Paul Walker

Dr Paul Walker is an economist at University of Canterbury. He has expertise in microeconomics, institutional economics and industrial Organization. He blogs for The Dismal Science.

A strange view of economics - The Dismal Science

Apr 10, 2015

From Gavin Kennedy at the Adam Smith's Lost Legacy blog comes this bit of information:

jundalisay has authored an interesting new Blog HERE:

“This is the public site of the new proposed science of socio-economics or ‘Smithonomics’ or ‘Political Economy version 2.0′ which is meant as an alternative to economics.”

“Economic science was created in the 19th century by intellectuals who championed the cause of businesses, which is to maximize profits based on the paradigm of personal utility or pleasure for the benefit of the self. This is in stark contrast to the old science of the Political Economy which advocated to maximize the benefit of the whole society through proper government policies and regulation and was based on moral philosophy.
This all sounds a bit strange to me. For a start if economics today is about businesses and their profits and not about the benefit of the whole society then what are we make of the work of people like Amartya Sen or Tony Atkinson? I don't see much an emphasis on firms and their profits in their work. Also, if the benefit of the whole society isn't an issue in economics what do we do with the subjects like welfare economics? In addition how do we interpret work like that of Bergson, Samuelson or, most famously, Arrow on social welfare functions (SWFs)? Isn't the whole point of an SWF to get a measure of total welfare of a society? Also even when working within a partial equilibrium framework the standard measure of welfare in the sum of producer and consumer surplus, not just producer surplus. So there is no singling out of firms' welfare for special treatment. How does behavioural economics fit into jundalisay's framework? Much of post-19th century economics is to do with proper government policies and regulation. The most obvious example would be that of Pigou and his taxes and subsidies for negative and positive externalities. Also what of competition policy? And there are a seemingly endless number of regulations on all aspects of the economy which are justified with reference to modern economics. So how does standard economics and 'Political Economy version 2.0' differ in this regard?

Who in post-19th century economics is it that championed the cause of businesses? Even today businesses are one of the most ignored institutions in economic theory.
"The theory of the firm has been a neglected area of study in mainstream economics. Despite Ronald Coase bringing the issue up for discussion in 1937, it was not on the research agenda until the 1970s. Even now, as both Coase and Oliver Williamson, the founder of and prominent scholar in the transaction cost-focusing analysis of firm organization, have received the Nobel Prize in economics, the area remains in the periphery of economic analysis” (Bylund 2011: 189).
Coase and Wang (2011: 1) remark,
“[b]ut the gain in rigor achieved in modern price theory comes with a heavy price tag. The most obvious and serious omission in price theory is that it sees no role for production, let alone entrepreneurship. How goods and services are actually produced, how new goods and services and new ways of production are constantly invented in the economy, how production and innovation are organized, and what forces are at work are rarely on the research agenda in economics. It is extraordinary that the process of production is virtually invisible in economic theory”
while Coase himself commented in an 2013 interview that
"[m]odern economics shows little interest in production” (Wang 2014: 118).

If we look back in the history of economics we find business have been ignored by most groups of economic thinkers.

