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Austrians Wrong on Maximum Hours Legislation?

Tom Woods had a podcast out recently in which he gave the Austrian explanation of the effect of maximum hours legislation:

Let’s take maximum hours legislation because that seems harmless enough. We don’t want people working too long so we will have maximum hours legislation. Who could possibly be against that? Well, I want to think through the logic of this here. Think about you yourself today. Think about you and the number of hours that you work. Now, you, no matter how much you work . . . could be working more. . . you could get a second job, a third job, you could work an extra two hours a week as a tutor, whatever. . .

Why aren’t you doing it?  Because you value the leisure. Because you’ve gotten to a point and society and the economy have gotten to a point where we are physically productive enough that we can produce enough goods that you would be physically satisfied, after, say a 40 or 50 hour week. . .

What if we said a 40 hour week was inhuman, it’s just too much? . . . And we impose on you, a limit. We have a law saying, you can’t work more than 30 hours a week.

Woods goes on to say that because you’ve already balanced your preference for work vs. leisure, the law clearly makes you worse off. If you now are forced to work 30 hours, sure, you’ll have more time for leisure, but you won’t be able to get as much money and buy as many goods as you did before. And you’ve already shown (through your allocation of time before the enactment of the law) that you value the extra income you receive over extra time for leisure.

The problem with this argument is that there are all sorts of situations in which someone might value their work/leisure balance after the law higher than their balance before it. For example, it is entirely possible that you did not limit yourself to working 30 hours prior to the law because in those circumstances, you could not find any 30 hour jobs in your local area and would have to commute between two jobs (which you highly dislike). Or perhaps the 30 hour jobs you could find didn’t pay enough. After the law is enacted, though, you might actually be happier with your new configuration because the situation has now changed. Since every employer is now forced to hire each employee for a maximum of 30 hours/week, the number of job opportunities goes up and you’re able to stick with your old job or find a new single job that pays well in your area.

It’s important to clarify what this means for Austrian economics. Woods’s argument makes complete sense within the Austrian framework. It is true that if we keep everything constant, a person’s action shows he prefers that action over his alternatives. However, when applying this argument to reality and making policy prescriptions, we have to take care not to go too far and make our claims too strong. Preferences or (in this case) situations might change over time, and therefore the actual effect may differ from the one Austrians have theoretically.

The number of other examples where this can happen is probably very large. I do not think Austrians can make policy prescriptions without adding certain empirical claims as well. However, what’s particularly pernicious about my example is that the situational effect is present within the law. It would be more accurate to say the law benefits you than to say the law would have harmed you, if not for the situational change – because the situational change is itself one of the law’s effects!

Krugman Calls for Increasing the Minimum Wage. Here’s Why He’s Wrong.

Krugman states:

And the evidence is overwhelmingly positive: hiking the minimum wage has little or no adverse effect on employment, while significantly increasing workers’ earnings.

It’s important to understand how good this evidence is. Normally, economic analysis is handicapped by the absence of controlled experiments. For example, we can look at what happened to the U.S. economy after the Obama stimulus went into effect, but we can’t observe an alternative universe in which there was no stimulus, and compare the results.

When it comes to the minimum wage, however, we have a number of cases in which a state raised its own minimum wage while a neighboring state did not. If there were anything to the notion that minimum wage increases have big negative effects on employment, that result should show up in state-to-state comparisons. It doesn’t.

So a minimum-wage increase would help low-paid workers, with few adverse side effects. And we’re talking about a lot of people. Early this year the Economic Policy Institute estimated that an increase in the national minimum wage to $10.10 from its current $7.25 would benefit 30 million workers.

He’s wrong and here’s why:

1) State vs. state cross-sections are still not controlled experiments, by a long shot. There are about a trillion kazillion million (if you were doubtful of my trustworthiness, how do you feel now?) ways one state is different from another. And yes, many of these ways will be relevant for the question at hand (whether the minimum wage affects unemployment maliciously or not).

