Thursday, December 24, 2015

Why the Man-in-the-Street is a Natural Keynesian

By Donald Boudreaux

The number of ways to be correct about any matter is small – in many cases, that number is one.  In contrast, the number of ways to be incorrect about any matter is very large – indeed, in all cases it approaches infinity.
I was reminded of this reality when I read the comment by “mulp” on this Marginal Revolution post by my colleague Tyler Cowen.  Tyler’s post is on the paper by David Autor, Alan Manning, and Christopher Smith in which the authors report (among other findings) that “the minimum wage reduces inequality in the lower tail of the wage distribution, though by substantially less than previous estimates.”
My first thought when I read the abstract of the paper (and then skimmed the paper itself) is the same as is the thought expressed by the very first commenter (“Asher”) on Tyler’s post:
A minimum wage will certainly reduce wage inequality, since it is truncating the wage. Even if assuming the worst-case scenario of “Ec 101” where every sub-minimum worker gets fired, wage inequality will be reduced and average wage increased. A more interesting question is whether income inequality is reduced insofar as some people lose their jobs, but his question does not seem to be addressed in the paper.
Spot-on correct.  (Indeed, it’s difficult to imagine how raising the minimum wage could have any effect on the wage distribution other than to “reduce inequality in the lower tail” of that distribution.  But put this question aside.)
In response to “Asher’s” comment, “mulp” wrote (I quote him or her in full):
Some employers hate workers so much they will fire their workers instead of paying a new higher minimum wage and turn away customers spending more thanks to their higher income thanks to the higher minimum wage??
I find it interesting that reduced gas prices and reduced employment and thus reduced incomes is expected to increase consumer spending and thus gdp, but higher incomes for people spending every penny of income is assumed to reduce gdp leading to reduced employment.
Clearly in the past three decades, workers have been turned into black holes sucking money from the economy and consumers with pockets of money are created by magic from nothing based on supply and profits creating wealth – the wealth effect.
I’m still stuck in the 60s and the Adam Smith model of economies: workers spend what they earn making the stuff workers buy – consumers are workers and workers are the consumers.
Obviously wage income can be time shifted by savings and borrowing. I grew up when you were supposed to save wages and borrow only to buy productive assets like cars and houses using future wages. But since 1980, spending future wages for consumption seems to increasingly be the way to offset lower and lower wages, and then people wonder why no one is buying productive assets.
mulp is no clear writer.  But it’s clear enough that he or she accepts the notion that a higher minimum wage results in a sufficiently large increase in demand for the goods and services produced by minimum-wage workers that a higher minimum wage gives no economic reason to employers to economize further on low-skilled labor.  (I know of no credible economist who accepts this justification for the minimum wage, although many non-economists, including the current president of the executive branch of the United States government and at least one former U.S. Secretary of Labor, fall for this fallacy.)
What’s telling about mulp’s comment is that it reveals complete obliviousness to the main economic argument against the minimum wage – namely, that by artificially raising the relative price of low-skilled workers it increases the attractiveness to employers of substituting other inputs and even of reducing total output.  That is, the main argument against the minimum wage is a microeconomic one; this argument has nothing to do with aggregate demand.  Yet mulp – who I assume is the typical economically uninformed ‘man in the street’ – thinks only of total demand and not at all of substitution effects.
mulp’s lack of understanding reflects an all-too-common economic myth – namely, that “wealth effects” dominate in reality over substitution effects.  The reason for the prevalence of this myth is that it take near-zero economic understanding to grasp wealth effects (which is why the man-in-the-street is a natural Keynesian).  In contrast, it takes some genuine economic insight – at least a bit of sophistication when pondering economic relationships – a degree of economic understanding greater than is typical of the man-in-the street – even to be aware of substitution effects and, certainly, to trace out their operation.
The good economist’s challenge is to refute the sort of ‘man-in-the-street’ misunderstanding that is revealed perfectly by mulp’s comment.
The above originally appeared at Cafe Hayek.
RW Note: I am posting the above Boudreaux comment because I find it fascinating that he holds the view that it easier for "the man-in-the-street" to understand the wealth effect versus substitution effects and that it makes such men "natural Keynesians". There may be something to this although I am not sure it is an ironclad rule. 
I do however want to point out one other statement in the comment by Boudreaux and that is with regard to what he writes about inequality. First, I believe the inequality "problem" is blown way out of proportion and merely referencing that there is such a problem implies some acceptance that there is something good about moving toward equality, which I consider a severe error.
Secondly, the idea that raising the minimum wage reduces inequality strikes me as ignoring the major problem with minimum wage laws: people lose their jobs. People who have lost their jobs are certainly not, after losing their jobs, more equal in terms of income. It appears that the commenter Boudreaux quotes, Asher, understands this somewhat, but Boudraux seems to remove this point when he comments on what Asher has said.


  1. "I am not sure it is an ironclad rule."

    Close enough for government work.

  2. I was thinking what Robert was thinking. That those who lost their job are no longer counted in the measure of income inequality though they went theoretically from minimum wage per hour to zero per hour. That they don't count is the only way that income inequality at that level could be reduced. Not, as Robert stated, that greater income equality is a positive thing.