’ as just a banker, or any one of many such code violations, one is a ‘corporate whore’, or a ‘sell-out’, and so forth. And if one supports one’s claims, or questions oversimplifications or generalizations and such, or dares to present ideas in proper paragraphs, well, that rates up there with crimes against humanity.
So, I’m trying to adjust, but old habits die hard. In the meantime, from what I have recently been told, I’m no longer a progressive person, lol.
The fundamental purpose of work is to provide the worker with what he needs to live. A living wage insures that purpose. If a worker is paid less than a living wage then somebody is subsidizing the worker and the employer and consumer also benefit from the subsidy,
I think that Economics 101 can be reconciled with zero effect if one uses an appropriate demand function for workers: instead of a finite decreasing slope around the equilibrium, use (say) a step function for each firm:
d(n) = D if nN, and in between if n=N
In other words, they lay off or don’t hire a worker if they can distribute his work among remaining workers (n>N). When n=N, they can’t distribute all his work among the remaining workers.
Clearly, the effect is minimal: it only affects the Nth worker, and only if the benefit from his work is within a narrow range.
Then include the increased demand for goods and services due to increased wages, and what do you get?
My previous comment: the less-than and greater-than signs got HTMLed. The demand function was
d(n) = D if n is less than N, 0 if n is greater than N, and in between if n=N.
One area where you see much “economism” is in behavioral economics, where decisions are considered irrational if they don’t follow the rules defined by economic theories. For example, Benartzi S, Thaler R. Naive diversification strategies in defined contribution savings plans. American Economic Review, 2001; 91(1):79–98 – found that in contrast to the “rational, mean-variance optimizing [MVO] investor,” individual retirement investors tend to employ a naïve diversification strategy, the “1/N heuristic,” in which contributions are simply divided evenly among the N options offered. Empirically, however, it has been known for decades that the “naive” 1/N strategy can outperform MVO, which assumes perfect information about the future distribution of returns. A recent example: DeMiguel V, Garlappi L, Uppal R. Optimal versus naive diversification: How inefficient is the 1/N portfolio strategy? Review of Financial Studies, 2009; 22(5):1915–1953. Nudge thyself.
Oh, those evil immigrants, overrunning the borders, taking our jobs. So they must all be sneaking back to their native lands with their ill-gotten gains, right? Because if they’re living here, they contribute nothing to the economy, right? Because they aren’t consumers like the natives are, right? (And illegal immigrants are never exploited because they’re forced to pay for goods and services in black/grey markets, right?) Malarkey indeed.
Bloodfreak,
Perhaps if you were to support some of that I’d have something to say back. As it stands, your comment is just not worthy of a reply. Can you show for example that their contribution outweighs the cost for others? Explain how the demand for labor implications might be solved?
And I’m not quite sure where your remark on exploitation fits here, are you trying to say that they should stay so that they might be exploited further? LOL
The odd thing about those who feign to care about the well-being of illegal immigrants is…that they rarely if ever even know that the NAFTA/CAFTADR agreements each have provisions to protect worker’s rights. And never have I seen or heard any complaints about these provisions being ignored from ‘those who feign to care’.
James, you and Noah should get together.
http://noahpinionblog.blogspot.com/2016/12/an-econ-theory-falsified.html
We, in the United States of America, are living in the Gutted Age.