Minimum wages: The economist as a psychologist

Both Ludwig von Mises and F.A. Hayek are known for arguing that there is no such thing as a good economist who is only an economist. For these two thinkers, a good economist-as-scientist also needs to know history, philosophy of science, ethics, and physics. Mises and Hayek are thinking of what an economist-as-scientist should be familiar with and have some minimum knowledge beyond his discipline.

I would add that the economist as public educator, that is, when the economist talks as an economist to non-economists, also needs some awareness of psychology. I may not be using the term “psychology” in the most proper way, but I mean the awareness to understand what the interlocutor feels and needs and then figure out how to communicate economic insights in a way that will not be automatically (emotionally or psychologically) rejected; how to make someone accept an economics outcome they do not want to be true. How to break the bad news with empathy? This is a challenge I try to get my students to understand as one day they, too, will be economists out of the classroom in the real world.

A few days ago I found myself unexpectedly in the “psychologist” position. Only seconds after meeting for the first time two persons dropped the question: “So, what do you think about increasing the minimum wages, should we do it?” I knew nothing about these two individuals, and the only thing they knew about me was that I’m an economics professor. The answer to such a question is an Econ 101 problem: if you increase the minimum wage (above the equilibrium price) some lucky workers will get a wage increase at the expense of other ones loosing their jobs.

The first question I asked myself was “what do these two nice ladies actually want, the analytical/scientific answer, or do they want instead the ‘professor’ to confirm their bias?” This might be a delicate discussion since they may well have a loved one in the minimum wage market.

The first thing to get out of the way is that my answer as an economist is not ideologically driven or does not respond to secret political agendas. How can that be made clear? One way is to show the economics profession’s consensus on the subject from an impersonal position. I explained to them that any economics textbook from any author from any country in the world used in any university would say the same thing: “If you put the price of labor above its equilibrium (a minimum wage), it will produce a disequilibrium (unemployment). You cannot fix the price outside equilibrium and at the same time remain in equilibrium.” Yes, as Ben Powell reminds us, even Paul Krugman agrees on this. By mentioning a worldwide consensus there is no room for ideological or political agendas. It is important to mention that economics is not always about politics. The economic analysis of minimum wages has nothing to do with being a Democrat or a Republican; the political position of each party may differ, but those are not economic analyses, those are political strategies.

The next step was to deal with the issue that if such a consensus exists, why are there mentions of studies showing no harmful effects of increases in minimum wages. This is no mystery either. A well known reason of why an increase in minimum wages does not increase unemployment is because in fact there is no such increase. The politician may say he is increasing the minimum wage, but he does not say that the minimum wage is being located just above the equilibrium level and therefore he is not doing much. Another reason is to look at the effect of a minimum wage increase in a small location where low skilled workers can get another job in the next town without the need to move and therefore they will not show up as unemployed. This is another case of an ineffective increase in minimum wages. Or maybe the minimum wage increases but a benefit goes down. The total compensation to the employee does not change, its composition does.

But can the economist show his claim? Is there more clear evidence that the effects of increasing minimum wages does do harm than the complicated cases where there are no harmful effects? Again, I went geographically large. First, I compared the U.S. with Europe, which has higher minimum wages with respect to the U.S. In Europe you find higher unemployment rates, higher unemployment in the youth population, and also higher long-term unemployment. Second, I brought the case of the U.S. Fair Labor Standard Act of 1938, which fixed the minimum wage at 25 cents per hour. This law included Puerto Rico where the many workers were earning between 3 to 4 cents. Bankruptcies and unemployment skyrocketed. It was in fact unions who asked Congress to make an exception for Puerto Rico, which took two years to consider. For two years people in Puerto Rico were forced to work in the black market or fail to make a minimum income. Want more cases? See here. “See,” the psychologist says, “minimum wages are very dangerous; you can seriously harm yourself. Is that a bet you really want to make?”

Two issues remain to be explained after dealing with these three problems, (1) objection to minimum wage increases is not (necessary) an ideological or political position, (2) studies that deny the effect are doubtful for easy reasons to understand, and (3) if you look at a sample broad enough the economist’s prediction is right there.

First, when an economist objects to an increase in minimum wages it does not mean we do not want wages to go up. We are just saying that a minimum wage increase is not the right way to do it. I wish it were so easy, but the laws of demand and supply inform otherwise. I guess most economists would advocate for minimum wages if their negative effects were not real. Second, explain Milton Friedman’s lesson that a policy is valued by its results, not by its intentions. The economist objects because of the unintended effects of fixing the price of labor outside equilibrium, not because we wouldn’t like to see real wages increasing.

