Today’s Quote of the Day…

…is from page 147 of the excellent new book Arguments for Liberty (edited by Aaron Ross Powell and Grant Babcock).  This quote comes from the essay on Contractarianism by Jan Narveson (original emphasis):

Liberalism is exemplified by normative systems that hold two points: (a) that the sole acceptable purpose of rules, laws, and in general interventions must be the good of those intervened upon; and (b) that it is those persons themselves, rather than any supposed authorities, who fundamentally embrace those values.  Individuals, then, are the basic holders of the values that interventionist institutions and personages are to respect….Both are essential.  So-called liberals of the present day tend to think that they, the pundits or theorists or the elected politicians, know what people want better than the people themselves.

The Unseen Costs of Taxation and Regulation

On a EconLog post about E-Verify, commentor “Jay” writes:

I’m confused, if [E-Verify] poorly enforced and therefore only sparsely followed by employers, how does it raise hiring costs?

Jay’s question is an excellent one, and one that gets down into one of the main reasons we have deadweight loss (DWL) stemming from taxes and regulation.  Taxes and regulations change behavior (if they didn’t, we’d only have a transfer of wealth from consumers/producers to the government and there would be no DWL).  The obvious way they change behavior is when people adopt less efficient use of resources (in the case of E-Verify, hiring a worker who may be less productive over a worker who would be more productive because the first worker will pass E-Verify and the second worker won’t).

But evasion of those taxes and regulations are also a cost.  For example, if an employer hires someone who would not pass E-Verify, and as such goes to lengths to ensure his hiring is not caught (paying him under-the-table, hiding him of INS come looking, that sort of thing), these are all extra costs being paid.  Costs of time, or money, or effort that would otherwise have been spent doing something productive (and that’s not even counting the government’s cost of enforcement!).

These costs, while unseen, are very real.  Employers face evasion costs just like anyone else, and will make decisions based upon them, even if they never show up explicitly as some budget item or in an official government report.  These costs will change their actions, and we are all worse off for it.

Today’s Quote of the Day…

…is from Robert Tollison’s forward for the Liberty Fund edition of Jim Buchanan and Gordon Tullock’s classic work, The Calculus of Consent:

“Politics and the market are both imperfect institutions, with the least-cost set of institutions not being obvious in any real case. The moral: We must better understand how institutions work in the real world to make such choices intelligently.”

The Subtle Cruelty of Efficiency Wages

One of the more sophisticated arguments for minimum wage stems from the Efficiency Wages Hypothesis (EWH).  The EWH asserts that firms will sometimes pay higher-than-market wages for their workers.  These wages reduce turnover and increase productivity, making the wages more viable for the firms.  However, it is important to note that with EWH, there is still unemployment in the industry: higher-than-equilibrium wages reduce quantity demanded and increase quantity supplied from the equilibrium point, creating a surplus of labor (unemployment).

Minimum wage activists will cite the EWH for reasons for the minimum wage, claiming the reduced turnover and increased productivity is a positive for the firms.  That much is true.  But how does the EWH increase productivity and reduce turnover?  Workers may be feeling better with a higher wage, so they’ll naturally work harder.  That’s possible.  But the real reason is the cost of losing the job is now higher.  With persistent unemployment in the industry, the threat of firing forces workers to work harder in order to keep their jobs (thus increasing productivity).  Turnover is reduced not out of some sense of loyalty to the firm now paying higher wages but because there are fewer jobs available and they are being competed for by more workers!  

In short, an Efficiency Wage (especially if legally mandated like the minimum wage) gives employers more power over workers; it reduces worker bargaining power and reduces worker ability to leave if conditions are unfavorable to them.

The minimum wage is a very cruel policy.  The minimum wage as an efficiency wage is even more so.

A Quick Thought on the Balance of Trade

When a foreign nation buys resources and goods from the domestic nation and takes them out of the country (exports), it’s considered “good” by mercantilists.

When a foreign nation sells goods and resources to the domestic nation (imports), it’s considered “bad” by mercantilists.

