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Economics and cognitive dissonance

Summary:
What is the value of economics? "Have you economists ever proved anything that isn't obvious?" is a common complaint.Tyler Cowen has an insightful post on Marginal Revolution, that provides a lovely insight into the power of economic thinking.Often, multiple policy questions come down to a single issue. We may not know the answers to any ...

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What is the value of economics? "Have you economists ever proved anything that isn't obvious?" is a common complaint.

Tyler Cowen has an insightful post on Marginal Revolution, that provides a lovely insight into the power of economic thinking.

Often, multiple policy questions come down to a single issue. We may not know the answers to any of the questions, but we can at least say that the single issue drives the answer to all of them. So once you decide one issue goes one way, you can't (rationally) believe another issue goes another way, no matter how politically convenient that might be.

The issue here is the "elasticity of labor demand." If wages go down 10%, how many more workers will employers hire? If wages go up 10%, how many fewer will they hire? Already, note, that's one number, and it makes little sense to believe a higher number in one direction than another except for some likely quite transitory adjustment costs.

Tyler
There is a longer history of minimum wage assumptions not really being consistent with other economic views. 
Have you ever heard someone argue for wage subsidies and minimum wage hikes?  No go!  The demand for labor is either elastic or it is not. 
Have you ever heard someone argue for minimum wage hikes and inelastic labor demand, yet claim that immigrants do not lower wages?  Well, the latter claim about immigration implies elastic labor demand. 
Have you ever heard someone argue that “sticky wages” reduce employment in hard times but government-imposed sticky minimum wages do not?  Uh-oh. [The link is good too - JC]  
It would seem we can now add to that list.  Maybe we will see a new view come along:
“Labor demand is elastic when licensing restrictions are imposed, but labor demand is inelastic when minimum wages are imposed.”

This is a bit of economic-ese, so let me translate just a bit. The argument for a minimum wage is that labor demand is inelastic -- employers will hire the same number of workers. They will just absorb the higher wages or pass along the costs to customers. Workers get all the benefit. If labor demand is elastic, employers cut back on the number of employees. Most people lose their jobs and only a lucky (or productive, or willing to tolerate harsher working conditions) few get the higher wage.

The argument for wage subsidies requires the opposite assumption. If we subsidize wages, do employers respond by just paying people less? (Or, of we pay the subsidy to the worker, are the same number now willing to work for lower wages from employers? An often forgotten core result of economics is, it doesn't matter who pays the tax or gets the subsidy.) That is the case if labor demand is inelastic. Or do employers respond by paying the same amount, and expanding the workforce? That is the result if labor demand is elastic. You need elastic labor demand for wage subsidies to work as intended.

Thus, you can't simultaneously be for higher minimum wages and for wage subsidies. That is cognitive dissonance. Or, inconsistency. Or wishful thinking. And very common.

Likewise, just about 99% of macroeconomics is centered on the proposition that wages are "sticky." (1%, consisting of basically me, still has doubts.) If deflation breaks out, wages do not fall. Wages are too high. Employers cut back on workers, and people are unemployed. For this argument to work, (among other things) labor demand must be elastic. And then inducing exactly the same situation by minimum wages must have exactly the same result -- fewer jobs.

The point on immigration is good. The labor demand curve unites a price and a quantity. Thus, if pushing on a price has little effect on quantity, we know that pushing on a quantity has a large effect on price. Or, you have a hard time believing one thing about pushing on a price, and another thing about pushing on a quantity.

If you don't like minimum wage hikes, you can't believe that immigrants are pushing down wages. If you like higher minimum wages, you must believe that immigrants are terrible for labor markets. This proposition should be equally uncomfortable on the left and the right.

(Supply demand graphs are great here. I leave them as an exercise for the reader. If you know how to read them, this was all obvious already.)

Yes, one can complicate the analysis in each case to get a desired result -- add adjustment costs, asymmetries, or whatever. But it is striking that most discussions don't do that -- they don't reconcile that what is good for the goose ought to be good for the gander, and defend why not in a specific case.

Tyler:
Third addendum: Of course there are numerous other ways this analysis could run.  What is striking to me is that people don’t seem to undertake it at all.
It is interesting in policy debates how people debating each issue seem not to connect with other issues. Clear thinking is hard. "Wait, this comes down to the elasticity of labor demand, and we made the opposite assumption last Tuesday discussing immigration" is not the sort of thought that occurs naturally.  It is also a sign that policy-oriented economics is all too often searching for justification of pre-determined answers.
John H. Cochrane
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!

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