BC’s weekend reads

  1. Understanding Trump’s trade mistakes
  2. Empiricism and humility
  3. Epistemological modesty and unintended consequences
  4. Immigrants and slaves
  5. 5 takeaways from the Dutch election

Epistemological modesty and unintended consequences

What has attracted me most to libertarianism – next to the Non-Aggression Principle – is its attitude towards our knowledge which can be described as epistemologically modest. Epistemology is a branch of philosophy that is concerned with our knowledge: how do we know what we know, what is the nature of our knowledge, what is its scope, and what is justified belief? Libertarianism is modest in the sense that it promotes an awareness of how little we know about the social forces in our society, and what the particular consequences are when certain social forces are at play.

In ‘The Pretense of Knowledge’ (1974), Friedrich Hayek had given an excellent account on the libertarian epistemological modesty. He writes that when policy makers are epistemologically immodest – meaning that they unjustly believe that they truly understand the social world to the extent that they can plan or direct certain social forces to achieve certain ends – they will do more harm than good in their efforts to improve the social order. Hayek argues that each individual knows just a fraction of what is collectively known. Since knowledge is decentralized and each individual has unique information with regards to his or her particular circumstances, it is best to leave those with local knowledge to take decisions on how to plan their lives. Unfortunately, many do-gooders ignore Hayek’s advice and attempt to plan and control society. The dangers of epistemological immodesty are visible all around us. Take for example the NATO-led war campaign against Gaddafi in Libya in 2011. The meddling with Libya’s internal affairs has led to many unintended consequences that were totally unforeseen by most politicians: in a country that was previously relatively peaceful, manifold precious lives have perished, many have been wounded, many children have become orphaned, millions of people are trying to flee the civil war and to find refuge in other countries, ISIS has taken control of several parts in Libya, and terrorism has now become more widespread. Politicians who believed that they knew enough about the social forces in Libya, and how they could overthrow Gaddafi and turn it into a peaceful democracy have been dead wrong.

The epistemologically modest libertarian knows that military, economic, and political interventionism, always leads to unintended consequences. It is therefore best to refrain ourselves from such interventions as much as possible. This anti-planning sentiment had been graciously expressed by the American physicist Robert Oppenheimer when he discussed world affairs:

It is perfectly obvious that the whole world is going to hell. The only possible chance that it might not is that we do not attempt to prevent it from doing so.[1]

[1] I cannot verify the authenticity of this quote. It was attributed to Robert Oppenheimer by Alan Watts.

Increased/Deadly Potency in Heroin Markets due to Fentanyl

The Boston Globe put out a piece yesterday entitled “DEA details path of deadly heroin blend to N.E.: Potent painkiller fentanyl believed added in Mexico.”

This headline could not be more representative of the problems Dr. Mark Thornton mentions in his book The Economics of Prohibition. To summarize Thornton:

“Prohibition statutes generally consist of three parts. First, to be illegal, products must contain a minimum amount of a certain drug… Second, penalties are generally levied on the basis of weight… Finally, penalties are established for production, distribution, and possession. The prohibition statutes consistently define the product in terms of minimum potency (without constraining the maximum). Also, the heavier the shipment, the more severe the penalty.” (Thornton, 1991, p. 96).

Therefore distributors and traffickers (the Mexican drug cartels moving the heroin that originated in Colombia to the U.S.) have every incentive, in order to avoid detection but keep revenue high, to increase the potency of the drugs they are moving such that they can move the same value of heroin but in a smaller quantity. This is what we see currently happening with Mexican cartels mixing heroin with fentanyl.

From the Boston Globe article, “Ruthless drug organizations are including fentanyl, an opioid 30 times more powerful than heroin, to provide a new, extreme high for addicts who often are unaware the synthetic painkiller has been added.” The final point of this quote is critical. There is a huge information asymmetry between traffickers and the end consumer. Because drugs often change many hands before they reach the final user, quality standards are hard to track and verify. Furthermore, end users have minimal recourse to deal with issues of product contamination or inferior quality. They cannot sue their dealer. They cannot take anyone to court. Therefore, as a direct result of the illegal status of heroin trade, consumers have very few rights and outlets to verify that their product contains what they were expecting. While many people want to point out the Mexican cartels as the villains (and they may very well be on other margins like the relentless killing that is going on as we speak) in this scenario, these cartels are only responding to the incentives set in front of them. If we want to take issue with anyone, we need to look at the laws that have been in place since 1924, and even back to 1914. Since then, these laws have only gotten more restrictive and deadlier to everyone involved in illicit drug trade.