When the number of resources coming in is higher than going out, and some resources are bought by the foreign nation and kept in the domestic country (trade deficit), it’s considered terrible by mercantilists.

Mercantilism is a strange doctrine.

Inspired by today’s Cafe Hayek post

Water, Water Everywhere

This morning at Cafe Hayek, Don Boudreaux writes on water, responding to a radio program describing water as “our most precious resource.”  Don says (emphasis added):

While it’s true that water is a scarce resource, it is simply untrue that water is a precious resource.  Potable water is sufficiently abundant today in most places where human beings live that it can be acquired at a low price.  Indeed, given modern techniques for delivering and safely storing potable water, water is widely available today even in some desert areas, such as Las Vegas and Tucson.  And while I don’t defend (quite the contrary!) government subsidies that make water more available where and to whom it would be less available, it remains silly-talk to say that water is “our most precious resource.”  The market price of water testifies powerfully to the contrary.

Don’s comment is true for most of the US.  But what about places it’s not?  Third-World countries and the like?  Why is it we can produce water in Las Vegas, Phoenix, and Tucson, but not Venezuela, Zaire, and Somalia?  It’s clearly not the environment; the US has harsh deserts and tundras and yet no water issues (in fact, water to spare!).  I suspect it has more to do with the free market institutions of the United States that allows us to bring water everywhere.  There’s a lot of private water here (think bottled water).  It is sold (mainly) at market prices, so places that have abundant water (like Maine) can bottle it and sell it to Arizona, where it is more scarce.  The areas where there are no functioning price systems and lots of trade controls (like Venezuela, Zaire, and Somalia) are facing water crises.

In short: water is precious in places where it is not treated as a commodity (and, in some cases like Venezuela, called a “right”).  It is abundant in places it is treated as a commodity.

The Importance of Failed Models

Earlier, I discussed an article by Jonathan Newman discussing  what he sees as scientism, specifically:

Scientism has many forms, one of which is the use of empirical methods to do economic science, or the dismissal of claims not based on experiment results that question other claims that are based on experiment results.

I had addressed the first condition of his scientism claim in my last blog post.  Now, I’d like to address the other.

It is true that rejecting claims not based upon experiment results in favor of claims that are based on experiment results can lead to scientism.  Note I said “can lead to scientism.”  I outright reject Newman’s claim that the rejection is in and of itself scientism.  If one gets empirical results that conflict with one’s model, one should ask “why?”  Failure to ask this question is what leads to scientism, not the rejection thereof.  Furthermore, failure to ask this question can lead one to avoid important insights.

Let’s look at two major turning points in the history of economic thought: the Marginal Revolution and the development of Public Choice.

Prior to the Marginal Revolution, the idea of a Labor Theory of Value dominated the economic world.  Promoted by men like Adam Smith and David Ricardo, it was a key concept of economic theory.  However, empirical and philosophical issues were coming about calling into question the LTV.  Rather than simply dismissing these concerns as “scientism”, economists decided to look at the theory.  Carl Menger (whose writings on the matter would become the foundation of the Austrian School of thought) was one of the main questioners.  He developed the idea of diminishing marginal utility and people use rank-ordering of utility to make choices.  William Jevons and Leon Walras also made major contributions to the theory which would eventually become foundational to modern economics.*

About a century later, Gordon Tullock took up Mundell’s challenge for economists to explore why empirically there so little deadweight loss from trade compared to what theory would predict.  It’s a good thing Tullock did not simply dismiss the empirical evidence as “scientism,” but rather explored why the model was failing.  His work lead to the creation of Public Choice economics (you can read in more detail the story here).

One of my professors, Garret Jones, likes to say it is important to see how models fail, if they fail in interesting ways.  The models of the Labor Theory of Value and international trade failed in interesting ways.  One gave us a new understanding of economics (the Marginal Revolution).  They other gave us better insight in economic theory (Public Choice).  I feel confident to say that, if we had simply ignored the concerns raised by empirical results as “scientism,” then the economics profession would be worse off for it.

*I must apologize for not giving Jevons and Walras the time they deserve here for their contributions to the Marginal Revolution; space constraints force me to economize.