With regard to the relationship between economic theory and business Edwin Cannan wrote,
“I do not mean to argue that a knowledge of economic theory will enable a man to conduct his private business with success. Doubtless many of the particular subjects of study which come under the head of economics are useful in the conduct of business, but I doubt if economic theory itself is. [ ...] economic theory does not tell a man the exact moment to leave off the production of one thing and begin that of another; it does not tell him the precise moment when prices have reached the bottom or the top. It is, perhaps, rather likely to make him expect the inevitable to arrive far sooner than it actually does, and to make him underrate, not the foresight, but the want of foresight of the rest of the world” (Cannan 1902: 459-60).
Cannan was not alone in making this type of argument. Arthur Pigou wrote:
“[ ...] it is not the business of economists to teach woollen manufacturers to make and sell wool, or brewers how to make and sell beer, or any other business men how to do their job. If that was what we were out for, we should, I imagine, immediately quit our desks and get somebody - doubtless at a heavy premium, for we should be thoroughly inefficient - to take us into his woollen mill or his brewery” (Pigou 1922: 463-4).
Lionel Robbins argued similarly, in that
“[t]he technical arts of production are simply to be grouped among the given factors influencing the relative scarcity of different economic goods. The technique of cotton manufacture [ ...] is no part of the subject-matter of Economics [ ...]” (Robbins 1935: 33).
In fact in the period following the classical economists, with the possible exception of Alfred Marshall, few economists, be they mainstream or heterodoxy, wrote anything much on the firm. When reviewing the contribution of the old institutionalists to the theory of the firm Hodgson (2012: 55) writes,
“[ ...] we search in vain for a well-defined ‘theory of the firm’ within the old institutional economics”.
Carl M. Guelzo argues that one of the leading old institutionalists, John R. Commons,
“[ ...] did not construct a rigorous theory of the firm since this was never his purpose” (Guelzo 1976: 45).
With reference to the German historical school Le Texier (2013: 80) writes
“[m]embers of the German historical school such as Gustav von Schmoller analysed at length the birth and growth of the business enterprise, but they were more historians than economists. None of these thinkers proposed a theory of the business firm”.
When writing about the work of Joseph Schumpeter, Hanappi (2012: 62) says
“[a] well-defined theory of the firm thus cannot be found in Schumpeter’s oeuvres”.
As to Austrian economics Per Bylund writes,
“[b]ut despite the focus in Austrian economics on [ ...] “mundane economics,”
and the fact that
“the Austrians [have] so many necessary ingredients for a theory of the firm” [ ...], there is no Austrian theory of the firm” (Bylund 2011: 191)
“[w]hereas the theory of the firm has been a neglected area of study in mainstream economics, it has been missing from the Austrian economics literature” (Bylund 2011: 191).
Hutchison (1953: 308) comments
“[t]he Austrian School, with the exception of Auspitz and Lieben, did not concern themselves much with the analysis of markets and firms, except in respect to their general principle of imputation”.
Hutchison also summarised the early neoclassical contributions to the theory of the firm, and markets, as
“Jevons has little on the firm. [ ...] Walras’s assumptions of perfect competition (maintained virtually throughout) and of fixed technical ‘coefficients’, limited his contribution to the analysis of firms and markets, [ ...]. Pareto’s contribution to the theory of firms and markets were not rounded off, and of very varying value, [...]” (Hutchison 1953: 307).
So where the idea that economics was created in the 19th century by intellectuals who championed the cause of businesses comes from I don't know.

Also there have been a number of alternatives to profit maximisation put forwards. We have seen models based on utility maximisation, sales revenue maximisation and output maximisation. There have been behavioural models put forward, along with cost-plus pricing and growth models but none of these have won out in the market place for idea since as a starting place, at least, profit maximisation is the most useful assumption. In addition there are models of no-for-profit firms and worker/consumer/producer cooperatives which are relevant in certain areas of the economy and need not assume profit maximisation.

So profit maximisation is the most common but not the only assumption utilised in the theory of the firm. Actually, for the neoclassical model at least, profit maximisation isn't technically an assumption at all, its a result. Utility maximisation implies profit maximisation. Crudely put, to maximise utility a consumer wants to maximise income and as part of their income comes from forms' profits they want firms to maximise profits. One could also add that there are not firms in the textbook approach to the production so championing the cause of businesses in the neoclassical model is championing something that doesn't exist.

GDP and social welfare in the long run - The Dismal Science

Apr 08, 2015

A few weeks ago over at the Offsetting Behaviour blog Eric Crampton was talking about The Case for Economic Growth, a new report put out by the New Zealand Initiative. An obvious question to ask about growth is, What's so great about it? Why should we care if the economy grows or not? After all GDP, and thus growth in GDP, is not identical to social well-being or growth in social well-being. The answer many economists would give, and the New Initiative report gives, is that growth of GDP over time has a positive correlation with human well-being broadly understood.

It turns out that Offsetting Behaviour isn't the only blog where the advantages of growth are being thought about. At the Conversable Economist blog Timothy Taylor takes a look at an OECD report from last year which asks, How Was Life? Global Well-Being Since 1820, edited by Jan Luiten van Zanden, Joerg Baten, Marco Mira d’Ercole, Auke Rijpma, Conal Smith and Marcel Timmer.

Taylor writes,

So how have other dimensions of human well-being been correlated with this rise in per capita GDP, both over time and across countries? The short answer is that there is a strong positive correlation between per capita GDP and and indicators of education and health status. There is a weaker but still positive correlation between higher per capita GDP and participatory political institutions. There is no clear-cut correlation between per capita GDP and personal security. The relationship between per capita GDP and the environment (viewed as a whole) seems to be an inverted U-shape: that is, growth of per capita GDP is first associated with higher environmental damage, but at some point it seems to be associated with lower damage. The relationship between per capita and income inequality seems to follow a regular U-shape: that is, growth of per capita GDP is first associated with greater within-country income equality up to about the 1970s, but since then is associated with greater inequality. Here are some details.

