Models, Monopsony, and Minimum Wage

At Cafe Hayek, Don Boudreaux has an excellent post on models and their usefulness in economics.  Don’s gist is as follows:

Anyone can devise a model to show almost anything.  And economics is filled with widely referenced models that are useless (or worse than useless).  The Keynesian Cross comes to mind.  So, too, the textbook model of so-called “perfect competition” (which, in addition to being a model in which almost everything resembling real-world competition is either squeezed out or appears as a monopolizing (!) tactic, isn’t even logically coherent – for in the model no room exists for any agent actually to change prices).

The value of an economic model is found in its ability to make the world more understandable.  Devising a model is no evidence that the named concepts in the model have anything in reality to correspond to them, or that the model is a useful analytical tool.

I have made similar points in the past, noting that the results from models are, well, model-dependent.

In short, the mere fact that a model can show that some preferred policy will increase/decrease economic efficiency doesn’t mean said model is of any analytical use.  Sure, the minimum wage in a monopsony may improve the situation, but that information does us no good if the market is not a monopsony.

But let’s build upon this idea.  Let’s assume, for the sake of argument, that a given market where a minimum wage is considered is indeed a monopsony.  As such, it is theoretically possible that minimum wage would be beneficial, that we would not see, over a given price range, a decline in employment.  The poor economist stops here.  He might even advocate for minimum wage at this point.  But, as Bastiat reminds us, the economist looks for not just the seen effects (ie, what the model says), but the unseen effects, too.  The good economist is prompted now to ask “is minimum wage the most cost-effective solution to the problem we are trying to address (in this case, low wages for workers)?”  Minimum wage may be an option here, but it may not be the most beneficial option!  There may be other options, other institutional arrangements, other agreements that can be reached that will create a better outcome!

Gordon Tullock and James Buchanan drive this point home in their 1962 book The Calculus of Consent.  The following is from page 61 of the Liberty Fund Edition of the book (original emphasis):

The most important implication that emerges from the [analytical] approach taken here [in this chapter] is the following: The existance of external effects of private behavior is neither a necessary nor a sufficient condition for an activity to be placed in the realm of collective choice.

While Tullock and Buchanan are discussing externalities here, we can easily generalize their comment to any form of collective action including minimum wage or other methods used to “improve” monopsonies:  The existence of a monopsony market resulting from private behavior is neither a necessary nor sufficient condition for a minimum wage to be imposed.  The burden of proof requires the good economist to demonstrate that any proposed solution is the best of all available options.  Otherwise, the result of the market process, even if less-than-ideal, may be the best choice.

It is easy to play around with models, and any given model may have any number of policy implications.  But the mere fact the model suggests Policy A would work doesn’t necessarily mean that Policy A is the best choice.  If the costs of imposing A are high, then it may likely end up being a net loss!

 

An Open Letter to President Trump

Mr. Trump-

Over the past year, the Washington Metropolitan Area Transit Authority (Metro) has been doing repairs on their subway lines, called “Safe Track.”  During this period, stretches of the different Metro lines have slowed service considerably or closed them entirely for weeks on end.  During this period, Lyft and Uber drivers such as myself have made lots of money ferrying frustrated commuters back and forth to operational Metro stations or their offices.  During rush hour, one could easily command high surge pricing.  As you can imagine, this has been quite a financial boon to us.

But now, Safe Track is coming to an end.  This will mean lost money for us Uber and Lyft drivers.  It is often cheaper for commuters to ride the Metro than pay us.  Furthermore, the Metro is subsidized by the evil governments of Virginia, Maryland, and the District of Columbia.  This is hardly fair.  Surely, you can see how this would be bad for America.

Mr. President, in order to Make America Great Again, I insist you demand the Metro to immediately cease their repairs.  Further, they should be required to rip out all the repairs they’ve already done, redo them, and then rip them out again just before being finished.  This cycle should be done into perpetuity.  This would have the duel effect of keeping Lyft and Uber drivers’ incomes high and keeping construction jobs in the area which would otherwise disappear once the work is done.

