Outside the Beltway

David Sirota: Economic Dunce

Steve Verdon · Monday, June 19, 2006 · 4 comments

David Sirota has gone after John Stossel, not that I care all that much, but in doing so he has come up with a pretty weak argument in favor of minimum wage laws.

Mr. SIROTA: Well, listen, John, I would encourage you stop reciting these dishonest talking points and the chatter you’re hearing on the cocktail party circuit because the stats don’t bear that out in any way at all. And here are the stats that you cannot dispute. In states that have raised the minimum wage, above the federal level, those states have created jobs at a far faster rate than the states that have not. That is because, when you raise the minimum wage, you put money into the pockets of people who will spend it and it spurs the economy. Now, that might not be heard in your book which purports to debunk lies, but those are the facts.

First off, lets get one thing clear. David Sirota is a liar. He says that “those are the facts” when in reality the paragraph above contains both facts and suppositions.¹

Second, it isn’t clear that this is strong evidence in favor of the minimum wage. Lets make some assumptions first.

Assumptions:
1. The Federal Minimum Wage is $5/hour.
2. The State Minimum Wage is $6.50/hour.
3. The State in question has a low unemployment rate.

These assumptions fit with the situation described by Sirota above. Now, lets consider some basic suppositions from economic theory. What does a low unemployment rate tell us? That the labor market is tighter than in other states. What does this mean? That wages are likely higher relative to other states. So, if the labor market is tight and wages are higher than say the national average, then what effect would raising the minimum wage have in the State? Little to none? Quite possibly.

Here is another way of thinking about it, but first assume for simplicity that we have only one labor market. Further, that the labor market clears at a wage rate above the Federal minimum wage–that is, say the market clearing wage is $7.00/hour. Now, in this State the state legislature passes a law raising the minimum wage to $6.50/hour. What is the effect on the labor market? Nothing at all. Since the market clearing wage is above both the State and Federal minimum wage there is no effect at all.

In short, the data the Sirota presents is not at all inconsistent with the view that minimum wage laws are bad for employment. And yes, there is a study or two that indicate that raising the minimum wage has no impact on employment rates. However, there are literally dozens that point to the opposite conclusion.

On top of this, the minimum wage acts very much like a tax. This tax is borne by both the consumer (and this group includes minimum wage workers) and firms (which can indirectly impact minimum wage workers as firms make hiring and firing decisions based in part on wage rates). Further, this is a questionable way to target the low income people. For example Sirota points to this study by the Center for Budget and Policy Priorities and concludes that the minimum wage is good for low income families. The problem is that the minimum wage is only an indirect method for accomplishing this goal. Another way that would be much more targeted would be to use/increase the Earned Income Tax Credit (EITC). In fact, if we were to implement this program broadly and eliminate the minimum wage welfare could go up far more than with just the minium wage alone.

So, is it clear that Stossel is a liar and raising the minimum wage is a good thing? Nope. Is it clear that David Sirota doesn’t know his ass from his elbow when it comes to economics and how to empirically test a hypothesis? Yep.

UPDATE (James Joyner): Cato’s Will Wilkinson has a related essay which begins:

The law of demand is a bitter pill for defenders of labor market price controls. Noted economic theorist Matt Yglesias has grown weary of appeals to “Economics 101″ in the minimum wage debate. “After all,” Yglesias writes, “there’s a reason they offer more economics classes and you don’t get your degree after taking just one.” His American Prospect colleague Ezra Klein says of the law of demand that “It’s a good guideline, but it’s got no end of exceptions.” The minimum wage, of course, is one those exceptions.

They’re both right in general, if not about the minimum wage in particular. There are more economics classes, and they do teach exceptions. However, let’s not imagine that there is some advanced economic class in which you learn that the law of demand is false.

Indeed. Much more at the link. (via Megan McArdle, whose own thoughts on the matter are worth reading.)

Update (Steve Verdon): I’d also like to point out that some of the “advanced classes” are refinements on things like supply and demand. For example, Akerlof’s lemon’s model, which was one of the papers that earned him the Nobel Prize, was really nothing more than an extension of the laws of supply and demand to incorporate uncertainty and product quality. The conclusion isn’t that the Law of Demand is false, but that markets can sometimes operate in a sub-optimal way. This isn’t good either and provides no safe harbor for people like Ezra Klein and Matthew Yglesias. And as Will Wilkinson notes, the advanced stuff doesn’t negate the Law of Demand. If anything that specific example points to problems with meddling in the economy, at least in a discretionary way. Heck one of the things we spent alot of time doing in graduate macroeconomic theory was going over micro-foundations. Basically what can go wrong when you forget Econ. 101.
______
¹Actually, the term liar here is sarcastic. This is often how people talk and calling this kind of thing a lie is rather silly, but this is how Sirota justifies calling Stossel a liar, so whats good for the goose….