1) Education

Gains in education have a strong positive correlation with per capita GDP over time and across countries, probably a part of a virtuous circle: that is, a more educated workforce helps economic growth, and an economy with higher per capita income can afford to spend more on education.


2) Health status over the long-term can be proxied by measures like life expectancy and height. It seems clear that higher per capita GDP is associated with gains in both, although there is some evidence that at the highest levels of GDP, higher incomes are not associated with larger health gains. The report says:
"Life expectancy at birth was about 33 years in Western Europe around 1830, 40 years in 1880, and almost doubled in the period after, with the largest improvements occurring in first half of the 20th century. In the rest of the world, life expectancies started to increase from much lower levels, rising in particular after 1945. Worldwide life expectancy increased from less than 30 years in 1880 to almost 70 in 2000. There is strong evidence of a shift in the relationship between health status and GDP per capita over the past two centuries. Life expectancy improved around the world even when GDP per capita stagnated, due to advances in knowledge and the diffusion of health care technologies."

3) Personal security over the long-run can be approximated by using data on homicide rates and on war. The report summarizes the evidence on per capita GDP and homicide rates like this: "Western Europe was already quite peaceful from the 19th century onwards, but homicide rates in the United States have been high by comparison. Large parts of Latin America and Africa are also violent crime “hotspots”, and so is the former Soviet Union (especially since the fall of communism), while large parts of Asia show low homicide rates. Homicide rates are in general negatively correlated with GDP per capita – the richer a country, the lower the level, but there are important exceptions."


4) The overall pattern of political institutions over time is toward greater participation, but the path has often been a bumpy one. [...] an Index of Democracy, where the measure of competition is based on what share of the vote is received by the winning party (when a winning party receives nearly all the votes, competition is low) and a measure of participation based on the share of the adult population that votes. On a worldwide basis, both are rising since 1820. But the rise is bumpy and spiky at times.


5) Environmental quality is proxied by three measures in this report: biodiversity, and emissions of sulfur dioxide and carbon dioxide. The summary reads: "A negative correlation with GDP per capita is clearly in place when looking at quality of the environment. Biodiversity declined in all regions and worldwide as land use changed dramatically. Per capita emissions of CO2 increased after the industrial revolution in Western Europe and its Offshoots, accelerating in the mid-20th century as other regions increased their GDP, and is still increasing globally. Per capita emission of SO2 (a local pollutant) also increased alongside higher industrial production, but were curbed since the 1970s thanks to the advent of cleaner technologies."


A key question is whether countries will tend to find ways to reduce environmental damage as their per capita GDP rises--as appears to be happening with SO2. Another way of making the point is that the ways in which economic growth affects the environment are strongly affected by public policy choices. As the report notes:
To some extent SO2 emissions follow an environmental Kuznets curve, with declining emissions beyond a certain level of GDP per capita, and in recent periods biodiversity is also less directly (negatively) related to real income levels. Overall, there is still a rather strong negative link between environmental quality (as measured by these indicators) and GDP per capita, but this link has been weakening in recent years (since the 1970s), probably as a result of successful policies to lower emissions (SO2 probably being the best example).


6) Inequality of incomes is hard to summarize, in part because we live in a time when there is growing inequality of incomes within countries at the same time that global inequality of incomes is falling (with the rise of incomes in countries like China and India).


For the global distribution of income, the curves [...] are gradually moving out to the right as economic growth raises the average world income. The area under the curves is also getting larger, which captures the fact that world population has dramatically expanded. It's interesting to notice that in 1970 and 1980, the global distribution of income had two humps, one at a lower income level and one at a higher income level. By 2000, the world is back to a one-hump income distribution.

From a national and regional level, the patterns show look different: "Long-term trends in income inequality, as measured by the distribution of pre-tax household income across individuals, followed a U-shape in most Western European countries and Western Offshoots. It declined between the end of the 19th century until about 1970, followed by a rise. In Eastern Europe, communism resulted in strong declines in income inequality, followed by a sharp increase after its disintegration in the 1980s. In other parts of the world (China in particular) income inequality has been on the rise recently. The global income distribution, across all citizens of the world, was uni-modal in the 19th century, but became increasingly bi-modal between 1910 and 1970 and suddenly reverted to a uni-modal distribution between 1980 and 2000."
What then is the take home measure from this? For a start it is clear that GDP is not the same thing as real social welfare. However, it tends to be true that countries with a higher level of per capita GDP are better off on other dimensions of well-being, not just the consumption of goods and services, but also other factors like education, health, and even personal freedom.

Both the New Zealand Initiative report and the OECD report make the same basic point, growth is good.

Effect of board quotas on female labour market outcomes in Norway - The Dismal Science

Apr 01, 2015

And the short answer is, not much.