Order, Order, Order

In the conventional wisdom, as you become older, you tend to like order more and more. That is, with age, one is supposed to become more “conservative” in the traditional sense of the term. Personally, I have escaped the curse. Instead, I find myself resenting more and more the growing imposition of petty rules by public entities.

It began a few years back when the city of Santa Cruz banned sleeping. OK, let’s be honest, you may still sleep legally in your bed. The city made it illegal to sleep in public. It’s true that the homeless are a plague here. Many are in a near-constant state of NDUI (not driving under the influence). Many are poor lost souls who are a danger to themselves and occasionally to others. Thus, three or four years ago, a local shopkeeper walking to work was knifed to death in broad daylight. Her killer had spent the previous 48 hours in a shelter muttering about and to his Bible. No one reported him,of course because he had not done anything illegal until then. Next!

The ban on sleeping made me acutely uncomfortable at the time. First, it was plainly inhumane. Second, if you prevent human being from doing what their human nature demands, they will find another way to do it. So, informal camps proliferate in the wooded areas juxtaposing the town. Here, in Central California, we are in a period of prolonged drought. Do we need unattended campfires and campfires attended by people who don’t play with a full deck?

A petty use of power, municipal power, applied in a search for orderliness led to greater and far more dangerous disorder.

I don’t even know if there are enough night shelters for everyone who wants one. I know that there will always be sane but houseless people who don’t want to be in a shelter, by choice. A sizable part of me respects their choice. You may not force people in places where they don’t want to be without due process. The Constitution is completely clear on this. And, I am not in favor of more shelters anyway because I believe they attract the economically feeble to Santa Cruz thus aggravating the problem.

You don’t have to be a “soft” to want the Constitution respected.

Now, since then, there as been a multiplication of city rules. This happens while the crime rate plunges. The fewer crimes the more rules. The crime rate is tanking all over the country; Santa Cruz city rules can hardly take the credit. What am I to think?

Here is a quiz: The Santa Cruz City Council is dominated by:

a Republicans;

b Democrats;

c Leftists to the left of the Democratic Party

Not far is the independent harbor. I used to admire the Santa Cruz (Small Yacht) Harbor. It was the only government and quasi-government organization I knew that stayed clear of reliance on taxes. Harbor users -in their many guises- supported the maintenance of the harbor. They included boat slip renters like me, of course, but also beach goers whose coffee paid for the rent the coffee shop paid to the harbor in return for an excellent commercial location. Harbor users also included patrons of the good restaurant that dominates the harbor entrance with its million dollar view. The restaurant goers gladly paid solid parking fees, of course, and a portion is remitted to the harbor.

I also liked the way the harbor administration put to work underused resources such as the large general parking lot reserved for boat owners that tends to stand more than half empty after four pm. The harbor had an agreement with the self- same restaurant to hold musical barbecues once a summer week evening on the beach it, the harbor, administers. The restaurant got its profits from the sale of barbecued food and the harbor pocketed full parking fees from those not holding slip stickers. The arrangement drew crowds. It was all a little bit untidy but not much. Twice, on such a barbecue evening, I leaned spontaneously out of my truck to congratulate the officer directing parking and to assure him, unsolicited, that this particular slip owner, me, was not (NOT) inconvenienced at all.

And then, someone retired and there was a new sheriff in town. Under the new harbormaster, several things that were allowed became forbidden overnight. The harbor hired a full-time parking enforcer, like the town next door. Suddenly, the one harbor employee the average harbor user interacted with was the parking enforcement officer. This necessarily hostile and heartless functionary supplanted the traditional harbor officers who save boats, and sometimes lives, every weekend. The mood changed and not for the better. I am not speaking for bitterness about parking fines here; with my slip rental goes a permanent parking sticker permit.

Maintaining a stricter order often requires stricter rules that make most people unhappy. Eve if it’s only a little bit unhappy, the bad feeling accumulates.