Some commuters might object to this, saying that the costs of their commutes are already too high.  Don’t listen to them!  They’re just being greedy.  They don’t care about America.

Some businesses might object and say the high cost of commutes may force them to relocate outside of the area.  Don’t listen to them!  They just want to protect their bottom line and don’t care about us workers.

Some economists might object and say that the dearth of transportation options is a cost, not a benefit, to the DMV.  Don’t listen to them!  They’re just in the pockets of Big Business.

Mr. President, for the sake of our jobs and incomes, I demand the above actions be taken!

Signed,

Jon Murphy
Fairfax, VA

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.

The Doctrine of Scarcity

Two brothers, Charles and Joseph, are sitting at home reading the news.  The following is a conversation between the two:

Charles: Joe, did you see the nation of Zimbabwe is facing a terrible drought?

Joseph: Are they?  What fabulous luck for them!

C: Luck?  How is this luck?

J: My dear brother, have you no capacity to reason?  The drought is a blessing for the farmers of Zimbabwe!  First, since it makes the supply of food more dear, the prices rise.  The farmers get more money!  This, they can spend on employing more workers (since the land is now less fertile) toiling all day to get the wheat out of the ground.  The demand for workers will increase their wages, making the Zimbabwean worker better off.  Surely, only good times can follow!  This is just Economics 101!

C: Perhaps, Joe, but this is only because there is less food.  Perhaps, in nominal terms, workers earn more, but they can buy less with their money.  Are they not worse off?

J: My dear brother, have you learned nothing?  Their increased pay will make them richer!  What they can’t spend on food, they’ll surely spend on other things!  That’ll further increase demand for workers, raising wages even higher!

C: But that doesn’t solve the initial problem, Joe.  There is still less food to go around.  Sure, they may have more money, but that doesn’t calm an angry belly.  Would it not be better for the rains to come and have the fields of Zimbabwe overflow with grains?

J: And have the price of food plummet?  Have the workers no longer needed (since the fields are now more productive) be unemployed?  Why, think of the chaos of having all those people unemployed!  You would undo the Zimbabwean worker with your mana from Heaven!

C: Perhaps there would initially be people who no longer need work in the fields, but they’d have more full bellies.  Since they are freed up from the labor, they could do other things (maybe make clothing?).

J: You are simply a theorist!  No, brother, it is far better for the people of Zimbabwe to have drought, to drive up prices, use more resources for less output.  Indeed, it is in scarcity, not abundance, that true wealth lies!

C: But you live with less-

J: So?  The workers have work!  That is all they need!  They have a sense of purpose, a sense of living!  What more could a person want?

C: Food, shelter, clothing, leisure…

J: Bah!  More of your theorizing!  The true strength of an economy is the number of jobs it has!

C: But what good are those jobs if you can’t buy anything?

J: Better than having lots to buy and not enough farm jobs.

C: But there are other kinds of jobs.  They can do something else.

J: “Something else!”  More theorizing!  Such an unsatisfying answer.

C: But true nonetheless.

(The conversation continued in this manner for some time).

Joe’s comments may seem weird to our ears, and yet it is the common claim of those who practice the doctrine of scarcity commonly known as “protectionism.”  Since scarcity, and not “protection” or “abundance”, is the foundation for “protectionism” I propose calling these people “scarcitists.”

The scarcitists have a weird idea that it is from scarcity that wealth arises, not abundance.   It is as if the best thing to happen to Man was to be cast from the Garden of Eden.  It is as if Hell, and not Heaven, is our goal.  Scarcisim is a strange doctrine.

A Tale of Two Roads

Commenting on this blog post at Carpe Diem, commentator (and friend of the blog) Walt Greenway says:

If people trade and not countries, should we condone theft from the Chinese people [in the form of subsidies on exported goods] just because we get a good deal in the U.S.?

Here is my response:

There are two issues here:

1) The question before us is whether or not trade with China (who subsidizes their stuff) harms us, Americans. That is an emphatic “no.”

