Friday, April 14, 2017

Why the 101 model doesn't work for labor markets


A lot of people have trouble wrapping their heads around the idea that the basic "Econ 101" model - the undifferentiated, single-market supply-and-demand model - doesn't work for labor markets. To some people involved in debates over labor policy, the theory is almost axiomatic - the labor market must be describable in terms of a "labor supply curve" and a "labor demand curve". If you tell them it can't, it just sort of breaks their brain. How could there not be a labor demand curve? How could there not be a relationship between the price of something and how much of it people want to buy?

Answer: If you can't observe it, you might as well treat it as if it doesn't exist.

People forget this, but demand curves aren't actually directly observable. They're hypotheticals - "If the price were X, how much would you buy?" You can give people a survey, but the only way to really know how much people would buy is to actually move the price to X. And the only way to do that is to shift the supply curve. But how do you know what the supply curve is? The only way is to shift the demand curve!

This is called an identification problem. Unless you can observe something that's clearly a shock to only one of the curves but not the other, you can't know what the curves look like. (Paul Romer explains this in section 4.1 of his essay "The Trouble With Macroeconomics".)

And with labor markets, it's very hard to find a shock that only affects one of the "curves". The reason is because almost everything in the economy gets produced with labor. If you find a whole bunch of new workers, they're also a whole bunch of new customers, and the stuff they buy requires more workers to produce. If you raise the minimum wage, the increased income to those with jobs will also boost labor demand indirectly (somehow, activist and businessman Nick Hanauer figured this out when a whole lot of econ-trained think-tankers missed it!).

Labor is a crucial input in so many markets that it really needs to be dealt with in general equilibrium - in other words, by analyzing all markets at once - rather than by treating it as a single market in isolation. That makes the basic Econ 101 partial-equilibrium model pretty useless for analyzing labor.

"But," you may say, "can't we make some weaker assumptions that are pretty reasonable?" Sure. It makes sense that since it takes some time for new businesses to be created, a surge of unskilled immigration should represent a bigger shock to labor supply than to labor demand in the very short run. And it makes sense that a minimum wage hike wouldn't raise labor demand enough to compensate for the wedge created by the price floor.

With these weaker assumptions, you can get a general sense of the supply and demand curves. Problem: The results then contradict each other. Empirical results on sudden unskilled immigration surges indicate a very high elasticity of labor demand, while empirical results on minimum wage hikes indicate a very low elasticity of labor demand. Those can't both be true at the same time.

So if you accept these plausible, weak identifying assumptions, it still doesn't make sense to think about labor markets as described by an S curve and a D curve.

Of course, you could come up with some weird, stinky, implausible identifying assumptions that could reconcile these empirical facts (and the various other things we know about labor markets). With baroque enough assumptions, you can always salvage any theory, as Romer points out (and as Lakatos pointed out). But at some point it just starts to seem silly.

In fact, there are a number of other reasons why the Econ 101 theory isn't a good fit for labor markets:

1. Supply-and-demand graphs are for one single commodity; labor is highly heterogeneous.

2. Supply-and-demand graphs are static models; because of labor laws and implicit contracts, labor markets involve lots of forward-looking behavior.

3. Supply-and-demand graphs are frictionless; labor markets obviously involve large search frictions, for a number of reasons.

If Econ 101 supply-and-demand models worked for every market, the vast majority of the modern economics profession would be totally useless. Claiming that the econ 101 model must always be a good model basically says that most of econ is barking up the wrong tree, and that it's just all in Marshall. Fortunately, economists tend to be a smart, scientifically-minded bunch, and so they realize that general equilibrium effects, heterogeneity, forward-looking behavior, search frictions, etc. exist, and often are essential to understanding markets.

The Econ 101 supply-and-demand model is just not a good description for the labor market. The theoretical construct known as "the labor demand curve" is ontologically suspect, i.e. it is a poor modeling choice. If we adopt some sort of positivist or empiricist philosophy - "if I can't observe it, it might as well not exist" - then we might as well say that "the labor demand curve" doesn't exist. It's not an actual thing.

49 comments:

  1. It's been a long time since I took int. micro, but on minimum wages, don't the simplest general equilibrium models (the ones that are just systems of linear equations in in >2 dimensions) also have the same policy implications as partial-equilibrium models, where a price floor above the market-clearing price causes a labor surplus?

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    1. Yeah, but the question is, how much? Also if there's imperfect competition for labor, the effect could go the other way.

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  2. Are you allowing for the possibility that *some* labor markets might have identifiable demand/supply curves? Such as demand for Java programmers?

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    1. Yeah, sure. The more disaggregated you get, the less many of those problems I talked about matter. But then when you get pretty specialized, you start running into issues like monopsony power - i.e., only a few employers to choose from.