2) Even if they were close enough to controlled experiments, there is no reason to assume that a historical fact, that a raise in the minimum wage had little or no effect on unemployment in one time period, should carry over to another time period. Human beings are not inanimate objects like the subjects of the physical sciences. Human beings have the ability to choose, and these choices can change over time. Economics deal with human beings, and as such, cannot use historical findings to create some sort of law set in stone. History by definition, has to do with specific dates and times and specific people and specific choices. They are not universals. We say “on April 12, 1950, Jimmy went to the store!” The date and the name and the action all can change as time goes on. The same applies to historical claim regarding the effect of an increase in the minimum wage.

3) Even if we let #1 and #2 slide, it is STILL a wrong statement. We cannot assume that the effect of one increase in the minimum wage, from some amount to $7.25, carries over to another amount, $7.25 to $10.10.

The empirical method applied to economics sucks, plain and simple. There are too many weaknesses with it. Economics is not a natural science, it is a social science. We can’t even point to the success of empiricism like scientists can in the natural sciences. Astronomers can point to correct predictions of objects such as comets, e.g. if we look in the sky at this time, we’ll see the comet right here. All that economists, meanwhile, have to point to, is blatant failures, from terrible predictions about what would happen to the economy (this is right before the Great Depression), to an inability to stop the financial crisis, to this piece of work (this one’s the funniest by the way).

The correct method of economics is not empiricism but praxeology. The social sciences can only lay claims to laws that do not have to deal with particular choices of humans, but the universal characteristics of all human action.

UPDATE:

Just anticipating a possible response. Some might say “oh but there could be reasons to assume that something that occurred in history would happen again.” I’m not saying this is impossible, but I’m saying it’s bad reasoning for a science dealing with human action, particularly when other methods are available.

Secondly if you’re wondering “how do you think the minimum wage affects unemployment?,” see here.

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I Cannot Believe This…

I have liked a TYT video on economics though it has nothing to do with cronyism in the economy (the only point on economics I typically agree with them on).

Peter Coy, in a Bloomberg Businessweek article, states:

A movement to give every person an “unconditional basic income”—no work required—is gathering speed in Europe. In its biggest victory to date, earlier this month supporters in Switzerland garnered more than 100,000 signatures on a petition and managed to get an initiative onto the national ballot.

The Swiss ballot initiative, which isn’t scheduled yet, doesn’t state how big the unconditional stipend would be, but supporters have mentioned 2,500 Swiss francs a month, which is a little under $2,800.

I’m glad TYT, particularly Cenk, is being honest in this video. A guaranteed paycheck from the government wouldn’t necessarily stop someone from working outright, but it would serve as disincentive to work in numerous ways: 1) if you’re unemployed, you will not try as hard to find a job (as Cenk admits he did), 2) if you do work, you will not work as hard as you used to (because you will have to work less than before to earn the same amount of income), etc. It’s a productivity killer and Switzerland’s standard of living will go down over the years.

For a causal explanation: human beings purposefully act, choosing one action over another based on which action is valued more highly. An individual, in deciding whether/how much to work, weighs the marginal benefit an additional unit of labor gives him (choice of action #1) against the marginal cost of working that is his leisure (choice of action #2). Now, the law of marginal utility tells us the more units of a good a person has, the less he will value each unit. Therefore, as he receives a guaranteed paycheck from the government, he’ll tend to value the benefit less relative to the cost, and thus work less.

(For an explanation of the law of marginal utility, consider yourself having access to X # of units of water. Let’s say units are gallons, and you have 1 unit – in other words, 1 gallon. You’re going to use this gallon for the most important thing to you, which is probably drinking water: after all, you need to survive. Let’s say you get 9 more gallons. Maybe now you can use a gallon to take a shower. What the law of marginal utility states is that, as the number of units you have increases, the less you value each unit. In the previous example, taking a shower was obviously not as valuable as drinking water. If you had to give up a unit, you would give up taking a shower, not drinking water. You’d give up an activity with less value. In other words, you’d give up a unit being used for an activity with less value. But if you only had one unit, you’d have to give up drinking water. The unit for taking a shower is not as highly ranked as the unit for drinking water, and thus, the more units you have, the less valuable uses they will be being used for, and the less value they have.)