2) As an economist, I advocate free trade for all. Were the Chinese government (or were I a Chinese citizen) to ask me what the best course to take would be, I’d argue for liberalizing trade. But I am not a consultant for the Chinese government nor a Chinese citizen. I am an American. I can only affect US barriers, not Chinese barriers. Therefore, I will content myself with reducing half of the trade barriers if I cannot reduce them all.

Allow me to elaborate in the manner of Frederic Bastiat:

There are two countries: Libertas and Protectistan.  The two build a road between one another; a road which overcomes barriers like mountains and deserts, allowing the two to trade with each other more cheaply.  For many years, both countries prosper from the trade.  One year, in a fit of madness, both erect artificial barriers (checkpoints, potholes, erroneous signs, anything to slow the flow and raise the price) along their halves of the road to keep the other from “flooding” their market.  As time moves along, the citizens of Libertas get frustrated they’re no longer once prospering the way they once did.  They hold a meeting.

One man gets up and says: “Our issues began when we erected barriers on the road to Protectistan.  First we paid for the road and then we paid for the obstructions!  That is absurd.  If we remove our barriers, we can improve our lot by making cheaper the goods we can get from Protectistan.  Let us do this post haste!”

Another man (this one from the government) stands up and says: “Do not listen to that crazy person.  We can only reduce our barriers if Protectistan lowers theirs! We have sent diplomats to Protectistan to negotiate the removal of barriers and they refused.”

The first man gets up again: “Sir, we have no control over what Protectistan does, but we do have control over what Libertas does.  Let us uphold our end and remove our barriers.  Perhaps, one day, they will see the folly of their ways, but why should we be punished just because they don’t want to remove barriers?”

The government man replies: “Do not listen to this dreamer, this theorist.  We can only prosper if our barriers are kept in balance.  Why, if we removed our barriers, all would be lost!  It would be more difficult to go than come, to export than import.  Our ruin would follow just as quickly as it has followed the cities at the mouths of the Mississippi, the Thames, the Amazon, the Yellow River, for it is easier to go downstream than upstream.”

A lady in the back responds: “The cities at the mouths are wealthier than the cities on the tributaries.”

The government man cries: “That is impossible!”

The same voice: “But it is a fact.”

The government man: “Then they have prospered against the rules!

The government man finished his oration by appealing to all manner of things: nationalism, patriotism, etc.  He spoke of murderous competition, of loss of pride.  The assembly, so moved, voted to keep the barriers in place, agreeing that it is only by paying and not receiving can profit be achieved.

Destroy the City to Save the City

Commenting on this blog post, a “Daniel DiMicco” says:

Your commentary couldn’t be more misleading and dead wrong. Rather than the picture you paint, the Steel Industry is the “canary in the coal mine”. It is the case study for the Massive trade Mercantilism and cheating that China is perpetrating on the USA’s entire Manufacturing sector. Your propaganda doesn’t pass the smell test!

Below is my response:

Daniel Dimicco:

You say that the steel industry is the “case study for the Massive [sic] trade Mercantilism [sic] and cheating that China is perpetrating on the USA’s entire Manufacturing sector.”

Presumably, this means China’s low steel prices are harmful to the American manufacturing sector.

However…what would happen to the US manufacturing sectors that are dependent on steel? Like auto-making, construction materials, and the like? They’d face higher price pressures from any resulting tariffs you demand. Assuming they can’t adjust prices, this would mean they’d need to cut adjust costs elsewhere…perhaps lay off workers, perhaps cut hours, all kinds of things. They’d be negatively impacted by your steel tariffs.

Even if they could adjust their prices, now you’re looking at the effects on the consumers of these steel products. They’d start looking for more cheap substitutes or simply cut back on the amount they purchase. This would weigh on the manufacturing sector as well (as well as the consumers).

In short, your effort to save one canary will kill off several others.

On a related note, I found a picture of protectionists celebrating a tariff hike:

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