Sunday, October 26, 2014

Intellectual Inconsistency and Economic Malpractice Regarding the Minimum Wage

Mark Perry writes:

Walter Williams explains why he considers it to be “economic malpractice” for (former) economist Paul Krugman (and others) to claim that the Law of Demand applies universally except apparently in one case: the demand for unskilled and low-skilled workers. As the title of his column suggests (“Embarrassing Economists“), Professor Williams finds it embarrassing that some (former) economists like Krugman are not bothered by their own “intellectual and economic inconsistency” (see graphic above). Here’s Walter:

Suppose the prices of automobiles rose by 100 percent. What would you predict would happen to sales? What about a 25 or 50 percent price increase? I’m going to guess that the average person would predict that sales would fall. Suppose that you’re the CEO of General Motors and your sales manager tells you the company could increase auto sales by advertising a 100 percent or 50 percent price increase. I’m guessing that you’d fire the sales manager for both lunacy and incompetency.
It turns out that there’s a law in economics known as the first fundamental law of demand, to which there are no known real-world exceptions. The law states that the higher the price of something the less people will take of it and vice versa. Another way of stating this very simple law is: There exists a price whereby people can be induced to take more of something, and there exists a price whereby people will take less of something.
There are economists, most notably Nobel Prize-winning economist Paul Krugman, who suggest that the law of demand applies to everything except labor prices (wages) of low-skilled workers. Krugman says that paying fast-food workers $15 an hour wouldn’t cause big companies such as McDonald’s to cut jobs. In other words, Krugman argues that raising the minimum wage doesn’t change employer behavior.
Krugman says that most minimum-wage workers are employed in what he calls non-tradable industries — industries that can’t move to China. He says that there are few mechanization opportunities where minimum-wage workers are employed — for example, fast-food restaurants, hotels, etc. That being the case, he contends, seeing as there aren’t good substitutes for minimum-wage workers, they won’t suffer unemployment from increases in the minimum wage. In other words, the law of demand doesn’t apply to them.
Let’s look at some of the history of some of Krugman’s non-tradable industries. During the 1940s and 1950s, there were very few self-serve gasoline stations. There were also theater ushers to show patrons to their seats. In 1900, 41 percent of the U.S. labor force was employed in agriculture. Now most gas stations are self-serve. Theater ushers disappeared. And only 2 percent of today’s labor force works in agricultural jobs. There are many other examples of buyers of labor services seeking and ultimately finding substitutes when labor prices rise. It’s economic malpractice for economists to suggest that they don’t.
MP: I’ve often referred to the “intellectual and economic inconsistency” described by Professor Williams above regarding the minimum wage (and displayed graphically above) as the “Fallacy of the Special Case.” For example, to somehow exempt the labor market for unskilled workers from the Law of Demand is to fallaciously create a “special case” for that market when in reality that supposed “specialness” cannot be supported by any theoretical or empirical evidence. In reality, there is really nothing “special” about the market for unskilled labor that would distinguish it in any economically important way from any other good or service. In other words, the Law of Demand and the Law of Supply are economic laws that apply universally, without exception, and without any “special cases,” in the same way that the Law of Gravity applies universally, without any exceptions or special cases (Walter Williams makes this point in his column). To allow for exceptions or special cases to market fundamentals and economic reality is faulty, inconsistent and fallacious thinking.
Here are some other examples of the Fallacy of the Special Case:
1. After a natural disaster like a hurricane, flood, tornado or earthquake, government-mandated price controls to prevent “price gouging” are frequently imposed by local or state governments because those major disruptions are incorrectly viewed as a “special case” that justifies temporarily ignoring fundamental economic laws of supply and demand and outlawing market prices.
2. Tickets to concerts or sporting events are a “special case” that justify laws and price controls that prevent those tickets from being sold above face value (i.e. “ticket scalping”). In contrast, other goods like old coins that sell above face value, new cars that sometimes sell above their sticker price, bonds that sell above their par (face) value, and houses that sell above their listed price are not considered to be “special cases,” and there are therefore no laws against “coin scalping,” “car scalping,” “bond scalping” or “house scalping.”
3. Rental apartments in some cities like New York City, Berkeley, and Santa Monica are viewed as a “special case” of housing that justifies special treatment in the form of rent control laws that exempt rental housing from fundamental economic laws of supply and demand. Other housing options like condominiums, homes, co-ops and hotels are not special, and are therefore not subject to any special exemptions from economic reality and market pricing.
Bottom Line: The real danger of the Fallacy of the Special Case is that those allegedly special exceptions to basic economic laws almost always result in legislation that is based primarily on political, and not economic, considerations – minimum wage laws, price gouging laws, ticket scalping laws, and rent control laws. Ignoring economics and/or attempting to circumvent market pricing by allowing for some markets or goods to be “special” might make sense politically, but the legislation that follows makes us much worse off economically, makes us all poorer, and lowers our standard of living. Politicians and the general public can be excused for falling for the Fallacy of the Special Case and supporting price controls like the minimum wage that make us worse off, but the economics profession and (former) economists like Paul Krugman should really know better.

1 comment:

  1. Good breakdown of the fallacy of the special case, thanks.