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  3. I agree with everything here except your points about empiricism/positivism. When you say, "If you can't observe it, you might as well treat it as if it doesn't exist" I assume you mean "if you can't observe it or its effects..." but even then the idea is philosophically suspect.

    I can't observe the fact that other individuals have subjective personal experiences and sensations, but that doesn't mean I can assume they don't exist! Similar claims could be made about moral truths.

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    1. When you say, "If you can't observe it, you might as well treat it as if it doesn't exist" I assume you mean "if you can't observe it or its effects..."

      Yep.

      I can't observe the fact that other individuals have subjective personal experiences and sensations, but that doesn't mean I can assume they don't exist!

      But they're a good modeling choice, since other people act sort of like we do, and by assuming they're like us we can predict their behavior. Also we probably have pragmatist reasons for making that assumption that go beyond empiricism. I'm personally more of a pragmatist than a positivist.

      Similar claims could be made about moral truths.

      Yeah, every once in a while some guy comes along and says "But I KNOW what's right and wrong, it's AXIOMATIC", and then some other people say "NUH-UH!!", and there the argument ends, because, well, that's just like, your opinion, man. :D

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    2. I could act on a model that assumes everyone else will act as though their pain is bad in the way my pain is bad, but that it's not actually bad. This would make all the same predictions as the model that their pain is actually bad. But these models are very different and it matters that we choose between them.

      Pragmatism is more appealing than empiricism. But I'd argue that actually believing there are moral truths — not necessarily that anyone in particular has privileged access to them — makes for better ethical discussions, because you can agree that there's something you might be wrong about. If you don't think there's any moral truth, then everything else is just haggling over price.

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    3. What does "bad" mean?

      I don't believe there are moral truths in the same way there are physical truths; in fact, there pretty obviously are not. But I still believe in some moral principles quite strongly.

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    4. "Pragmatism is more appealing than empiricism. But . . ."

      Cody's "but" is ironic because he then proceeds to make a pragmatic argument for moral truth.

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  4. Really sound article, and generalizable beyond the specific economic topic. However, doesn't the Hanauer link oppose your point about identification problems? For example, he cites Card-Krueger as evidence that minimum wage increases CAUSE higher employment. The article is a little ambiguous, but it seems like he is assuming a clear worker consumption channel to higher aggregate demand.

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    1. Yeah, I'm not sure Nick's theories about this are totally well-defined...but he definitely did get the thing about people spending their higher wages buying other people's labor...

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  5. “If you raise the minimum wage, the increased income to those with jobs will also boost labor demand indirectly..”

    Er – given that AD can easily be increased any time, the question as to whether increased minimum wages increases AD or not is near irrelevant.

    It could be that an increased tax on alcohol with the proceeds being spent on rehab clinics would increase or decrease AD. But if I was a politician contemplating such a tax increase, the effect on AD would not be uppermost in my mind.

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    1. "Er – given that AD can easily be increased any time, the question as to whether increased minimum wages increases AD or not is near irrelevant."

      No. AD is currently being increased in the most inefficient way conceivable -- Giving extra dollars to billionaires on the bond market and waiting for demand of milk and fruit loops to go up. Meanwhile all the markets of things that billionaires actually buy are being pushed uniformly and asymptotically to ROI 0

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  6. "Yeah, I'm not sure Nick's theories about this are totally well-defined...but he definitely did get the thing about people spending their higher wages buying other people's labor..."

    Good grief, the only thing Hanauer's "got" is that there's a populist issue ripe for a billionaire who wants to run left as he seeks office.

    *Ahem*...I might be a little biased here.

    But there's nothing new about this anyway. It's just the marginal propensity to spend/save. It's in Michael Reich's models of the minimum wage for example.

    It also ignores something quite important, if money isn't spent by those richer people then it obviously becomes savings. And savings do then get used - banks tend to lend out deposits after all. And if it's actually invested I works in the GDP equation the same way C does.

    I'm back to waiting to see which office Hanauer thinks is worthy of his running for it.

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    1. I would rethink Nick's motives. I don't think political office is what he's looking for. He's more of an activist than a politician.

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    2. Tim, I was reading in the NYT this morning ...

      Supply-Side Economics, but for Liberals, NEIL IRWIN
      https://www.nytimes.com/section/upshot ...

      ... "460,000 more women who headed their household were working than would have been without the E.I.T.C. expansion."

      I have always held E.I.T.C. to be a minor fraction of what's needed to mend poverty: shifts all of half of one percent of income while 45% of earners are paid less than we think the minimum wage should be ($15).

      Nevertheless, skipping right over the minimum wage, what do you think about rebuilding US union density to be something like Germany's -- and letting the free market go to work to see how much the consumer will fork over for labor?

      Good reason(s) to test the market here. Fed min wage is now $4 below 1968 while per capita income has doubled since. Bottom 45% now take 10% of income share over their earlier 20% (doubled overall income leaves them in the same absolute place).

