Minimum Wage Laws: A Litmus Test for Economists

by Gary North, Gary North’s Specific Answers

I have learned over the last half-century that there are two litmus tests of an economist’s commitment to the idea of voluntary exchange as a means of increasing net productivity and net income. One of them is the doctrine of free trade. The other is the doctrine of minimum-wage legislation as a source of increased unemployment.

The first of these litmus tests goes back to Adam Smith’s Wealth of Nations (1776), and before him, over 20 years earlier, to the writings of his friend David Hume. Both of them took a stand against what today is called mercantilism: state coercion to increase national wealth.

Both of these positions – free trade across borders and free trade in labor relations – argue in favor of voluntary contracts between individuals.

The case for free trade is usually presented in terms of trade across national borders, but the same case can be made in terms of transactions across any border. Nobody raises the issue with respect to goods crossing state borders, county borders, and ZIP code borders, but the case is made with respect to national borders. This is because opponents of free trade discuss only national borders. This jurisdictional restriction is illogical, but that is because protectionism is illogical.

Minimum-wage legislation thwarts voluntary contracts between employers and employees. It reduces the number of these contracts, because it raises the cost of bargaining. It makes it illegal for individuals to bargain over wages below the minimum wage, in exactly the same way that import quotas make illegal any contracts between individuals who live on opposite sides of a national border. The costs are raised by legislation, meaning the threat of negative sanctions. Therefore, the most fundamental economic law comes into play: at a higher price, other things being equal, less is demanded. If you deny this, you thereby deny all economic reasoning. If the price-quantity demanded relationship is not true, then the entire corpus of economic theory is not true. There is no consistent theory of economics if it is not true that, at a higher price, other things being equal, less is demanded.

SPECIAL-INTEREST GROUPS

Special-interest groups hire economists, who then argue that this price-demand relationship is not true in a particular case. Some business groups want higher tariffs and higher import quotas in order to secure a protected domestic market, and therefore higher prices, and therefore greater profits. They hire economists who argue that tariffs and quotas do not restrict economic growth. They do not argue that tariffs and quotas do not do exactly what tariffs and quotas are obviously intended to do, namely, restrict trade. But they argue that this restriction of trade is good for the nation as a whole.

In contrast, those economists who defend legislation to increase the legal minimum wage that an employer is allowed to pay an employee, actually argue that this legislation increases personal choice, increases the welfare of workers in general, and need not even hurt employers. This is nuts. There is no way to put it more accurately. This is nuts. This means that economics cannot have any coherence at all. Yet we find, year after year, that more and more economists come to the conclusion that minimum-wage laws are good idea. Over the last 35 years, the percentage of economists who believe that minimum-wage legislation creates unemployment for low-wage workers has decreased from about 90% to something in the range of 50% of all economists.

Because of a recent report by the Congressional Budget Office about the unemployment effects of a minimum-wage at $10 an hour, which the CBO says create unemployment for half a million people, those who defend minimum-wage legislation have been on a rampage to deny the legitimacy of this report. It is a major issue, because Obama wants to increase minimum wages to $10 an hour. It is a hot political issue. It will be a major victory for Obama if he can persuade a majority of Republicans in the House of Representatives to vote for this legislation.

A DEFENDER OF MINIMUM WAGE LAWS

The following information is important. We learn this from an article published on the Politico site. “Michael Reich is professor of economics and director of the Institute for Research on Labor and Employment at the University of California, Berkeley.”

Who is he? The entry on Wikipedia tells us. He was a founder in 1968 of the Union of Radical Political Economists, the New Left/Marxist wing of the economics profession. We also learn this:

In the 1960s and 1970s, Reich worked with David Gordon, Richard Edwards, and other well-known Marxist and Neo-Marxian economists. Focusing on labor economics, the group specifically narrowed in on segmented labor markets. . . .

Reich was a teacher at Boston University for three years, and then in 1974 became an assistant professor of economics at the University of California at Berkeley. In 1989, he was promoted to full professor. According to Reich, he regularly taught courses at Berkeley in Marxist economics, political economy, and the history of economic thought.

What is the Institute for Research on Labor and Employment? It is a far-Left adjunct at Berkeley that has been operating for 60 years. It gets money from Left-wing foundations. It presently does research in these areas: California Living Wage, Green Economy, Health Care Reform, Job Creation, Minimum Wage. (Berkeley.edu).

Unlike the Hoover Institution, which is legally separate from the privately funded Stanford University, the IRLE is part of the taxpayer-funded University of California. It derives considerable prestige from this legal connection.

None of this is mentioned by Politico.

In an article by Reich that is published on Politico, we learn this.

We’re not in the simple world of Econ 101 here, in which a higher price, i.e. a higher minimum wage, automatically means less demand for workers.

From the very beginning, the author says that what he is about to present is not what is taught in economics 101. But what is taught in economics 101 is what is regarded as the basis of modern economic theory. It is usually Keynesian. It may be neoclassical. It is not Austrian School. But it is the heart of the matter with respect to the formal instruction of economic theory, and from the very outset, the author says that what he is about to say is not what is taught in economics 101.