Some respond that individuals could be more creative if they had their basic living income provided for. But this doesn’t mean the laws of the marketplace go out of existence. Creativity will have to obey market forces – in other words, people who are creative still need to satisfy the needs of others in order to generate income from their activities. “Creativity” is just another way of saying risky behavior, and individuals with almost $3000 in guaranteed income would take many more risks, a good amount which would end as utter failures.

On the judgment side of things, I believe that this policy would have a particularly horrendous effect on Switzerland’s economy. $2800/month is a lot, even enough to survive off of. It’s possible you could see the workforce destroyed and the tax revenue necessary to pay out the $2800 become smaller and smaller, until it ceased to exist.

I get the argument that people’s basic living should be provided for them. “Human beings have a right to live and goods are not so scarce that we cannot provide for every person’s basic needs in food, water, and shelter.” The issue with this type of thinking is that such a policy of guaranteed income by the government would kill incentives. People don’t have to work anymore – therefore, some people will outright stop working, some people will not try as hard to find work, and some people will “be creative” – but even while engaging in these creative ventures, individuals will lack as much of an incentive to apply this creativity in such a way that they earn income from the market. Losses are now trivial because basic income has been guaranteed. Therefore, the money (in real terms) used to provide for the basic income of citizens will go down, year after year, until scarcity actually is a problem for even basic needs.

And as that happens, if policy does not change, people will starve, and the population will decrease. What’s necessary to maintain a population like ours is private property and the incentives that come with it. The reason poor people in third world nations starve and lack basic amenities is because they lack private property.

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Knowing vs. Thinking

Often, after someone hears of anarchocapitalism, all sorts of objections on practical grounds are raised. How would the roads be built? How would private defense function? Wouldn’t warlords just take over?

The ironic feature of all these questions is that they are purely speculative. Meanwhile, more fundamental knowledge is on the side of the anarchist libertarian, who points out, e.g. in response to the second question, that not only is there nothing logically incoherent about private defense (you could just defend yourself or hire others, after all), but practically speaking, we have reason to expect private defense to be much more efficient.

Ex ante, two individuals that engage in a voluntary transaction both gain from the trade. Otherwise, they would not have engaged in the trade. So we know that private defense would satisfy the desires of consumers far more effectively than government, an institution completely separated from the satisfaction of preferences.

I find this analogous to the knowing vs. thinking (or believing) distinction. The more fundamental knowledge i.e. knowing, is what we can deduce from human action about voluntary transactions, e.g. that a private defense agency must satisfy the preferences of consumers or it would go out of business, and a more efficient competitor would take its place. The less fundamental knowledge, thinking, is the speculative objection, e.g. that an incentive exists known as the “free rider” incentive and such an incentive could possibly lead to worse defense service production on a free market (for a quick rebuttal, note that the free rider incentive is one of many competing incentives involved in human action. Another, for example, is the desire for social acceptance, and those who paid for a private defense agency could socially reject free riders). Of course, this distinction can be applied to a number of examples.

This is why so many libertarians who read Mises and Rothbard (especially the latter) on economics have no problem imagining a stateless society. If the state can’t manufacture and sell shoes as well as the market, why should we expect it to do better anywhere else? Praxeology, after all, makes no distinction between the content of means or ends, but only discusses the fact that man does have means and ends (and so a consistent application of the praxeological analysis to economics should lead one to taking the libertarian position on every issue when it comes to economic efficiency).

In fact, as I heard Tom Woods say recently, to him it’s so clear a stateless society could work (he did not say this last phrase, but I believe it was a hidden part of his argument; if he ever sees this and doesn’t think this is accurate, then I would take his word over mine), we should accept that as our initial premise and fully accept the non-aggression principle, and those in favor of a State must make their case why a stateless society cannot work. In other words, it should not be up to the libertarian to prove a stateless society could work.

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Economics Deals with the Acts of Men to Satisfy Their Desires

Economics, therefore, is not a science that deals particularly with “material goods” or “material welfare.” It deals in general with the action of men to satisfy their desires, and, specifically, with the process of exchange of goods as a means for each individual to “produce” satisfactions for his desires. These goods may be tangible commodities or they may be intangible personal services. -Rothbard; Man,Economy, and State with Power and Market p. 162
This insight is important for the definition of ‘economics’ and for the layman who might wrongly think economics is just an overly materialistic subject.