After Norway passed a law, in late 2003, mandating that public limited-liability corporations create boards with no less than 40 percent of each gender represented, the number and quality of women board directors rose and the pay gap vis-a-vis male board members shrank. But 10 years into this experiment, which now is being copied in other countries, there's not much evidence of a trickle-down effect for other women in the workforce,

In their paper Breaking the Glass Ceiling? The Effect of Board Quotas on Female Labor Market Outcomes in Norway authors Marianne Bertrand, Sandra E. Black, Sissel Jensen, and Adriana Lleras-Muney write,

We find no evidence of significant differential improvements for women in the post-reform cohort, either in terms of average earnings or likelihood of filling in a top position in a Norwegian business.
At best, the reform may have increased women's representation in the C-suite - top executive positions in the firm - of targeted firms, a very small group of individuals.
The representation of women does not improve anywhere else in the [targeted] firms' income distribution (top 95th percentile, top 90th percentile, top 75th percentile). We also see no improvements on gender wage gaps among top earners and find no evidence of changing work environments in affected firms.
Additionally, there is no evidence that the rise in female board members inspired younger women to consider business careers or delay child-rearing in order to further careers. In the authors' survey of 763 students at the prestigious Norwegian School of Economics, from which many board members have graduated in the past, fewer than 10 percent of women said the reform encouraged them to get a business degree.
If anything, the share of women obtaining business degrees fell after 2004 (except for 2007).
The authors also note that
[...] we see no apparent reduction in the large gender gap in earnings that emerge in the first few years post graduation.
Now what of the law of unintended consequences?

When faced with the quota, firms could either choose to comply with the law or change their status from public to private. The paper shows that a large number of public limited liability companies changed their status to private after 2003. Of the 563 companies that were ASA - that is, public limited liability companies in Norway - in 2003, only 346 remained ASA by 2005 and only 179 by 2008. Focusing on companies listed on the stock exchange prior to the reform (a strict subset of all ASA firms), it has been shown that the likelihood of delisting anytime between 2003 and 2009 was larger among those with a smaller pre-quota share of women on their board, suggesting that many firms might have delisted to avoid complying with the mandate. Thus the final number of new positions reserved for women was ultimately smaller than expected when the law was passed.

Also, using publicly available data, Matsa and Miller (2013) examine the effect of the quota on accounting performance. Using firms in Sweden as a control group, they show that the change in the board quota law led to a decline in operating profits.

Isn't this the real issue? If having more women on company boards really does lend to reduced profits then you can see why firms may not be too keen on having them.

The paper's abstract reads:
In late 2003, Norway passed a law mandating 40 percent representation of each gender on the board of publicly limited liability companies. The primary objective of this reform was to increase the representation of women in top positions in the corporate sector and decrease gender disparity in earnings within that sector. We document that the newly (post-reform) appointed female board members were observably more qualified than their female predecessors, and that the gender gap in earnings within boards fell substantially. While the reform may have improved the representation of female employees at the very top of the earnings distribution (top 5 highest earners) within firms that were mandated to increase female participation on their board, there is no evidence that these gains at the very top trickled-down. Moreover the reform had no obvious impact on highly qualified women whose qualifications mirror those of board members but who were not appointed to boards. We observe no statistically significant change in the gender wage gaps or in female representation in top positions, although standard errors are large enough that we cannot rule economically meaningful gains. Finally, there is little evidence that the reform affected the decisions of women more generally; it was not accompanied by any change in female enrollment in business education programs, or a convergence in earnings trajectories between recent male and female graduates of such programs. While young women preparing for a career in business report being aware of the reform and expect their earnings and promotion chances to benefit from it, the reform did not affect their fertility and marital plans. Overall, in the short run the reform had very little discernible impact on women in business beyond its direct effect on the newly appointed female board members.

  • Matsa, David A., and Amalia R. Miller, 2013. “A Female Style in Corporate Leadership? Evidence from Quotas.” American Economic Journal: Applied Economics, 5(3): 136-69.

Wage inequality and firm growth - The Dismal Science

Mar 27, 2015

At Holger Mueller, Paige Ouimet and Elena Simintzi look at the relationship between Wage inequality and firm growth. Rising wage inequality has received much attention recently and this column describes new evidence on the determinants of the 'skill premium'.

There are two basic findings:

1) larger firms have grown substantially and
2) skill premia are larger at larger firms.
They therefore conclude that the growth of larger firms could help explain growing wage inequality.