Then, stand-up surfboards had to be segregated from boats. Boats are limited to 5 m/h inside the harbor anyway. Some boats under sail inside the harbor regularly exceed the speed limit. Those are steered by aces. How bad can a collision be under these conditions, really? Has there been a single collision involving a standup board? Did a boat owner complain about stand-up boards being in the way? Maybe. Did ten complain? I doubt it. (I have not asked; I don’t trust I would get a valid answer I could cite.) My point is that one can always find a complainer or two. If you handed out free ice cream to poor children and cleaned carefully afterward, there would be some curmudgeons to object. I am sure there are boat-owning slip renters who complain even about the ocean swells. But everyone knows that good harbors are bustling with activity. Those who detest the corresponding moderate disorderliness have no business in a harbor at all. They should be reminded of the fact that there is a long waiting list for their slips instead of listened to.

The art of civilized administration requires that complaints be ignored up to a point. It also includes remembering the second most important American maxim: “If it ain’t broke, don’t fix it until it is.”

Then, there are the new signs that shout at you that fishing from docks is “prohibited.” For as long as I remember, 20 year-plus, children fished from the docks. It was an excellent, healthy, commendable form of leisure for kids, including poor kids, if you ask me. Were there ever any accident as a result, even one? I don’t think so. The signs affirm further and vengefully that the prohibition is: “strictly enforced.” No joking with serious matters here! We are not kidding. Don’t even think of enjoying yourselves!

The posted “minimum” fine is $174. Think about it: Your otherwise well-behaved 12-year old gives you the slip to try to catch a sardine or two. He gets caught. You are into it for about twenty hours of minimum wage. This comes close to a violation of the Eighth Amendment, prohibiting cruel and unusual punishment, I think. There may also be here a subtle breach of contract involved here. When I first rented a slip in the harbor, fishing from the docks was common practice. The locked dock that was part of the rental gave me special access to a pleasant fishing spot. Then, after twenty years, the contract becomes unilaterally modified to my detriment. The harbor did not bother to re-negotiate the contract.

I agree that this is a very small kind of tyranny but it’s tyranny all the same. The habit of being oppressed nearly always begins small in democratic countries. Our tiny liberties are eroded slowly until we don’t even remember we ever had them.

In the same period, I have heard the crew of one of the few remaining commercial fishing boats left in the harbor complain that they are made to feel unwelcome. I have no proof that their allegation is correct but, I wonder, why would they make it up? It jibes with the other forms of turning of the screw I mention. There is no doubt that the harbor would be neater without fishing boats. Fish smells and the rushed commercial fishermen drop the occasional dead fish into the harbor water. And, well, it’s a yacht harbor, after all. And, by the way, if slips only went to middle-aged nuns who work as librarians, the harbor would be even neater.

Occasionally, I take my grand-daughter to buy live crabs directly from a boat. It’s an expedition for her. It’s unforgettable. It shows her that some food does not come from the supermarket. But who am I to lay claim to such privilege? And who the hell are the commercial fishermen to insist on making a living from a harbor originally created by the Army Corps of Engineers with tax money?

On 2/3/14, coming out of a restaurant, my family and I were treated to a wonderful geyser-like spout of water reaching much higher than a three storied building. No, it was not a whale; the scene was a couple of miles inland, on a busy commercial artery, at a street intersection. We watched in utter fascination for more than fifteen minutes. (I posted a still picture of the event on my Facebook. Look for it.) I am obviously no expert, but I believe that while I looked on several hundreds of thousands of toilet flush- equivalents of city water were lost forever. I know, I know, accidents happen; no system is perfect. But why did it take so long to cap the leak? There is a fire station five or six blocks away.

I almost forgot to tell you: At the very same time, the same evening, there was an important meeting of the Santa Cruz Water Commission to make recommendations about water rationing to the City Council in view of the current drought.

Would I make this up? Would I dare? Do I have the talent?

In my immediate surroundings, the only rule or law I have seen abolished in the past twenty years or so concerns dogs. They used to be prohibited on the main commercial drag of Santa Cruz, Pacific Avenue. The prohibition has been rescinded. Dog owners are numerous and determined. Their victory renews my faith a little in democracy. I wish I could cite more examples though.

