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!

 

A Non-Technical Guide to Econometrics

Chris Auld has an excellent piece on his blog regarding interpreting the “competing” Seattle minimum wage studies from the University of Washington and UC Berkeley.  It’s long, but very much worth the read.  In fact, it’s probably the best short introduction to statistics/econometrics I think I’ve read (another great one is Chapter 1 of Robert Abelson’s Statistics as a Principled Argument.  I’m also a big fan of Angrist & Pischke’s Mastering ‘Metrics).

Allow me to highlight two items in particular from this blog:

There is no statistical magic which can fully overcome these fundamental [causal] problems.  We will never be able to “prove” what the effect of the minimum wage was: that’s not the way statistics work in general, and in a case study like `what was the effect of the 2015 increase in minimum wages on employment in Seattle?’ the best we can hope for is to bring some suggestive evidence to the table. [Emphasis added]

 

In other words, what they Berkeley team means when they report “no effect” on employment is not that there is no effect on employment (yes, that is confusing).  What they mean, again, is that there is no statistically significant effect on employment, whereas the UW team, using different data and somewhat different statistical methods, finds a statistically significant effect.  But the difference between statistically significant and statistically insignificant is often itself not statistically significant.

…

One team found there were no statistically significant effects on employment, but that result should not be misunderstood as a claim that the study “proves” the effect was actually zero… [original emphasis]

Any additional commentary I add here will only detract.  Read Dr. Auld’s post.  It’s excellent stuff.

H/T: Michael Enz

Minimally Critical

Below is a letter to Ben Zipper and John Schmidt of the Economic Policy Institute:

Dear Sirs,

In your June 26th report on the University of Washington’s minimum wage working paper on Seattle, you claim:

One initial indicator of these problems is that the estimated employment losses in the Seattle study lie far outside even those generally suggested by mainstream critics of the minimum wage (see, for example, Neumark and Wascher [2008])—as the authors themselves acknowledge.

With respect, sirs, this is a rather weak criticism.  In fact, it’s logical that the results of the study are outside the norm given that the Seattle wage hike itself is outside the norm; it’s an unusually strong hike.  Given that the wage hike is higher than previous studies, it’d signal to me methodological or empirical issues if the results weren’t outside the typical range.

In short, your criticism amounts to saying “it cannot be true slamming on the breaks causes an abrupt stop because tapping the brakes causes just a slight deceleration!”

Sincerely,

Jon Murphy
George Mason University
Fairfax, VA

Update: an eagle-eyed reader caught a spelling error.  It has been fixed

What-ifs and Whatnot

Two friends are sitting by a pool on a hot day.  One of the friends, Joe, casually says to Smith (the other): “Smith, it sure is a hot day today.  I hope the sun doesn’t dry up all the water!”

“Don’t be stupid!” says Smith.  “The sun doesn’t cause water to evaporate.  It causes the water level to go higher!”

Joe looks at his friend perplexed.  Smith continues:

“It’s real simple.  The sun hits the water, water gets warmer and starts to evaporate, right?  So the pool master comes out and adds more water to the pool.  On net, the water rises!  Ergo, the sun causes a higher water level!”

Joe, still confused, says “No, that’s not true.  The effect of the sun is to evaporate the water.  The pool master coming in is serendipitous; it’s a ‘what-if’.”

Smith laughs.  “Oh Joe.  Don’t be so dogmatic in your thinking!  Always insisting that the sun causes evaporation!  But I have clearly proven that wrong.  These chemists who constantly insist evaporation occurs because of the sun are just ideologues.”

Joe, rolling his eyes, goes back to his book.

 

And so it is with minimum wage, too.  Minimum wage advocates love to construct all kinds of “what-ifs” to explain why minimum wage has no effect (or even a positive effect) on employment.  But by doing this, they hide the effect of minimum wage behind all sorts of stories and claim, then, they have turned theory on its head.  But constructing what-ifs are easy.  Any storyteller can do it.  But what-ifs and serendipity make poor bases for public policy.