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(Also, men = men and women, Rothbard is not being sexist here)

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Gresham’s Law and Coin Clipping

Champions of the government’s coinage monopoly have claimed that money is different from all other commodities, because “Gresham’s Law” proves that “bad money drives out good” from circulation. Hence, the free market cannot be trusted to serve the public in supplying good money. But this formulation rests on a misinterpretation of Gresham’s famous law. The law really says that “money overvalued artificially by government will drive out of circulation artificially undervalued money.” – Murray N. Rothbard, What Has the Government Done to Our Money?, p. 24

Rothbard goes on to give an example of this occurring, which I’ll state in my own words here (I was annoyed earlier because I couldn’t explain this myself). Centuries ago, before the rise of fiat (paper) currencies and money substitutes, governments had to find alternative ways of inflating their money supplies and profiting. Since coins were often in use, governments would try to establish monopolies on the supply of money and “clip” the coins, removing some amount out of their base value. For example, if one ounce gold coins were the norm, the government, after getting some of the supply in its hands, would clip 1/10 of the gold off of the coins. The coins would then have 9/10 of its previous value, and governments could use the extra metal to create new coins. Through this method, they could achieve profits.

What does this have to do with Gresham’s Law? If the government mandated that all coins were equal, that the 9/10 ounce gold coins must be treated the same as the full ounce gold coins, Gresham’s law would come into effect. People, realizing that the 9/10 ounce gold coins could be used in exchange the same way as the full ounce coins, would exchange all of the former coins away domestically. As for the latter, they would either hoard these (A) because they might perceive some chance of government removing this artificial price control in the future, in which case their full ounce coins would be worth more, or B) because they could attempt to use these metals to their full value in some other respect rather than exchange, such as melting them down) or trade these overseas (because other countries would not be so accepting of the “illegitimate” coins). Thus the “good coins” would be driven out of circulation, not because of the free market, but because of the government.

I’ll post examples of Gresham’s Law occurring with gold/silver coins and fiat currencies later.

Economics is About Human Action, not Mechanical Processes

 

It is misleading, furthermore, to say that money “circulates.” Like all metaphors taken from the physical sciences, it connotes some sort of mechanical process, independent of human will, which moves at a certain speed of flow, or “velocity.” – Murray N. Rothbard, What Has Government Done to Our Money?, pg. 33

This is one of the major problems with economics, as well as other social sciences today. By attempting to create mathematical formulas that describe human action, economists are sucked into the trap of assuming these “laws” will hold forever. Unfortunately, even if a formula describes a historical circumstance well, there is no certainty it will apply to future circumstances. Not only can expectations change, but humans can invent new ways to act or act differently due to different pieces of knowledge, different circumstances, and lastly of course, because they are completely different human beings.

What is praxeology?

Commenter ‘Bruce‘ at Free Advice asks:

“It’s dangerous to look ignorant, but I suppose I will.

What is: praxeology???”

 

My response:

It’s the deductive method of Austrian economics. It starts with the premise that persons act, that actions are purposeful, they involve the use of a means to attain a end and are motivated by that end. It goes on to deduce conclusions from this premise through the use of logic: if a premise is true, and valid logic is applied, then the conclusion must also be true. Logical chains can be formed by using the old conclusion as a new premise and then again using valid logic. Austrians have used this method to explain marginal utility, the law of demand, how the business cycle occurs, and much more.

If you’re looking for an introduction to the type of reasoning used by Austrian economists, you can look at An Introduction to Economic Reasoning by David Gordon or look at praxgirl‘s videos on YouTube. If you’re interested in reading about Austrian economics in depth, you can look at Man, Economy, and State by Rothbard.

A guest also posts a link to a youtube video lecture I would highly recommend: Is Austrian Economics ‘Unscientific’? Here, Dr. Jeffrey Herbener compares and contrasts Austrian economics with the natural sciences, statistics, and morality. He also explains the methodology in an easily understandable way.

The Minimum Wage Does Indeed Cause Unemployment

The minimum wage is being spoken about again thanks to Obama’s recent State of the Union Address. To be honest, I don’t know how people still manage to sit through the whole thing to find out what he’s saying, but kudos to them!