To get to these results first it is necessary to identify the 'skill premium' and know how to measure it. The 'skill premium' is simply the wage difference between high and low skill workers. Defining the skill premium is one thing, measuring it is another.
Existing measures of skill premia, such as education, experience, or even occupations, are not adequate as they do not reflect a one-to-one mapping between job tasks and skill requirements. [...].

In our data, provided by Income Data Services (IDS), we observe how much a firm pays workers employed in different occupations and, crucially, how these occupations map into broader ‘job level’ categories which are comparable across firms. Since job levels are determined based on the skills required for the job, comparing wages for a worker classified at a high job level to a worker classified at a low job level allows us to more directly measure the skill premium. Moreover, since we have these data for a broad cross-section of firms measured at multiple points in time, we can observe within-firm and across-time patterns in the skill premium.

To provide further detail, consider a cleaner and a finance director. The cleaner corresponds to job level 1, work that “requires basic literacy and numeracy skills and the ability to perform a few straightforward and short-term tasks to instructions under immediate supervision”. The finance director corresponds to our highest skill category – job level 9 and involves “very senior executive roles with substantial experience in, and leadership of, a specialist function, including some input to the organisation’s overall strategy”. We measure skill premium using a ratio of a high-skill to low-skill job, at the same firm, in the same year.
When examining ‘top-bottom’ wage ratios in our sample (e.g., the wage associated with job level 8 divided by the wage associated with job level 1 within the same firm and year), we find they increase with firm size. A similar, albeit weaker, relationship arises when we look at ‘top-middle’ wage ratios (e.g. the wage associated with job level 8 divided by the wage associated with job level 4 within the same firm and year). In contrast, ‘middle-bottom’ wage ratios (e.g. the wage associated with job level 4 divided by the wage associated with job level 1 within the same firm and year) stay flat, or if anything slightly decrease with firm size.
  • What is interesting is that when low job levels (1 to 5) are compared to one another, an increase in firm size has no effect on within-firm skill premia.
  • In contrast, when high job levels (6 to 9) are compared to either one another or low job levels, an increase in firm size widens the wage gap between higher and lower skill categories.
The question this give rise to is Why do wages in high-skill job categories increase with firm size but not wages in low- and medium-skill job categories?
We provide two possible explanations.
  • First, larger firms invest more in automation which allows them to replace labour with technology in certain routine jobs [...].
Consistent with this hypothesis, we find that wages associated with routine jobs decline relative to those associated with non-routine jobs as firms become larger, especially in medium-skill job categories.
  • Second, larger firms may pay relatively lower entry-level managerial wages in return for providing better career opportunities [...].
Consistent with this hypothesis, we find that managerial wages in low- to medium-skill job categories are relatively lower in larger firms, while those in high-skill job categories are relatively higher in larger firms.
Is there a third factor here? We know that the division of labour is limited by the extent of the market and bigger firms have larger internal labour markets which gives raise to a greater levels of specialisation with some areas of specialisation being more valuable than others. These higher value jobs receive greater remuneration.

The last question is, What do the results say about overall wage inequality?
An increasing skill premium at larger firms will lead to greater wage inequality inside those firms. But how has the size of the median employer changed over the last two decades? US firms with 500 or more employees accounted for 51.5% of all employment in 2011. As such, we measure firm size by focusing on the largest firms and find evidence of strong firm growth among larger firms in practically all of the developed countries in our sample. These results suggest that part of what may be perceived as a global trend toward more wage inequality may be driven by an increase in employment by the largest firms in the economy.
So the upshot of this is that the growth of larger firms in the economy may partially explain the rise in wage inequality seen over the last few decades.

The eugenic effects of minimum wage laws - The Dismal Science

Mar 24, 2015

I came across a bit of the history of the minimum wage that I didn't know today. A 2005 article by Thomas C. Leonard in the Journal of Economic Perspectives (Vol. 19 No. 4 Fall 2005) discusses Eugenics and Economics in the Progressive Era. Leonard opens the article by noting,

American economics transformed itself during the Progressive Era. In the three to four decades after 1890, American economics became an expert policy science and academic economists played a leading role in bringing about a vastly more expansive state role in the American economy. By World War I, the U.S. government amended the Constitution to institute a personal income tax, created the Federal Reserve, applied antitrust laws, restricted immigration and began regulation of food and drug safety. State governments, where the reform impulse was stronger still, regulated working conditions, banned child labor, instituted “mothers’ pensions,” capped working hours and set minimum wages.

