July 21, 2017

Minimum wage ― a fatal error in economic reasoning

Comment on NYT on ‘Minimum Wage and Job Loss: One Alarming Seattle Study Is Not the Last Word’

Blog-Reference

Economics suffers from the fact that the subject matter is ill-defined. Economists think that they are doing economics while they bungle amateurishly in sociology and psychology. What economists overlook is that their subject matter is the structure and behavior of the economic system and that all questions about Human Nature/motives/behavior/action are NOT their business.

Economics is a system science. Accordingly, the correct approach is not microfoundations but macrofoundations. The elementary version of the correct (objective, systemic, behavior-free, macrofounded) employment equation is shown on Wikimedia.

From this equation follows:
(i) An increase of the expenditure ratio rhoE leads to higher employment L (the Greek letter rho stands for ratio).
(ii) Increasing investment expenditures I exert a positive influence on employment.
(iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment.

Item (i) and (ii) cover the familiar arguments about aggregate demand. The factor cost ratio rhoF as defined in (iii) embodies the price mechanism. The fact of the matter is that overall employment INCREASES if the AVERAGE wage rate W INCREASES relative to average price P and productivity R. This is the OPPOSITE of what microfounded economics teaches.

“We economists have all learned, and many of us teach, that the remedy for excess supply in any market is a reduction in price. If this is prevented by combinations in restraint of trade or by government regulations, then those impediments to competition should be removed. Applied to economy-wide unemployment, this doctrine places the blame on trade unions and governments, not on any failure of competitive markets.” (Tobin)

“If the price of bananas is kept too high in relation to the price required to balance supply and demand there will be a surplus of bananas. If the price of bananas is below the market clearing price there will be a shortage. The same applies to labour. If the price ― i.e. the wage ― is too high there will be a surplus of workers, i.e. unemployment. If it is kept too low there will be a shortage of workers … Workers do sell their services just as banana producers sell their bananas.” (Brittain)

The banana theory of the labor market is just that: bananas. The lethal methodological blunder of microfounded employment theory consists in the Fallacy of Composition, i.e. the illegitimate transfer of truths that hold for one firm/market onto the economy as a whole.

False theory leads to false policy guidance. Scientifically incompetent economists bear the intellectual responsibility for the social devastation of mass unemployment.*

Egmont Kakarot-Handtke

* For details see cross-references Employment


Related 'The minimum wage debate: a showpiece of economists’ hereditary idiocy' and 'How economists murdered the economy and got away with it'