Thursday, November 21, 2019

Some Terrible Economics Out of the American Economic Review

Rain in India
By Robert Wenzel

Tyler Cowen retweeted this:

 Cowen apparently thinks it could be "the best paper on nominal wage rigidity."

I think it is coprolite.

That said, these days in top economic journals there is a lot of bad economics because of the obsession with empirical studies by economists who have no clue how to structure their studies who then make the further methodological mistake by thinking they are discovering theory (See: The Ultimate Foundation of Economic Science: An Essay on Method).

So let us take a look at this Supreet Kaur paper, Nominal Wage Rigidity in Village Labor Markets.

The abstract reads:
This paper develops a new approach to test for downward wage rigidity by examining transitory shocks to labor demand (i.e., rainfall) across 600 Indian districts. Nominal wages rise during positive shocks but do not fall during droughts. In addition, transitory positive shocks generate ratcheting: after they have dissipated, wages do not adjust back down. Ratcheting reduces employment by 9 percent, indicating that rigidities distort employment levels. Inflation, which is unaffected by local rainfall, enables downward real wage adjustments—offering causal evidence for its labor market effects. Surveys suggest that individuals believe nominal wage cuts are unfair and lead to effort reductions.
I mean just how bad can you get?

I immediately thought to myself, "I wonder what the laws and regulations are in India with regard to lowering wages or firing an employee." The minute you have a situation where an empirical study seems to defy the basic rules of supply and demand economics, you must ask: Why might this be so?

I read the full Kaur paper, there is not one mention of how wages may be sticky in India because of government regulations. Kaur doesn't consider it while "developing his new approach to testing."

I did a quick Wikipedia search for "Indian labor law."

Here is some of what I found:
  • Traditionally, Indian governments at federal and state level have sought to ensure a high degree of protection for workers
  • Central and state governments have discretion to set wages according to kind of work and location
  • Some of India's most controversial labour laws concern the procedures for dismissal contained in the Industrial Disputes Act 1947. A workman who has been employed for over a year can only be dismissed if permission is sought from and granted by the appropriate government office.[30] Additionally, before dismissal, valid reasons must be given, and there is a wait of at least two months for government permission, before a lawful termination can take effect.
  • A permanent worker can be terminated only for proven misconduct or for habitual absence
  • Indian laws require a company to get permission for dismissing workers with plant closing, even if it is necessary for economic reasons. The government may grant or deny permission for closing, even if the company is losing money on the operation
  •  An employee who has worked for 4 years in addition to various notices and due process, must be paid a minimum of the employee's wage equivalent to 60 days before retrenchment, if the government grants the employer a permission to lay off.
  • Each state in India may have special labour regulations in certain circumstances. Every state in India makes its own regulations for the Central Act. The regulations may vastly differ from state to state. The forms and procedures used will be different in each state.
  • In 2004 the State of Gujarat amended the Industrial Disputes Act to allow greater labour market flexibility in the Special Export Zones of Gujarat. The law allows companies within SEZs to lay off redundant workers, without seeking the permission of the government, by giving a formal notice and severance pay
  • The West Bengal government revised its labour laws making it virtually impossible to shut down a loss-making factory.
  • In Uttam Nakate case, the Bombay High Court held that dismissing an employee for repeated sleeping on the factory floor was illegal - a decision which was overturned by the Supreme Court of India. Moreover, it took two decades to complete the legal process.
Here's more from Wikipedia:

Many observers have argued that India's labour laws should be reformed. The laws have constrained the growth of the formal manufacturing sector.[50] According to a World Bank report in 2008, heavy reform would be desirable. The executive summary stated,
India's labour regulations - among the most restrictive and complex in the world - have constrained the growth of the formal manufacturing sector where these laws have their widest application. Better designed labour regulations can attract more labour- intensive investment and create jobs for India's unemployed millions and those trapped in poor quality jobs. Given the country's momentum of growth, the window of opportunity must not be lost for improving the job prospects for the 80 million new entrants who are expected to join the work force over the next decade
My point is that is is, well, idiotic to do an empirical test where you think you are reaching some kind of conclusion without considering what might be the true driving factor, in this case, government interference in the wage and labor markets.

My quick scan of what is going on with labor in India and the regulation and interventions is an obvious consideration. It points to the very strong possibility that what Kaur is really detecting when he detects sticky wages is government interference rather than some magical defiance of supply and demand economics because of beliefs.

Yet, mainstream economists are sure to point to this paper as a finding that by supply and demand, alone, with a given set of beliefs, there is proof of nominal wage rigidity.

Here is what I will tell you about an economist studying rain and nominal wage rigidity this way, he is all wet.

This is the state of current mainstream economics.

Robert Wenzel is Editor & Publisher of EconomicPolicyJournal.comand Target Liberty. He also writes EPJ Daily Alert and is author of The Fed Flunks: My Speech at the New York Federal Reserve Bankand most recently Foundations of Private Property Society Theory: Anarchism for the Civilized Person Follow him on twitter:@wenzeleconomics and on LinkedIn. His youtube series is here: Robert Wenzel Talks Economics. More about Wenzel here.


  1. It should be obvious by now that all non-libertarian and non-Austrian economists and personalities lie all the time when attempting to refute libertarian and Austrian analysis. Don't act surprised.

    1. Mainstream economics see government intervention as the answer which can lead them to neglect looking at it as a problem. In this case I would bet the Kaur group has neglected to look at the whole picture so they can focus on their study more than a blatant attempt to obfuscate. They did all that work collecting and analyzing the numbers, they don’t want that data overshadowed by externalities (I am using externalities here as a bit of a double entendre not strictly as defined in economic terms).

      Ultimately they lied but, can’t we just let them have their fun with numbers without bringing up reality?

    2. I will give you high points for pragmatism Alex! I would imagine that some or even many economists are forced to self constrain out of a sense of survival. Once you talk about any analysis outside the state there is a real sense of shuffling out on the gangplank.

  2. While government creates a lot of rigidity in nominal wages, they would certainly be prevalent in a free market. Rothbard explains on pages 44-45 of AGD:

    "Both workers and businessmen may become persuaded by the
    mistaken idea that artificial propping of wage rates is beneficial.
    This factor played a great role in the 1929 depression. As early as
    the 1920s, “big” businessmen were swayed by “enlightened” and
    “progressive” ideas, one of which mistakenly held that American
    prosperity was caused by the payment of high wages (rates?) instead
    of the other way round. As if other countries had a lower standard
    of living because their businessmen stupidly refused to quadruple
    or quintuple their wage rates! By the time of the depression, then businessmen were ripe for believing that lowering wage rates
    would cut “purchasing power” (consumption) and worsen the
    depression (a doctrine that the Keynesians later appropriated and
    embellished). To the extent that businessmen become convinced of
    this economic error, they are responsible for unemployment, but
    responsible, be it noted, not because they are acting “selfishly” and
    “greedily” but precisely because they are trying to act “responsibly.” Insofar as government reinforces this conviction with cajolery
    and threat, the government bears the primary guilt for unemployment."

    Putting government intervention aside, if businessmen have motivation to do so (whatever it may be), or if workers have reasons to resist lower wages (they often do), then wages won't adjust downward efficiently.