Less well known is that a crude eugenic sorting of groups into deserving and undeserving classes crucially informed the labor and immigration reform that is the hallmark of the Progressive Era (Leonard, 2003). Reform-minded economists of the Progressive Era defended exclusionary labor and immigration legislation on grounds that the labor force should be rid of unfit workers, whom they labeled “parasites,” “the unemployable,” “low-wage races” and the “industrial residuum.” Removing the unfit, went the argument, would uplift superior, deserving workers.
He goes on in the article to write about "The eugenic effects of minimum wage laws".
During the second half of the Progressive Era, beginning roughly in 1908, progressive economists and their reform allies achieved many statutory victories, including state laws that regulated working conditions, banned child labor, instituted “mothers’ pensions,” capped working hours and, the sine qua non, fixed minimum wages. In using eugenics to justify exclusionary immigration legislation, the race-suicide theorists offered a model to economists advocating labor reforms, notably those affiliated with the American Association for Labor Legislation, the organization of academic economists that Orloff and Skocpol (1984, p. 726) call the “leading association of U.S. social reform advocates in the Progressive Era.”

Progressive economists, like their neoclassical critics, believed that binding minimum wages would cause job losses. However, the progressive economists also believed that the job loss induced by minimum wages was a social benefit, as it performed the eugenic service ridding the labor force of the “unemployable.” Sidney and Beatrice Webb (1897 [1920], p. 785) put it plainly: “With regard to certain sections of the population [the “unemployable”], this unemployment is not a mark of social disease, but actually of social health.” “[O]f all ways of dealing with these unfortunate parasites,” Sidney Webb (1912, p. 992) opined in the Journal of Political Economy, “the most ruinous to the community is to allow them to unrestrainedly compete as wage earners.” A minimum wage was seen to operate eugenically through two channels: by deterring prospective immigrants (Henderson, 1900) and also by removing from employment the “unemployable,” who, thus identified, could be, for example, segregated in rural communities or sterilized.
While both progressive economists and their neoclassical critics believed that a minimum wage caused unemployment, it was the neoclassical economists of the time, like Alfred Marshall, Philip Wicksteed, A. C. Pigou in the U.K. and John Bates Clark in the U.S, who regarded the job losses as a social cost of minimum wages, not as a putative social benefit as the progressives saw them.

Leonard continues,
Columbia’s Henry Rogers Seager, a leading progressive economist who served as president of the AEA in 1922, provides an example. Worthy wage-earners, Seager (1913a, p. 12) argued, need protection from the “wearing competition of the casual worker and the drifter” and from the other “unemployable” who unfairly drag down the wages of more deserving workers (1913b, pp. 82–83). The minimum wage protects deserving workers from the competition of the unfit by making it illegal to work for less. Seager (1913a, p. 9) wrote: “The operation of the minimum wage requirement would merely extend the definition of defectives to embrace all individuals, who even after having received special training, remain incapable of adequate self-support.” Seager (p. 10) made clear what should happen to those who, even after remedial training, could not earn the legal minimum: “If we are to maintain a race that is to be made of up of capable, efficient and independent individuals and family groups we must courageously cut off lines of heredity that have been proved to be undesirable by isolation or sterilization ... .”

The unemployable were thus those workers who earned less than some measure of an adequate standard of living, a standard the British called a “decent maintenance” and Americans referred to as a “living wage.” For labor reformers, firms that paid workers less than the living wage to which they were entitled were deemed parasitic, as were the workers who accepted such wages—on grounds that someone (charity, state, other members of the household) would need to make up the difference.

For progressives, a legal minimum wage had the useful property of sorting the unfit, who would lose their jobs, from the deserving workers, who would retain their jobs. Royal Meeker, a Princeton economist who served as Woodrow Wilson’s U.S. Commissioner of Labor, opposed a proposal to subsidize the wages of poor workers for this reason. Meeker preferred a wage floor because it would disemploy unfit workers and thereby enable their culling from the work force. “It is much better to enact a minimum-wage law even if it deprives these unfortunates of work,” argued Meeker (1910, p. 554). “Better that the state should support the inefficient wholly and prevent the multiplication of the breed than subsidize incompetence and unthrift, enabling them to bring forth more of their kind.” A. B. Wolfe (1917, p. 278), an American progressive economist who would later become president of the AEA in 1943, also argued for the eugenic virtues of removing from employment those who “are a burden on society.”
Frank Taussig, one of the leading economists of the time, asked the question “how to deal with the unemployable?” in his book Principles of Economics (Taussig 1921, pp. 332–333)
Taussig identified two classes of unemployable worker, distinguishing the aged, infirm and disabled from the “feebleminded . . . those saturated with alcohol or tainted with hereditary disease . . . [and] the irretrievable criminals and tramps. . . .” The latter class, Taussig proposed, “should simply be stamped out.” “We have not reached the stage,” Taussig allowed, “where we can proceed to chloroform them once and for all; but at least they can be segregated, shut up in refuges and asylums, and prevented from propagating their kind.”
The idea held by progressive economists that the unemployable could not earn a living wage was bound up with the progressive view of wage determination.
Unlike the economists who pioneered the still-novel marginal productivity theory, most progressives agreed that wages should be determined by the amount that was necessary to provide a reasonable standard of living, not by productivity, and that the cost of this entitlement should fall on firms.

