Why is there So Much Economic Illiteracy? Paul Krugman Is One Reason

John C. Goodman
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Posted: Sep 12, 2015 12:01 AM
Why is there So Much Economic Illiteracy? Paul Krugman Is One Reason

Stanford University economist Thomas Sowell was asked the other day whether the understanding of basic economics has been elevated in political discussions over time. His answer? Economic literacy hasn’t gotten better. It’s gotten worse.

“At one time you had a lot of people who hadn’t had any economics saying foolish things. Now you have well-known economists saying foolish things,” he said.

Although he didn’t name names, New York Times columnist Paul Krugman must rank high on the list of guilty parties. There was a time, not long ago, when The New York Times called for a zero minimum wage and Krugman agreed with them. The reason? A minimum wage law isn’t just a restriction on employers. It’s also a restriction on workers.

A $15 minimum wage, for example, means that you won’t have a job if you can’t produce $15 worth of goods and services in an hour. A lot of young people can‘t do that – especially kids that have never had a job before.

Then there is a common sense point: at risk teenagers from low-income households will never learn the skills they need to be successful in the labor market if they never get a first job. As scholars at the Brookings Institution forcefully point out:

Finding and keeping a job is a key step in a young person’s transition to adulthood and economic self-sufficiency. Employment obviously allows young people to cover expenses for themselves and their families, but it also provides valuable opportunities for teens and young adults to apply academic skills and learn occupation-specific and broader employment skills such as teamwork, time management, and problem-solving. Additionally, it provides work experience and contacts to help in future job searches.

Finally, economists almost universally understand that the minimum wage law is a lousy poverty tool:

· Only 11.3 percent of workers who earn the minimum wage live in households officially defined as poor.

· A whopping 63.2 percent of workers who earn the minimum wage are second or even third earners, living in households with incomes equal to twice the poverty line or more.

Flash forward to last Saturday. In an editorial endorsing a $15-an-hour minimum wage, the editors of The New York Times repeat the canard that the typical minimum wage earner is a lone individual trying to “eke out a living” on that wage, ignoring all economic research to the contrary. Then, for the first time ever if memory serves, they make an economic argument for intervention:

Markets do reliably establish the prices of goods and services when businesses have to compete. When businesses compete for workers, for example, wages rise because employees gain a modicum of bargaining power. The law has long recognized, however, that low-wage workers seldom have bargaining power. An adequate federal minimum wage effectively substitutes for that lack.

Wow. When you walk into Walmart’s, how much bargaining power do you have? Zilch. But is that bad? Not at all. If you want to bargain over price, go to a garage sale. Walmart has low prices -- not because customers have bargaining power, but because it is competing with other stores for customers.

The same thing is true in the labor market. Hourly workers almost never bargain over their wages. It’s typically take it or leave it. But employers compete against other employers – on wages, benefits and other aspects of work. Competition keeps wages as high as they are, just as competition keeps Walmart’s prices as low as they are.

That brings us to Paul Krugman, who repeatedly argues that small increases in the minimum wage do not cause unemployment. Economic studies and even the Congressional Budget Office disagree with him. In fact, David Brooks summarized much of the contrary evidence in a column on the very same op ed page Krugman writes for. And in the Wall Street Journal, Andrew Puzder notes that there are already indications of layoffs because of minimum swage increases in San Francisco and Seattle.

Krugman does make one valid point: the market for labor is not like the market for wheat. But then he ignores all the implications of that point.

In the market for wheat, there is just wheat and a price. But in the market for labor, a lot more is involved than an hour’s worth of work and a wage. Some fast food restaurants will send workers home when business is slow. A lot of employers have on-call scheduling – requiring employees to be ready for last minute shifts, but requiring them to call in an hour or so ahead of time to see if they are really needed. Some employers start paying their employees, not when they show up for work, but when the first customer arrives. Some employers have flexible hours – allowing employees to come and leave at times that best fit their family needs. Working conditions matter. We are having a serious slump in agriculture produce because farms can’t attract enough workers even with a $17-an-hour wage.

When government forces employers to pay higher wages, employers typically react by changing these other aspects of the job, including reducing other types of spending on their employees – less training and fewer fringe benefits, such as health insurance. Economist Richard McKenzie summarizes what we know about this subject:

· When the minimum wage was increased in 1967, economist Masanori Hashimoto found that workers gained 32 cents in money income but lost 41 cents per hour in training — a net loss of 9 cents an hour in full-income compensation.

· Similarly, Linda Leighton and Jacob Mincer in one study, and Belton Fleisher in another, concluded that increases in the minimum wage reduce on-the-job training and, as a result, dampen long-run growth in the real incomes of covered workers.

· Additionally, North Carolina State University economist Walter Wessels determined that a wage increase caused New York retailers to increase work demands. In most stores, fewer workers were given fewer hours to do the same work as before.

On balance it appears that employees are left worse off.

Even if there were an argument for a minimum wage, there is no conceivable argument for making the minimum the same in all parts of the country. Even Krugman admits that imposing the national US minimum wage on Puerto Rico has cost jobs. Historically, the minimum wage has been set at about half the average wage in the economy. A $15 minimum in 2020 would be close to that in Washington, Seattle, Boston and New York. But it would have a much bigger impact in other parts of the country. In Miami, the average wage right now is less than $15.

There is a far more effective way of helping low income families. It’s called the Earned Income Tax Credit. It’s targeted (it supplements family income, but only if your income is low) and it encourages work (the more you earn, the higher your rebate). Almost all economists understand this.

Yet Paul Krugman recently asserted that the minimum wage makes the EITC more effective. He’s wrong. The reverse is true. Combining the EITC with a minimum wage makes workers worse off – as Steve Landsburg shows, using supply and demand curves in a demonstration that any freshman in Econ 101 can follow.

Krugman, by the way, is not alone. Apparently, a number of well-known economists have signed a public letter endorsing a higher minimum wage and repeating many of the myths debunked in this post. Economist Alex Tabarrok has a one-word reply to his colleagues: Rubbish.