Monday, August 5, 2019

Economics needs better critics: Jared Bernstein edition

A couple of weeks ago 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.


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 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 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.