But how should a living wage be determined? Were workers with more dependents, and thus higher living expenses, thereby entitled to higher wages? Arguing that wages should be a matter of an appropriate standard of living opened the door, in this era of eugenics, to theories of wage determination that were grounded in biology, in particular to the idea that “low-wage races” were biologically predisposed to low wages, or “under-living.” 7 Edward A. Ross (1936, p. 70), the proponent of race-suicide theory, argued that “the Coolie cannot outdo the American, but he can underlive him.” “Native” workers have higher productivity, claimed Ross, but because Chinese immigrants are racially disposed to work for lower wages, they displace the native workers.
John R. Commons, one of the leading (old) institutional economists (the new institutional economics follows from the work of Ronald Coase) argued that wage competition not only lowers wages, it also selects for the unfit races.
“The competition has no respect for the superior races,” said Commons (1907, p. 151), “the race with lowest necessities displaces others.” Because race rather than productivity determined living standards, Commons could populate his low-wage-races category with the industrious and lazy alike. African Americans were, for Commons (p. 136), “indolent and fickle,” which explained why, Commons argued, slavery was required: “The negro could not possibly have found a place in American industry had he come as a free man . . . [I]f such races are to adopt that industrious life which is second nature to races of the temperate zones, it is only through some form of compulsion.” Similarly, Wharton School reformer Scott Nearing (1915, p. 22), volunteered that if “an employer has a Scotchman working for him at $3 a day [and] an equally efficient Lithuanian offers to the same work for $2 . . . the work is given to the low bidder.”
Leonard continues by looking at the reaction of the progressives to the situation in other countries,
When U.S. labor reformers reported on labor legislation in countries more precocious with respect to labor reform, they favorably commented on the eugenic efficacy of minimum wages in excluding the “low-wage races” from work. Harvard’s Arthur Holcombe (1912, p. 21), a member of the Massachusetts Minimum Wage Commission, referred approvingly to the intent of Australia’s minimum wage law to “protect the white Australian’s standard of living from the invidious competition of the colored races, particularly of the Chinese.” Florence Kelley (1911, p. 304), perhaps the most influential U.S. labor reformer of the day, also endorsed the Australian minimum-wage law as “redeeming the sweated trades” by preventing the “unbridled competition” of the unemployable, the “women, children, and Chinese [who] were reducing all the employees to starvation . . .”

For these progressives, race determined the standard of living, and the standard of living determined the wage. Thus were immigration restriction and labor legislation, especially minimum wages, justified for their eugenic effects. Invidious distinction, whether founded on the putatively greater fertility of the unfit, or upon their putatively greater predisposition to low wages, lay at the heart of the reforms we today see as the hallmark of the Progressive Era.
As an aside, Austria wasn't the only place down-under which tried to protect the white workers standard of living against competition from the Chinese. New Zealand however used a taxes rather than labour regulation. The 1881 Chinese Immigrants Act has imposed a 10 pound poll tax on Chinese immigrants. There were also steep custom duties on opium.

So the history of the minimum wage isn't, unfortunately, just about making the worst-off better-off.

EconTalk this wek - The Dismal Science

Feb 01, 2015

Alex Tabarrok of George Mason University talks to EconTalk host Russ Roberts about a recent paper Tabarrok co-authored with Shruti Rajagopalan on Gurgaon, a city in India that until recently had little or no municipal government. The two discuss the su...

Venezuela should be rich, but its government has destroyed its economy - The Dismal Science

Jan 26, 2015

Thats a headline from the Wonkblog at the Washington Post, which says it all.