I raise this issue: “Why should we believe his conclusions?” Furthermore, if we do believe him, why should we believe in economics 101? In other words, if he is right, then economics 101 is incorrect – all of it. At a higher price, more will be demanded. But if economics 101 is incorrect, what is economics? It is obvious what he wants us to believe: New Left economics or maybe even Marxism.

Why is a mandated increase in the minimum wage a good thing? He says this:

Labor supply can also respond, for example, making it easier for employers to recruit workers and retain them longer. Those more experienced workers are then more productive workers. Firms can also raise their prices rather than reduce the number of employees. So economists regard the employment effect of a minimum-wage hike as a question to be decided by empirical testing.

If it is possible for employers to recruit workers and retain them longer under a minimum-wage law, then it is even more possible for employers to do this if they raise wages unilaterally. This assumes that they are willing to pay higher wages in order to gain the result: less turnover. If it is possible to gain an advantage if everybody follows the practice, it would be even more advantageous if only entrepreneurial firms were to test this theory first. Then the other firms can copy it. There will be lots of case studies on the benefits from raising wages in this way.

But the author does not recommend this. He does not even mention this. What he says is that there ought to be a national law mandating this change, and only then, under the coercion of the threat of negative sanctions, will businesses discover that higher wages that are imposed by the law will produce these benefits. In other words, the state is required to impose negative sanctions in order for businessmen to recognize the tremendous benefits that an above-market wage rate will bring them. It does this by making illegal the market pricing system in those areas of the economy that are under the minimum-wage legislation.

He doesn’t stop there. He wades even deeper into the swamps of economic irrationality. Knee-deep in the big muddy, Dr. Reich says to push on.

My co-authors and I show that comparisons between states that have increased minimum wages are not a random sample of all the states. They differ from the other states in ways that affect their low-wage employment trends, but which are unrelated to minimum-wage policy. We then show that teen employment was already growing more slowly in the higher minimum-wage states than in the other states, even as much as two years before a minimum wage increase is introduced. In other words, higher minimum wages are correlated with less employment growth, but it doesn’t follow that the higher minimum wages caused it.

So, teenage unemployment was growing more slowly in the higher minimum wage states than in the other states. This is exactly what economics 101 teaches, and it is exactly what Austrian school economics teaches. But he says that the increase of the minimum-wage did not cause this slowdown. He does not say what did cause it, but it was not minimum-wage legislation.

This is the standard approach argument of economists when they find something that empirically confirms economic theory, but when they don’t want a particular economic theory to be confirmed. They blame something else. It has to be something else, because if there is cause-and-effect in economic theory, then the voters may resist the state’s intervention. So, the statistical fact that the outcome of a state or federal law is exactly what economics 101 says will happen, and if this outcome is negative for economic growth, then the resisting economist says that statistics merely correlate with respect to this negative outcome. The correlation is just one of those things, just one of those crazy things. But it is not causation.

In short, they argue that there is no economic cause and effect. But in this case, the absence of cause and effect is one of the two litmus tests. This economist is affirming the legitimacy of price controls – a price floor – for improving the economy.

BLACK MALE TEENAGERS

We know where the main effects of minimum wage legislation are manifested most predictably: in the employment of teenage black males. This is where the economist should begin his statistical study. Why? Because the least desirable employees are black teenage males. They are discriminated against by employers. This has been true throughout the postwar era. This is why studies on the effects of minimum-wage legislation in the past have focused on black teenage male unemployment. The statistical correlation is so tight that this has been a favorite example of those who oppose minimum-wage legislation. Whenever federal minimum wage laws mandate an increase in the minimum wage, within a very short period of time, the unemployment rate for black teenage males increases. This has been studied for over half a century. There have been no exceptions to this outcome. Conclusion: statistics confirm price theory.

So, economists who do not want to accept this correlation go looking for other kinds of correlations, so that they can deny that the correlation has anything to do with causation. This is what defenders of minimum-wage laws have done for over half a century. The trouble is, about half of the economics profession has come to the conclusion that this sleight-of-hand operation is legitimate, and not only legitimate; it disproves the logic of economics 101.

We live in a world where there is an increasing quantity of people who have Ph.D.’s in economics, yet who do not understand economics. They do not believe economics 101. They do not believe the fundamental axiom of economics, namely, that when a price increases, other things being equal, less is demanded. They don’t believe this axiom in those areas of the economy where they have an ideological commitment to maintaining the power of the federal government to regulate market exchange.

I am waiting for one of these non-economists to produce a detailed, comprehensively research study that shows that black teenage male unemployment does not increase within 12 months after every past increase in the minimum-wage law. If it is a state minimum-wage law, then I want to see from the record that this increase did not lead to an increase in unemployment among black teenage males.

CONCLUSION

Ultimately, economics is either logical or else it isn’t. Either it leads to insights in the way people behave, or else it doesn’t.

If minimum-wage increases do not lead to an increase in unemployment among groups that are not favored by employers, then economics 101, economics 1, and economics in general are not true. Economics is not then a science. It is not worth going to college to study. It is not worth earning a Ph.D. in the field, except to be employed by public relations departments of special-interest groups.