The minimum wage is a contentious issue among economists, and yet it enjoys near-universal support among the public. In my view, public views of the minimum wage are simply the result of a lack of careful thought by most people. Daniel Kahneman’s theory that people, when faced with a difficult question, substitute a simpler question that they can easily answer, applies particularly well in this case. People answer the question of whether they would like people to earn more when the real question is whether government should mandate higher wages (I first heard this argument from Bryan Caplan on EconLog).
A purely empirical argument for or against the minimum wage is methodologically wrong-headed because empirics do not speak for themselves. Sound theory must be the economist’s first tool in understanding the effect of a policy such as the minimum wage.
Before we can understand something like the minimum wage, we must understand the role of prices in allocating factors of production to their various uses. The price of a factor signals to entrepreneurs that that factor is scarce, that it is needed elsewhere in the economy, and that the entrepreneur who can reduce his usage of relatively more scarce factors in favour of relatively less scarce ones can earn profits, while entrepreneurs who fail to do so earn losses. I give the example of a sandwich shop during an oil boom; the high price of labour caused by the oil boom leads the sandwich shop to substitute away from labour in various ways. Continue reading Price Theory and the Minimum Wage→
In this episode, Diana Thomas discusses the relationship between the Virginia School of Political Economy and the Austrian School of Economics. Diana is an Associate Professor of Economics at the Heider College of Business at Creighton University.
The Virginia School is a branch of public choice, the application of the tools and techniques of economics to the study of political actors. The Virginia School’s founders, James Buchanan and Gordon Tullock, were the first to systematically apply a rational choice framework to the study of politics in The Calculus of Consent.
Two assumptions commonly made by neoclassical economists are the “benevolence assumption” and the “omniscience assumption.” The benevolence assumption is implicit in normative analysis of what governments “ought” to do, as this assumes that political actors are motivated to maximize the common good rather than pursuing their self-interest. This assumption is challenged by public choice economists. The omniscience assumption is at play in economic models that depict the economy as being in equilibrium, whereby nobody is misinformed of or surprised by economic reality. This assumption is challenged by Austrian economists. Continue reading Virginia Political Economy and Entrepreneurship with Diana Thomas→
A key difference between Austrian economics and the neoclassical-mathematical economics developed in the mid-twentieth century by Paul Samuelson and others is the assumption by the latter that people are essentially omniscient. What neoclassical economists call “rationality” effectively means omniscience. When the agents in neoclassical models face any uncertainty, the uncertainty is always fully understood in advance; for instance, a stock’s value tomorrow might be drawn from a normal distribution with a known mean and variance. Without the assumption of omniscience, the Austrian school faces the important question of how people can make economic decisions in a complex, uncertain world.
Ludwig von Mises’ answer (see his 1920 essay, Economic Calculation in the Socialist Commonwealth) was that capitalist entrepreneurs calculate in monetary terms. That is, they use the prices of the immediate past as their starting data, and attempt to direct factors of production in such a way as to maximize the spread between costs and revenues. If their predictions of price changes are good, they earn profits. If their predictions are bad, they earn losses. Thus, their direction of scarce resources is subject to immediate and consequential feedback allowing a selective process for only the best entrepreneurial forecasting methods. Without monetary exchange and prices, the problem of directing factors of production to their highest uses becomes intractable.
An interesting thing about Mises’ calculation argument is that it does not only relate to socialism, but to free, capitalist societies also. Mises states that, “Economic goods only have part in this system [of monetary calculation] in proportion to the extent to which they may be exchanged for money.” Thus, when a good cannot be exchanged for money, for any reason, it is subject to a Misesian calculation problem. Continue reading Economic Calculation and Education→
In this episode, Ash Navabi discusses whether the Austrian School of Economics is a cult and the value of mathematics in economic theory. Ash is an economics student at Ryerson University.