Sometimes, the ugly thought crosses my mind that public entities are increasingly run for the benefit of their nominal employees. Karl Marx was almost right about classes, maybe . (See, on this topic: “Karl Marx Was Right (Pretty Much)“)

More on local government action: “Coyotes: How Government Bureaucrats Think

Uruguayan government: “monopoly” on pot

Last week, Uruguay’s government passed legislation to legalize marijuana. While the government will not be growing any cannabis plants (they are leaving that to private cultivators and farmers), the state will be playing a major role in the market… by fixing the price for marijuana at $1 per gram.

The rationale behind this production legalization and price fixing is to limit the amount of marijuana being trafficked into the country (mainly from Paraguay). As many of you may know, the narcotics trafficking business in Latin America is wrought with intense violence and organized crime. By fixing the price at $1 a gram, government officials believe this initiative will drive these traffickers out of business (at least in Uruguay). However, as all government interventions go, we need to ask ourselves, what are the possible unintended consequences lurking around the corner?

The issue I have is not with the legalization of marijuana, but with the price-fixing component of the legislation. Interventions into the market distort information (price) signals, forcing entrepreneurs to work off of incorrect information for their profit and loss calculations. Given that the drug market is already entrenched in these distortions, is this price-fixing component of the legislation a step in the right direction, or does it just complicate matters further?

The incentive structure, given the fixed price, is not the same as it would be in a free market. Any incentive that could have pushed these traffickers to move away from violence if it resulted in greater profits has been removed. Perhaps these violent traffickers will leave the marijuana business in Uruguay, but will they relocate efforts to other countries, or perhaps begin focusing on different illegal narcotics to traffic into Uruguay? If these new freedoms being granted to Uruguayans are coming at the cost of increased violence in other countries as a result of this price-fixing component, should we consider this a success?

University Graduation Rates are Too High

A proposal has surfaced to “punish” California state universities, including San Jose State where I teach, if they either (1) continue to raise tuition rates or (2) fail to raise their graduation rates. The punishment would take the form of reduced state support.

First of all, we taxpayers (including me; I’m a net tax payer) should rejoice at such “punishment” as it would lessen the burden on us. Taxpayers aside, how might the state universities respond to such punishment? On the fiscal side, they could recruit more out-of-state and foreign students who pay full freight. The UC campuses are already cutting admissions of in-state students in favor of out-of-state full payers – will UC eventually become UNC – University of Non-Californians? Furloughs are unlikely; they were tried once and didn’t work. They can’t cut salaries; there’s a faculty union. They’ll never cut out administrators. No, all bureaucracies, when forced to cut expenses, make cuts that are most painful to the public. Therefore, in addition to recruiting more full payers, they will cut classes.

What about graduation rates? They can’t raise admission standards because that would be “unfair” to racial minorities who are disproportionately ill-prepared for college work. They already have programs to try to coax students to study, with marginal results, and the obligatory special privileges for students with “learning disabilities.” It’s not clear what more could be done along those lines. No, I contend that the most humane policy for state universities would be to cut graduation rates. Here’s why.

It is indeed unfortunate that so many students, more than half at SJSU and other state universities, fail to graduate within six years. Those students have paid a big price in terms of money spent, debt incurred in many cases, and foregone income, with almost nothing to show for it. A bachelor’s degree from a state university, unless it’s in engineering, is worth little enough; two or three years of class work is worth nothing. Those who do make it all the way to the sheepskin gain a marginal advantage; their degree signals a certain amount of persistence. Their value to an employer remains uncertain; many, I fear, couldn’t be trusted with such simple tasks as reading with understanding, writing, doing simple calculations or, perish the thought, critical thinking.

All too many students who enter SJSU are ill-prepared and/or poorly motivated. Large numbers must take remedial math or English because they learned nothing in their public high schools. Many have little or no idea why they are there – some seem to view college as a way to delay their entry into responsible adulthood.

A good number surely have aptitudes for jobs that may require some specialized training, but not a college degree. I’m thinking of welders, hospitality workers (wait – you can get a B.A. in hospitality!), tile setters, carpenters, electricians, roofers, beauticians, nannies; the list goes on and on. What a tragedy that such students fall into the sinkhole (for them) that is a university campus.

Since admissions standards aren’t likely to be raised, the only humane thing to do is to get these students out the door as fast as possible. I expect to give a lot more D’s and F’s in my class this semester than I normally do, not because I’m pursuing any agenda but because they won’t have learned the material. Those students will be hurt, short term, but it’s the right thing for them, long term, especially if it hastens their exit from a university where they don’t belong.