Noah Smith wrote a piece last week for Bloomberg View titled Most of What you Learned in Econ 101 is Wrong. Noah is a PhD economist who teaches at Stony Brook University.
Noah tells readers that introductory econ textbooks have a big problem and that problem is that most of what is in them is probably wrong.
“In the last three decades, the economics profession has undergone a profound shift. The rise of information technology and new statistical methods has dramatically increased the importance of data and empirics. This means that many professional economists are no longer, as empirical pioneer David Card put it, “mathematical philosophers.” Instead, they are more like scientists, digging through mountains of evidence to find precious grains of truth.
Only in Noah’s dreams (a physics undergrad) are economists like scientists. Data and empirics are useful, but many economists now worship at the altar of empirical analysis (a $200 word for statistics). If the statistical analysis disagrees with the theory, this crowd would suggest we ignore the theory.
Take the minimum wage for example. Here’s what Noah has to say about the minimum wage.
For example, Econ 101 theory tells us that minimum wage policies should have a harmful impact on employment. Basic supply and demand analysis says that in a free market, wages adjust so that everyone who wants a job has a job — supply matches demand. Less productive workers earn less, but they are still employed. If you set a price floor — a lower limit on what employers are allowed to pay — then it will suddenly become un-economical for companies to retain all the workers whose productivity is lower than that price floor. In other words, minimum wage hikes should quickly put a bunch of low-wage workers out of a job.
That’s theory. Reality, it turns out, is very different. In the last two decades, empirical economists have looked at a large number of minimum wage hikes, and concluded that in most cases, the immediate effect on employment is very small. It’s only in the long run that minimum wages might start to make a big difference.
So because the statistical models have found little correlation in the data between a higher minimum wage and lower employment, we are advised to throw common sense out the window.
The simple truth is that when you raise the price of a good or service, demand falls. That is as true for widgets as it is for workers.
That’s all you need to know about the minimum wage. Trying to measure the impact of a minimum wage hike using complex data analysis techniques is not at all productive. Common sense will due, or if you must, go ask the businessmen who hire minimum wage workers what they’ll do if their labor costs spike.
Just because economists have the computing power to better analyze data doesn’t mean we should interpret the results of that analysis as gospel. Economic data is messy and sloppy and the economy is complex. Trying to isolate the impact of A on B when C,D,E,F,G,H,I,J,K,L,M,N,O,P,Q,R,S,T,U,V,W,X,Y, and Z are also influencing B often leads to erroneous results.
And then there are the motivations of the economists to consider. Is it just a coincidence that the economists at liberal think tanks always come to the conclusion that agrees with the desires of liberal politicians and that economists at conservative think tanks come to the conclusions that agree with conservative politicians? I think not.
Statisitcal analysis is neither as reliable nor as objective as Noah would have us believe. This shouldn’t come as a surprise. Darrell Huff wrote the classic How to Lie with Statistics way back in 1954 and before that Mark Twain pointed out there are lies, damned lies, and statistics.
Sound economic theory and good common sense are the recipe for better economic policy. Empirical analysis should only be a secondary consideration.
Jeremy Jones, CFA
Latest posts by Jeremy Jones, CFA (see all)
- Are Canadian Banks in Trouble? - March 22, 2019
- Fed Delivers a Sucker Punch to Retired Investors - March 21, 2019
- Is This a Generational Opportunity in Foreign Stocks? - March 21, 2019