Ash wrote an article responding to recent criticisms of the Austrian school by Keynesian bloggers Noah Smith and Paul Krugman. Krugman approvingly referenced Smith’s attacks on the “hermetic system that is Austrians.” Just a week later he made the following telling comment about the economics mainstream:
“And modern academic economics is very much an interlocking set of old-boy networks; to some extent this has become even more true since the decline of the journals, with most discourse taking place via working papers long before formal publication. I used to refer to the international trade circuit as the floating crap game — the same 30 or 40 people meeting in conferences all over the world, reading and citing each others’ work; it’s the same in each sub-field. And to some extent it’s inevitable: there’s so much stuff out there, and you have to filter somehow, so you mainly read stuff by people you know and people they tell you are worth reading.”
[M]odern labour economists’ use of discrete reasoning in job-matching models should be lauded as a step towards greater realism. In these models, there are a discrete number of unemployed workers seeking to fill a discrete number of job openings. These models are summarized by Alvaredo, Atkinson, Piketty, and Saez:
“[I]n the now-standard models of job-matching, a job emerges as the result of the costly creation of a vacancy by the employer and of job search by the employee. A match creates a positive surplus, and there is Nash bargaining over the division of the surplus, leading to a proportion β going to the worker and (1 – β) to the employer.”
In these models, as in the real world, workers and employers must find each other before they can engage in exchange. Often, the model is set up such that only one worker and one employer find each other at a given time, making their exchange a case of isolated exchange. If multiple workers or employers discover each other at the same time, then Böhm-Bawerk’s analysis of one- or two-sided competition applies. Both workers and employers form their valuations based on their expectations of the other opportunities they might find if they engage in further search.
However, while Böhm-Bawerk and his heirs in the Austrian school are satisfied to leave the determination of price unspecified within the range bounded by the marginal pairs, modern economists feel the need to uniquely determine prices within their models, thus the addition of Nash bargaining and the nebulous “β” term, the “bargaining power” of the worker. β must be precisely specified and known so that the homines economici in search models can form their valuations based on perfect knowledge of the random processes determining the future outcomes of search and of their exact payoffs under all possible matchings. If economists were to admit that the division of surplus is inherently idiosyncratic and unpredictable, their models would break.
Furthermore, simply by referring to “bargaining power,” economists imply more than their models can support. Suppose that the marginal pairs determined that the price of a given item should fall between $396 and $412. If the actual price attained is $400, should we conclude that buyers’ “bargaining power” is four times that of sellers, or that they settled on $400 simply because it is a round number acceptable to both buyers and sellers? One cannot know.
In this episode, James Caton discusses the classical and inter-war gold standards. James is an economics PhD student at George Mason University.
Gold has many qualities that make it an ideal money: It is valuable, scarce, divisible, and easy to transport. It is also easy to verify the value of a given amount of gold: The Old Testament references weights and scales being used to measure gold. Ancient people could verify the purity of the gold by observing its water displacement.
Simple English Wikipedia is an edition of the open-source encyclopedia designed to be intelligible to small children, adults with learning disabilities, and people who are learning English. It is also an entertaining read, because the simple language often makes things silly. I found the article on Keynesian economics to be particularly silly and entertaining:
Keynesian economics (also called Keynesianism) describes the economics theories of John Maynard Keynes. Keynes wrote about his theories in his book The General Theory of Employment, Interest and Money. The book was published in 1936.
Keynes said capitalism was a good economic system. In a capitalism system, people earn money from their work. Businesses employ and pay people to work. Then people can spend their money on things they want. Other people work and make things to buy. Sometimes the capitalism system has problems. People lose their work. Businesses close. People cannot work and cannot spend money. Keynes said the government should step in and help people who do not have work.
This idea is called “demand-side policy”. If people are working, the economy is good. If people are not working, the economy is bad.
Keynes said when the economy is bad, people want to save their money. That is, they do not spend their money on things they want. As a result there is less economic activity.
Keynes said the government should spend more money when people do not have work. The government can borrow money and give people jobs (work). Then people can spend money again and buy things. This helps other people find work.
Some people, such as conservatives, libertarians, and people who believe in Austrian economics, do not like Keynes’ ideas. They say government work does not help capitalism. They say when the government borrows money, it takes money away from businesses. They do not like Keynesian economics because they say the economy can get better without government help.