In his speech, Obama proposes raising the federal minimum wage from its current $7.25/hr to $9.00/hr. Why anyone would want to raise the minimum wage when unemployment is already very high is beyond me. Oh, but wait! The Department of Labor says it doesn’t cause unemployment  (HT2 EPJ).

The president’s plan to raise the federal minimum wage will benefit 15 million American workers, and have a positive effect on the economy. Still, there are some common myths about raising the minimum wage. We checked in with our Chief Economist Jennifer Hunt on the following three myths:

Myth: Raising the minimum wage reduces employment. False Minimum wage increases have little or no adverse effect on employment as shown in independent studies from economists across the country. Additionally, a recent letter by leading economists including Lawrence Katz, Richard Freeman, Joseph Stiglitz and Laura Tyson points out that “[i]n recent years there have been important developments in the academic literature on the effect of increases in the minimum wage on employment, with the weight of evidence now showing that increases in the minimum wage have had little or no negative effect on the employment of minimum wage workers, even during times of weakness in the labor market.

Myth: Raising the minimum wage will negatively affect teen employment. False Eighty-nine percent of those earning the minimum wage are 20 years of age or older, and studies have shown that minimum wage increases have had little or no adverse effect on teen employment.

Before I show why the above is incorrect, let me go through the logic of why the minimum wage does cause unemployment. I have already explained it here and here, but I will give a very brief explanation again. Many economists like illustrating the effect of the minimum wage on employment through supply and demand. If a price floor is put above a market equilibrium price, then it will cause a surplus. In the case of the minimum wage as a price floor, the wage is the price, and labor is the commodity. In other words, there will be a surplus of labor supplied by prospective workers over labor demanded by employers.

However, a simpler and even more intuitive explanation exists. The goal of most companies is to earn profits. Employers will not hire employees unless it helps them earn a profit. So if an employee contributes $8/hr, an employer will not hire that employee at a wage any higher than $8/hr. If in this example, the minimum wage is at $7.25/hr, the employer can profitably hire that worker for $0.75/hr ($8.00 contribution – $7.25 wage = $0.75 profit). If, however, the minimum wage is raised to $9/hr, then he would earn losses of $1/hr by hiring that worker ($8.00 contribution – $9.00 wage = $1.00 loss); in other words, he will not hire that worker and the worker will be unable to find a job. Therefore, the higher the minimum wage, the fewer workers that can find a job, and the higher the unemployment rate.

But what about those studies the DoL is claiming disproves my logic? Well, to put it simply, they don’t. Logic should be debated against on its own terms. If a premise is true, and valid logic is used, then the conclusion must also be true. Empiricism does not change this. Empiricism may give us reason to doubt logic and look for errors, but it does not disprove logic itself.

In addition, many empirical studies come to completely opposite conclusions. I and two classmates did an econometric study about the effect of the minimum wage on youth unemployment, comparing state by state. We found a positive correlation of 4.6 (i.e., for every increase of $1.00/hr in the minimum wage, there was a corresponding increase of 4.6% in the youth unemployment rate). This is in complete contradiction of the study they cite above.

Does my study prove that there will always be an increase of 4.6% in the youth unemployment rate for every $1.00/hr increase in the minimum wage? Absolutely not. The study is only historical. It is not predictive. Economics is the study of human action. Human action can always change. Humans can invent new ways to act. They don’t have to act exactly as they did in the past. There is no law of behavior mandating that human interactions lead to a 4.6% increase in unemployment for every $1/hr increase in the minimum wage.  Unfortunately, this is only the first of numerous problems with econometrics.

Although such studies are only historical, are they even correct? Can we undoubtedly say that the effect of the increase of $1/hr in the minimum wage was a 4.6% increase on youth unemployment? Even this we cannot be sure about. There are a myriad of variables we simply cannot account for, or would even think to account for. How do we know it was the effect of the minimum wage that caused that unemployment? What about the business cycle? Maybe certain businesses coincidentally made poor decisions. Etc. etc.

