Economic law is not suppressed by legislated law. — Armen Alchian
Few people really understand what the great economist Armen Alchian, who died the other day at age 98, put so plainly. Considering that in the recent past over a quarter of polled economists said they saw no harm in raising the minimum wage, this absence of understanding apparently is not confined to the lay public. (See Paul Krugman’s column “Raise That Wage.”)
The minimum wage is back in the news because President Obama has called for a phased-in increase from the current $7.25 to an inflation-indexed $9 an hour by 2015, a 24 percent increase.
Raising the minimum wage is always popular with the public. If you stand on a busy sidewalk, hand strangers a clipboard, and ask them to sign a petition to put a proposition to raise the minimum wage on the state ballot, you will have the needed signatures in no time. When the question appears on the ballot, a large majority of voters will mark “yes.” Most pundits agree with the public on this issue.
What are we to conclude from all this? It tells me that most people have a premodern, prescientific mentality about society. The advent of modernity was marked by an understanding that the marketplace (or society more generally) was not deliberately designed, but rather was governed by economic laws. Therefore rulers should not expect their arbitrary decrees to have their stated effects. If they want a product, say, milk, to be cheaper than it is, they cannot achieve this aim simply by forbidding milk to be sold above a mandated price. Trying to do so will result in less milk brought to market and unsatisfied demand, presumably not the results sought by the ruler. Likewise, if they seek to raise the incomes of low-skilled workers, it would be a mistake to forbid those workers from accepting jobs that pay less than a decreed minimum wage, because the supply of workers will outstrip demand, producing unemployment.
In general, if government forbids the free search for market-clearing prices (and wages), shortages or surpluses will result, depending on whether a maximum or minimum price is mandated.
It took humanity a while to realize that the social order consists in what Israel Kirzner calls “systematic chains of cause and effect.” Economic laws such as the law of supply and demand are rooted in the logic of human action: In a world of ignorance, scarcity, and hence tradeoffs, individuals choose entrepreneurially among ends, while economizing on limited means, according to subjective marginal utility and opportunity cost. Interpersonal coordination of individual plans and spontaneous social order emerge as if by an “invisible hand.” If the price of a good rises, consumers will tend to buy less, economizing on the current supply and stimulating an entrepreneurial response. If the price of a good falls, sellers will tend to supply less, shifting scarce resources to other products demanded by consumers. Seeing that large-scale coordination can exist without overall planning changed the way people viewed the social world — at least those people who grasped the point.
Rulers and would-be social engineers, however, did not receive the news well. It was bad enough they had to accept limits imposed by the physical laws. But market forces too? Oh, the indignity! As a result, they had a vested interest in denying the validity of economic science. (We may put Lord Keynes in this class.)
Ludwig von Mises addressed this matter in Epistemological Problems of Economics (1960):
The scattered and fragmentary insights of the historical and normative sciences themselves achieved scientific status only with the development of economics in the eighteenth century. When men realized that the phenomena of the market conform to laws, they began to develop catallactics and the theory of exchange, which constitutes the heart of economics.…
The development of economics … did more to transform human thinking than any other scientific theory before or since. Up to that time it had been believed that no bounds other than those drawn by the laws of nature circumscribed the path of acting man. It was not known that there is still something more that sets a limit to political power beyond which it cannot go. Now it was learned that in the social realm too there is something operative which power and force are unable to alter and to which they must adjust themselves if they hope to achieve success, in precisely the same way as they must take into account the laws of nature.
This realization had enormous significance for men’s action. It led to the program and policies of liberalism and thus unleashed human powers that, under capitalism [i.e., the free market], have transformed the world. Yet it was precisely the practical significance of the theories of the new science that was responsible for its undoing. Whoever wished to combat liberal economic policy was compelled to challenge the character of economics as a science. Enemies arose against it for political reasons.
Earlier, in “Social Science and Natural Science” (1942), Mises had written,
The founders of Political Economy discovered regularity in the operation of the market. They discovered that to every state of the market a certain state of prices corresponded and that a tendency to restore this state made itself manifest whenever anything tried to alter it. This insight opened a new chapter in science.
Not all advocates of the minimum wage are completely oblivious of the operation of economic laws. Krugman concedes that raising the minimum wage to $20 an hour would harm its presumed beneficiaries. This raises a question: How does he know $9 won’t harm unskilled workers? Krugman claims to know what only the free market can disclose. “For about four decades,” he writes, “increases in the minimum wage have consistently fallen behind inflation, so that in real terms the minimum wage is substantially lower than it was in the 1960s. Meanwhile, worker productivity has doubled. Isn’t it time for a raise?”
This is what F. A. Hayek called the “pretence of knowledge.”
Note the problems with this argument: First, Krugman uses an aggregate of all worker productivity. But labor is not homogeneous. There’s a vast range from unskilled to highly skilled. Are we to believe that the average productivity figure for all workers applies to unskilled labor? Moreover, how can he know that a $9 wage won’t eliminate jobs, prevent the creation of new jobs, and degrade the conditions of workers who manage to keep their jobs? This is the kind of information that only the market process can yield. Obama, Krugman & Co. are playing with the lives of real people (in more ways than one. See this post by Russ Roberts).
Economic productivity is determined by consumers’ subjective marginal valuation of the things that different kinds of labor produce. (All products compete with one another.) In a freed market devoid of privilege, wages are determined by the haggling among those who want jobs and those who seek to buy labor services, with consumers hovering over the bargaining. It’s the full competitive process and free pricing that produce information about the marginal productivity of workers. There is no way to discover this information independent of that process.
If $9 would more accurately reflect the productivity of unskilled labor, advocates of a minimum wage must explain why employers haven’t already bid the wage up to that level. Even in a corporate state with inhibited competition, there are many potential employers of unskilled labor — gas stations, movie theaters, fast-food restaurants, and more. (Remember, most people who make the minimum wage are young and inexperienced.) It is unlikely that all such employers have colluded to suppress the price of unskilled labor. Why, then, is the wage not already at $9?
This is not to say that labor markets are free. The government distorts them in myriad ways: through tax and regulatory measures that inhibit the formation and growth of businesses and through impediments to self-employment, including occupational licensing, costly permits, and zoning. And let’s not forget the horrendous government schools. It’s curious that most pundits and politicians who claim to care about unskilled workers never call for the repeal of these barriers to individual advancement. Instead they go for bogus solutions like the minimum wage. This might have something to do with the fact that politically well-connected interest groups whose members make far more than the minimum but who fear competition from unskilled workers are the most vigorous supporters of the legislation. It’s worth noting that the original agitation for a minimum wage was motivated by a wish to exclude certain “undesirables” from the marketplace. This doesn’t necessarily mean that today’s minimum-wage supporters have unsavory motives, but it does mean that their policy predecessors had a better grasp of economics.
As others have pointed out, most people have no trouble seeing that a tariff discourages people from buying foreign goods and a tobacco tax discourages people from buying cigarettes. Why, then, is it so difficult to see that a minimum wage discourages employers from hiring unskilled workers?