During the late 1970s Keynesian economics became less popular because inflation was high.
When a big recession happened in 2007, Keynesian economics became more popular. Leaders around the world (including Barack Obama) created stimulus packages which would allow their government to spend a lot of money to create jobs.
The economic argument for state certification of certain professions rests on asymmetric information. The idea is that consumers might not know enough about medicine, for instance, to tell the difference between a good doctor and a quack. If we let consumers choose their doctors without constraint, so the reasoning goes, we would be overrun with quacks.
This is a decent argument for certification, but it’s not a good argument for mandatory state certification. If mandatory state certification were necessary to combat asymmetric information problems, the world would be overrun with bad piano teachers. Most parents are not pianists; how are they expected to know the difference between good and bad piano teachers? The answer is that they don’t have to know. If they want to know that their kid’s piano teacher is qualified, they just need to hire a teacher that a respected institution like the Royal Conservatory of Music has certified. Parents may not know what makes a good piano teacher, but this only means there is a market opportunity in delivering that information.
Private certification has many advantages over mandatory state certification. The first is that consumers who care less about quality, such as the parent who only wants a piano lesson as a substitute for babysitting and doesn’t intend his child to become a virtuoso pianist, can still choose to hire the cheaper, uncertified service. Continue reading How Private Certification Regulates the Market for Piano Teachers→
Last night I had a nice conversation with some other Queen’s economics alumni. When the conversation turned to politics, I said that I didn’t want to follow the next election and that I had promised myself I wouldn’t support the lesser evil. I may have come off as apathetic about politics, but that was not my intention.
The way I see it, there is a tradeoff between having a small (i.e. negligible) influence on present politics, by volunteering for political parties, talking (or blogging) about current political issues, and of course voting, and having a potentially larger influence on future politics. Here is the opening paragraph of Hayek’s essay, The Intellectuals and Socialism:
In all democratic countries, in the United States even more than elsewhere, a strong belief prevails that the influence of the intellectuals on politics is negligible. This is no doubt true of the power of intellectuals to make their peculiar opinions of the
moment influence decisions, of the extent to which they can sway the popular vote on questions on which they differ from the current views of the masses. Yet over somewhat longer periods they have probably never exercised so great an influence as they do today in those countries. This power they wield by shaping public opinion.
Hayek’s view, which I share, is that there is a fundamentally different mechanism at play in short-run politics and in long-run politics: The short run turns on popular opinion, while the long run turns on the forces that shape popular opinion. Continue reading Radicalism and the Political Landscape→
J. K. Rowling has revealed in interviews what some of her characters went on to do after the close of the Harry Potter series. Unfortunately, they all became bureaucrats! Here is what she revealed about Hermione Granger’s future:
Hermione began her post-Hogwarts career at the Department for the Regulation and Control of Magical Creatures where she was instrumental in greatly improving life for house-elves and their ilk. She then moved (despite her jibe to Scrimgeour) to the Department of Magical Law Enforcement where she was a progressive voice who ensured the eradication of oppressive, pro-pureblood laws.
I think a lot of people see politics as the noblest and most altruistic career path. The world would be a better place if the misplaced respect for politicians was instead directed at entrepreneurs. A better epilogue for Hermione would go something like this:
Hermione began her post-Hogwarts career working in potion development. Her greatest creation was an elixir for the enhancement of non-pureblood wizards’ magical abilities. She used the wealth from this popular elixir to start a financial firm that specialized in extending loans to house elves and their ilk, allowing them to buy their freedom from servitude. Despite an extended legal battle with the Department for the Regulation and Control of Magical Creatures, Hermione’s firm became large and successful. She retired wealthy and comfortable, and when the history of house-elf servitude was written, the wizarding world remembered that over 60 per cent of freed house elves had bought their freedom with a Granger Capital loan.
There, now isn’t that better?
Garrett M. Petersen's blog about markets, institutions, and ideas.