We can show whatever we want with an econometric study. The methodology is completely flawed. The correct methodology of economics, of human action, is what Mises came up with: praxeology. The causal-realist approach allows us to look at human action and understand what specific causes lead to certain effects, rather than rolling around endlessly in a sandbox saying one grain of sand does this or that when there are millions of other grains that may actually be more important.

Let’s again look at the logic and think more about the absurdity of saying increases in the minimum wage don’t cause unemployment. If that’s true, why not raise the minimum wage to $20.00? Or $50.00? Or $100.00? If we can achieve prosperity with the wave of our magic legislation wand, why not do it on a bigger scale? Because it would cause massive unemployment. When people talk about raising the minimum wage by a smaller amount, they are only talking about increasing unemployment by a smaller amount. And this is probably why econometric studies on the minimum wage come to different conclusions so often. Because what they’re measuring isn’t very large, and a lot of other factors they don’t account for may be more important.

An anonymous commentor at a blog I found today makes another very important point:

So if increasing the minimum wage does not mean jobs will be destroyed and unemployment will go up, then does the contrapositive hold true that if you lowered or eliminated the minimum wage that jobs would not be created and unemployment wouldn’t decrease?

Liberals complain non-stop about job shipped overseas since 40% of the world lives on less than $2/day. Those jobs went overseas because they are illegal to create here and pay a wage that makes economical sense.

Many individuals that realize jobs go overseas because wages are cheaper over there don’t pursue the logic all the way. The reason we lose out on many of those jobs are  because those jobs are illegal here, thanks to the minimum wage.

An increase in the minimum wage will cause an increase in unemployment, all else equal. If Obama is successful in increasing the federal minimum wage, unemployment will be higher relative to whatever level it would have been otherwise. This means that you could see the unemployment rate even go down even with an increase in the minimum wage, not because of the minimum wage but in spite of it. This is precisely why empiricism is an incorrect method for discovering causal relationships.

Rothbard was trained in…

Ever wonder why people are so obsessed with this guy?

Well, for one, he was an absolutely brilliant writer. He never pulled back punches against others and was extremely entertaining while writing informative content. Here’s one example from Man, Economy, and State, with the background first (in my multi-year expedition of this book, I am thrilled to announce I am finally on Ch.5!). You can skim through this first block-quote if you’re short on time.

The use of the mathematical concept of “function” is particularly inappropriate in a science of human action. On the one hand, action itself is not a function of anything, since “function” implies definite, unique, mechanical regularity and determination. On the other hand, the mathematics of simultaneous equations, dealing in physics with unmotivated motion, stresses mutual determination. In human action, however, the known causal force of action unilinearly determines the results. This gross misconception by mathematically inclined writers on the study of human action was exemplified during a running attack on Eugen Böhm-Bawerk, one of the greatest of all economists, by Professor George Stigler:

. . . yet the postulate of continuity of utility and demand functions (which is unrealistic only to a minor degree, and essential to analytic treatment) is never granted. A more important weakness is Böhm- Bawerk’s failure to understand some of the most essential elements of modern economic theory, the concepts of mutual determination and equilibrium (developed by the use of the theory of simultaneous equations). Mutual determination is spurned for the older concept of cause and effect.

The “weakness” displayed here is not that of Böhm-Bawerk, but of those, like Professor Stigler, who attempt vainly and fallaciously to construct economics on the model of mathematical physics, specifically, of classical mechanics.

Again, the above is just the background. In the footnotes, Rothbard states (my bold):

Stigler appends a footnote to the above paragraph which is meant as the coup de grace to Böhm-Bawerk: “Böhm-Bawerk was not trained in mathematics.” Stigler, Production and Distribution Theories. Mathematics, it must be realized, is only the servant of logic and reason, and not their master. “Training” in mathematics is no more necessary to the realization of its uselessness for and inapplicability to the sciences of human action than, for example, “training” in agricultural techniques is essential to knowing that they are not applicable on board an ocean liner. Indeed, training in mathematics, without adequate attention to the epistemology of the sciences of human action, is likely to yield unfortunate results when applied to the latter, as this example demonstrates. Böhm-Bawerk’s greatness as an economist needs no defense at this date.

The only response I can imagine Stigler coming back with is “Touché.”

Oh, and Rothbard was trained in mathematics.