Sadly, Danny Finkelstein gets it wrong

Clearly and obviously wrong as he’s taking Robert Reich as a serious analyst of the economy. Paul Krugman dispensed with that error over 25 years ago.

The general idea that the rules make the market is true to some extent. What gets missed here is that if the rules end up banning some part of the market then it doesn’t disappear, it just goes off to where there are no legal rules. The drug and prostitution markets are clear enough evidence of that. Thus the argument is not true in that wider extent – the market is, the rules don’t in fact define it, they define only the legal part of it.

Which is, in large extent, Reich’s basic error, to believe that by tweaking the rules we can change the underlying market. We can’t – we can only change the legal and visible part of it and even then only at the margin.

At which point the two specific examples Finkelstein uses:

“We Conservatives said that if a minimum wage was introduced, it would cause increased unemployment but it didn’t. Why?” and “How is it that chief executives are earning amounts that are surely in excess of those necessary to do their jobs?” And if these questions seem intriguing but wonkishly irrelevant to a government in immediate distress, I’d like to explain why they aren’t.

On the minimum wage, from 2005:

Tony Blair today announced plans to cut the jobs and hours of low-paid workers.
He’s going to raise the minimum wage, from £4.85 an hour to £5.05 in October. This as the Low Pay Commission recommends in its report today; it also recommends a rise to £5.35 in 2006.
The first rule of economics, of course, says that if you raise the price of something, you’ll reduce demand. And this means shorter hours and job losses for some of the low paid.
The Low Pay Commission pretends this won’t happen. Its chairman Adair Turner says: “Our analysis suggests that previous upratings [to the minimum wage] have largely been absorbed without adverse effects.”
Can I give Mr Turner some advice? Try reading your own report matey.
In particular, appendix 3, which starts on page 213 of this pdf. It contains a survey of employers who were affected by the rise in the minimum wage in 2003. It shows that: 37 per cent of them cut staffing levels, whilst only 4 per cent raised them; 31 per cent cut basic hours worked whilst 3 per cent raised them; 28 per cent cut overtime hours; 81 per cent said their profits fell; and 63 per cent said they raised prices.

This, of course, is exactly what basic economics would predict. It corroborates this research, which shows that where the minimum wage bites hard – for example in care homes – it does reduce labour demand.

We can still go on and argue about whether this is a good idea and all the rest but what we cannot do is try to insist that the minimum wage has no effect upon employment. That basic contention that it doesn’t is simply an untruth.

As to those high wages, we also have evidence that they work:

This hypothesis is verified by results showing that US firms substantially cut down on the scale of assets and workforce to increase return on assets following leadership changes, whereas Japanese firms tend to work on reducing liabilities. Despite excelling in technologies, organisational management, and human resource management, Japanese firms seem to have lower earning power because CEOs, who are responsible for corporate management, do not prioritise profit maximisation. Such tendency leads to a loss of shareholders’ equity and inefficient usage of firm resources, causing a major negative macroeconomic impact.

US CEOs are, famously, paid rather more and rather differently than Japanese.

The essential assertions that Reich makes to bolster his case simply are not true. Which really isn’t a good logical base upon which to build a political or economic system. Finkelstein should know better quite frankly. For as Krugman has indeed pointed out Reich really doesn’t grok economics in the slightest.

10 thoughts on “Sadly, Danny Finkelstein gets it wrong”

  1. My own anecdotal evidence. I have two lodgers who both work at Tesco which recently announced loudly that it was increasing pay to around the National Living Wage level.

    Both lodgers mentioned that Tesco were reducing overtime payment rates and available overtime hours.

  2. AndrewC,

    And outsourcing and automation. Once someone has invested in automation, created say, a parking system based on ANPR that cuts security guards driving around places, you’re never going to get those jobs back.

  3. There are quite a few jobs that would have been quite hard to automate, say, 20-30 years ago, which now look increasingly automatable. And in the next few decades, even more low-wage jobs (couriers and other drivers for example) look vulnerable.

    Does the growth of technological alternatives, or at least technologically-supported efficiency measures that require less human input, make the effect of minimum wage increases more potent? Or does the fact that my statement about “increased automatability” could have applied to pretty much any multi-decade period since the start of the Industrial Revolution negate it?

  4. They often misunderstand “low unemployment” when they pioint and shout “look, more jobs!”, but the unemployment isn’t “vertical” – the number of jobs, it’s “horizontal” – the *amount* of jobs.

    I have one job, but it averages 2 days a week. Ten years ago I had one job but it averaged 5 days a week, and there’s still somebody today doing that job averaging three days a week. So clearly, unemployment has gone down because there are two jobs today where there was one job ten years ago.

  5. Daniel Finkelstein writes, ““We Conservatives said that if a minimum wage was introduced, it would cause increased unemployment but it didn’t. Why?”

    Can anyone tell me how the the evidence that the introduction of the minimum wage in the UK didn’t cause unemployment, as Mr Finkelstein says and seems to be generally accepted, was actually gathered?

    Was it just the absence of a spike at the relevant time (compared to expected cyclical changes)?

    In the US, different states have different minimum wages so the effect of changes on one state can be clearly tracked by comparison to neighbouring states. But in the UK a change in the law happens everywhere at once, so that method can’t be used.

    I’m no economist and may have got the wrong impression, but I’ve often been surprised by how much reliance seems to be placed on simply asking employers what they plan to do, or did do, when the minimum wage comes in or goes up. It seems obvious to me that employers have incentives to keep plans for redundancies quiet and/or to pretend that automation was going to happen anyway. There is no upside for a company in announcing to the world that it will make a bunch of people redundant in order to avoid paying them more. They will be pilloried.

    But I might be wrong in thinking that asking employers plays much of a role in determining what the relationship between minimum wage and employment levels is.

  6. ^An excellent case for devolving minimum wage policies to local authorities.
    And if Momentum want to protest about the outcome they have to spread themselves thin organising 300 barneys, rather than the usual one or two in places like Albert Sq, Manchester and London.

  7. @ Natalie Solent
    The evidence is quite clear – the Minimum Wage DID increase unemployment. Tony Blair’s poster-lady for Minimum wage was a Pakistani womean in Leicester working a few hours each day in a sweat-shop in Leicester while her children were at school tyo augment her husband’s income. Within a few years 90% of all UK textile workers had lost their jobs.
    The impact was not overnight because New Labour passed a law that said nobody could be sacked because his/her wages were increased to the Minimum Wage – many, probably most, of the jobs were lost when the employers went bankruot because they couldn’t afford to pay all their workers the minimum wage.

  8. Great Tim, we get it; setting a floor for P at higher than market clearing rate will set a lower-than-market-clearing value for Q. This is, or should be basic. It should also be basic accepted stuff that shifting the supply curve along will lead to a lower market clearing rate for P, with the absolute sale from extant suppliers falling as well.

    So, are you going to suggest to Sam Bowman that he pops off to Boston, Lincs to spout his denier bollocks or shall we?

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