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.