A couple of weeks ago Vox.com published and essay by Jared
Bernstein titled “What
economists have gotten wrong for decades: Four economic ideas disproven
by reality.” I was unaware of it until a discussion emerged on twitter last
week, in which people were offering explanations for why economists were not
only wrong but wrong in ways that harmed lower income people
disproportionately. The discussion was irritating because it was premised on
the assumption that Bernstein’s essay was a accurate, when nothing could be further
from the truth. The four economic ideas are not economic ideas at all.
Bernstein begins by describing Alexandria Ocasio-Cortez
questioning Jerome Powell, the Chair of the Federal Reserve, about the natural
rate of unemployment:
“The topic was the so-called natural rate of
unemployment: the idea, believed by many economists and policymakers, that
there is a rate at which unemployment could get so low that it could trigger
ever-rising inflation.”
He then went on to argue that the natural rate is one of a
number of things that economists have gotten wrong and that have hurt low
income individuals:
“The natural rate of unemployment that AOC questioned is
one such idea (more on that below). There are three others worth singling out:
- that
globalization is a win-win proposition for all, an idea that has deservedly
taken a battering in recent years;
- that
federal budget deficits “crowd out” private investments; and
- that
the minimum wage will only have negative effects on jobs and workers.
Economists and policymakers have gotten these ideas wrong
for decades, at great cost to the public. Especially hard hit have been the
most economically vulnerable, and these mistakes can certainly be blamed for
the rise of inequality. It’s time we moved on from them.”
This is pretty much all wrong. The statements about globalization
and the minimum wage are flat out false. They are not consistent with basic economic
theory. You will not find them in any textbook that I know of. They are not
consistent with any economic research that I know of. The other two statements contain
a grain of truth, but are poorly explained by Bernstein.
The Natural Rate of Unemployment
Is there a rate of unemployment below which inflation will
start to accelerate? I would answer “Yes.” And I think most economists would
agree with me. What is that rate? I would answer “Damned if I know.” And I
think most economists would agree with me. The problem is that the rate at
which inflation will start to accelerate does not appear to be constant. In
addition, as Betsey Stevenson pointed out in a
recent article in the Washington Post the Fed’s actions have made it more
difficult to identify the relationship.
In order to completely deny the idea of a rate of
unemployment below which inflation will accelerate you would have to claim that
the unemployment rate could go down almost to zero without causing prices to
increase. Certainly, our experience during WWII when government demand drove the
unemployment rate down well below normal levels does not support this conclusion.
Price increases eventually led to government price controls and rationing.
Globalization
Next Bernstein turns to the economic theory suggesting that
globalization is win-win for all. But half-way through his discussion of
globalization he throws this in:
“But the theory never said expanded trade would be
win-win for all. Instead, it (and its more contemporary extensions)
explicitly said that expanded trade generates winners and losers, and
that the latter would be our blue-collar production workers exposed to
international competition. True, the theory maintained (correctly in my view)
that the benefits to the winners were large enough to offset the costs to the
losers and still come out ahead. But as trade between nations expanded,
policymakers quickly forgot about the need to compensate for the losses.”
That’s right Bernstein just said that economic theory never
said it was a win-win for all, it always said there were winners and losers. This
wrong idea of economists was never even an idea of economists.
Crowding Out
Like the natural rate of unemployment there is a kernel of truth here. Other things equal, an increase in government borrowing can raise interest rates and discourage private investment, but economists do not all believe that any government borrowing
will necessarily crowd out private investment. Many economists would argue that
it depends on the circumstances. Many textbooks also include the possibility of
an accelerator effect, or crowding in. If the economy has a lot of unemployed
resources, government borrowing resulting from deficits may have little effect
on interest rates, and if the deficit spending increases aggregate demand it
could encourage private investment. The results for a model depend on the
assumptions you make. The result, in reality, is an empirical question, and
there is no reason to believe that the answer is always going to be the same.
The Minimum Wage
Bernstein claims that “The theory is
that free markets set an “equilibrium” wage that perfectly matches supply and
demand given employers needs and workers’ capabilities. Force that equilibrium
wage up and rampant unemployment will result.
When I was coming up in the profession, our textbooks argued
that believing minimum wages could help low-wage workers was akin to believing
that water flowed uphill.
Their message was particularly comforting to conservative politicians who
wanted to protect the profits of employers of low-wage workers.”
The phrase “Force that equilibrium wage up and rampant
unemployment will result,” should make any economists cringe. If one of your
students said it, you would feel a deep sense of sadness at your failure to
convey the basics of supply and demand.
This is the classical textbook model of the minimum
wage.
The minimum wage only affects the market to the extent that
it increases the wage above the equilibrium, not the extent to which it raises
the equilibrium. The positive effect for employees is the increase in the wage.
The negative effect is the decrease in demand for labor. Those who still have
jobs gain those who are unable to get work lose. Bernstein knows that textbook models
of the minimum wage do not claim that everyone will be worse off. How do I know
that? Because the graph is from jaredbernsteinblog.com
where he refers to it as the classic textbook model.
By the way, the blogpost also has a pretty good description
of the way that variations in the model (What if the higher wages increase demand?
What if employers do not respond very much to increases in wages? What if labor
markets are not competitive?) Unfortunately, the fact that Bernstein appears to
understand the economics of minimum wage increases makes his Vox.com piece even
more irritating. What they do point out is that it is possible to create models
that produce very different outcomes. And these differences do not arise from
making completely ridiculous assumptions. Whether the higher minimum wage
creates an increase in demand is an empirical question. Whether labor markets
are competitive is an empirical question. The same goes for how much demand for
labor responds to a higher wage. By the way, occasional I run in to people who
seem to think it will be completely unresponsive to an increase in the wage. If
you truly believe this then you should not be willing to settle for an increase
to $15. Why not $50, or better yet $1,500?
So, economic theory suggests that the effect of the minimum
wage is an empirical question. My reading of this research is that small increase
in the minimum wage tend to have small negative effects on employment.
Economics should be criticized for actual flaws. There are
plenty of them. Women and African Americans are significantly under-represented
in economics. Economists don’t study enough history. How can you really
understand how people respond to changes in constraints if you don’t know
anything about how constraints change over time? Economists tend to take a good
thing and go too far. Math is good, but does everyone who wants to be an
economist need to master real analysis and get a perfect score on the quant
section of the GRE? Identifying causality is a good thing, but should we only
studying things where we see a clear path to doing this? The list could go on.
We don’t need to make up imaginary flaws.