Matt O'Brien makes a simple but important point when he writes,

It [Venezuela] should be rich. But it isn't, and it's getting even poorer now, because of economic mismanagement on a world-historical scale. The problem is simple: Venezuela's government thinks it can have an economy by just pretending it does. That it can print as much money as it wants without stoking inflation by just saying it won't. And that it can end shortages just by kicking people out of line. It's a triumph of magical thinking that's not much of one when it turns grocery-shopping into a days-long ordeal that may or may not actually turn up things like food or toilet paper.
The problem?
Venezuela, you see, has the most oil reserves [in the world], but not the most oil production. That's, in part, because the Bolivarian regime, first under Chavez and now Maduro, has scared off foreign investment and bungled its state-owned oil company so much that production has fallen 25 percent since it took power in 1999. Even worse, oil exports have fallen by half. Why? Well, a lot of Venezuela's crude stays home, where it's subsidized to the you-can't-afford-not-to-fill-up price of 1.5 U.S. cents per gallon. (Yes, really). Some of it gets sent to friendly governments, like Cuba's, in return for medical care. And another chunk goes to China as payment in kind for the $45 billion it's borrowed from them.

That doesn't leave enough oil money to pay bills. Again, the Bolivarian regime is to blame. The trouble is that while it has tried to help the poor, which is commendable, it has also spent much more than it can afford, which is not. Indeed, Venezuela's government is running a 14 percent of gross domestic product deficit right now, a fiscal hole so big that there's only one way to fill it: the printing press. But that just traded one economic problem — too little money — for the opposite one. After all, paying people with newly printed money only makes that money lose value, and prices go parabolic. It's no wonder then that Venezuela's inflation rate is officially 64 percent, is really something like 179 percent, and could get up to 1,000 percent, according to Bank of America, if Venezuela doesn't change its byzantine currency controls.
So what is the government up to?
The Maduro regime wants to throttle the private sector but spend money like it hasn't. Then it wants to print what it needs, but keep prices the same like it hasn't. And finally, it wants to keep its stores stocked, but, going back to step one, keep the private sector in check like it hasn't. This is where its currency system comes in. The government, you see, has set up a three-tiered exchange rate to try to control everything — prices, profits, and production — in the economy. The idea, if you want to call it that, is that it can keep prices low by pretending its currency is really stronger than it is. And then it can decide who gets to make money, and how much, by doling out dollars to importers at this artificially low rate, provided they charge what the government says.

This might sound complicated, but it really isn't. Venezuela's government wants to wish away the inflation it's created, so it tells stores what prices they're allowed to sell at. These bureaucrat-approved prices, however, are too low to be profitable, which is why the government has to give companies subsidies to make them worthwhile. Now when these price controls work, the result is shortages, and when they don't, it's even worse ones. Think about it like this: Companies that don't get cheap dollars at the official exchange rate would lose money selling at the official prices, so they leave their stores empty. But the ones that are lucky, or connected, enough to get cheap dollars might prefer to sell them for a quick, and maybe bigger profit, in the black currency market than to use them for what they're supposed to. So, as I've put it before, it's not profitable for the unsubsidized companies to stock their shelves, and not profitable enough for the subsidized ones to do so, either.
A big issue for Venezuela is its reliance on oil.
Not when 95 percent of its exports come from oil, and its price has fallen by half. (It's actually a little worse than that, since Venezuela's crude is so heavy that it sells at a $5 a barrel discount to the rest of the world's). Without as many petrodollars, Venezuela has had to cut back on imports so much that its shortages, which had already hit 30 percent of all goods before the central bank stopped keeping track last year, have gone from being a fact of life to the fact of life. Things are so bad that there isn't a bank run — who wants to save their worthless currency? — but rather, as Jonathan Wheatley puts it, a supermarket run. People have lined up for days to try to buy whatever they can, which isn't much, from grocery stores that are even more empty than usual. The government has been forced to send the military in to these supermarkets to maintain some semblance of order, before it came up with an innovative new strategy for shortening the lines: kicking people out of them. Now they're rationing spots in line, based on the last digit of people's national ID cards.
This is a story which simply can't end well. If the government keeps on doing what its doing things will only get worse and if starts to deal with the problems it has created the short term results will see a lowering of the already low standard of living for all citizens, but especially the poor, of Venezuela.

EconTalk for two weeks - The Dismal Science

Jan 24, 2015

Greg Page, former CEO of Cargill, the largest privately-held company in America, talks to EconTalk host Russ Roberts about the global food supply and the challenges of running a company with employees and activity all over the world. Page talks about t...

More on the minimum wage - The Dismal Science

Jan 14, 2015

The seemingly never ending debate on the effects of the minimum wage continues with a new NBER working paper out on The Minimum Wage and the Great Recession: Evidence of Effects on the Employment and Income Trajectories of Low-Skilled Workers by Jeffre...

Hayek and the knowledge problem - The Dismal Science

Jan 09, 2015

A short video of Lynne Kiesling discussing the knowledge problem.Hayek's work in the 20th century explored a range of ideas, one of the most important of which was the argument that the fundamental economic challenge in a society is the coordination of...