      100,000 out of my guesstimate 200,000 Chicago gang-age males are in street gangs. Makes sense to see this as the same as rust belt withdrawal from the labor market. To put it plainly, both groups are not interested in the up-to-date kitchen -- most especially not interested in $10 an hour jobs (spoiled Americans) ...

      ... both would be very, very much interested in $20 an hour jobs -- which only collective bargaining can bring about -- IF the consumer will pay. Every eighth-grade math measure (doubling per capita while income share halves) suggests that the money is there.
      http://www.cbsnews.com/news/gang-wars-at-the-root-of-chicagos-high-murder-rate/

      Tim, what do you think about allowing the truly free market (labor monopoly v owner monopsony) sorting out the truly big IF?

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    3. I like the EITC. The aim is to subsidise low skill labour so that more of it is employed rather than left to fester in unemployment. It's a useful and also rare government program which does what it says on the tin.

      I also like it for moral reasons. We, the voters, are insistent that no one should be truly left behind. That's great, we should do this of course. Thus there's going to be a welfare system, there's going to be taxation and redistribution from richer to poorer. We might differ on he levels at which this happens but the basic concept is going to happen come what may.

      Some say that raising he minimum wage is the way to do this. I don't--leave aside how well it works and consider what is being said. I, the voter, think that that person over there has a moral right to an income of $x. OK. And now, I, that voter, am going to insist that that $x come out of the pocket of someone else. The employer (no, don't think through the economics here of whether that's where it does come from, think of the voter's moral posture here).

      No, the moral action is that if I insist that an income of $x is just and righteous then I must be willing to pay that $x. That is, morally, it should be tax me to provide that result, not shift the costs to someone else.

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    4. An EITC that restored the 10% overall income share lost by the bottom 45% -- IOW that doubled (!) their incomes -- would come in at something like $1.4 trillion a year, not today's $70 billion. Before we tear out hair out figuring out how we would distribute that -- it would obviously upend the whole (consumer) market-based direction of production.

      I'm not nearly as interested in the min wage as I am in rebuilding labor union density. That would sort out production by the max the consumer would put up with rather than the minimum labor will up with (starting with the most vulnerable workers and working up).

      I'm guessing if the mid 54% pay 14% more of their incomes through higher prices (10% of overall income) -- they in turn with their new union generated political power can just confiscatory-tax back the 10% overall the top 1% squeezed out over the last two generations.

      Their moral question there could be phrased as do they want to keep the 54% in penury (may not be a choice if the 45% refuse to show up for work [strike]) or do they want pro quarterbacks to work for a million a year instead of ten million. When faced with questions like this I ask myself: what would Jimmy Hoffa do? :-)

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    5. "But there's nothing new about this anyway. It's just the marginal propensity to spend/save. It's in Michael Reich's models of the minimum wage for example."

      But does the community get it? I was in the book store for one of the best universities in the US a few years ago and I rifled through a few books in the economics section. In the 373 class, about two/thirds of the way through, I saw a graph of propensity to spend dropping and in the caption it read that "propensity to spend dropped in the 1980s and no-one knows why this happened". Good grief!

      You don't have to run for office to want to fix what is broken in the economics community.

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  7. In practical, everyday political discussions (which I'm more familiar with than general equilibrium effects, heterogeneity and forward-looking behavior) ...

    ... what's endlessly lost is that labor is bought and sold more or less on margin -- the price of labor being only a fraction (33% fast food, 7% Walmart) of the price of the product "demanded" by the ultimate consumer. Discussions of the minimum wage for the easiest example unthinking assume something like 10% higher labor costs may mean 10% fewer product buyers.

    The buyer of labor has to figure out how to input higher costs into his product prices -- just like any other input.

    Should a broad section of labor -- example lower income labor unionize enough to raise their labor price significantly -- that could actually cost higher wage labor to lose some jobs as demand is redirected towards products of lower wage economy -- as people tend to buy proportionately more at levels they get paid at.

    Super-simple, but seems lost in every political discussion.

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    1. I guess I should throw in my little theory that an influx of low skilled labor(ers) should not depress low skilled labor's price that much as long as collective bargaining is setting the price by the max the consumer will pay rather than the minimum the most desperate worker will show up for.

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    2. "that could actually cost higher wage labor to lose some jobs as demand is redirected towards products of lower wage economy"

      What type of higher wage labor? Engineers, doctors, dentists, and lawyers, or are you talking about CEOs and capital holders?

      A dentist can make a living off of lower prices if it keeps his seat filled, but in a highly unequal society he is forced to price to treat the rich. Meanwhile every penny he earns could conceivably be lured away from him if only someone builds a product that is desireable enough, whereas you and I have a better chance of winning the mega-millions lottery than one of Charles Kochs dollars has of buying his morning coffee or bagel. Those dollars can do one thing and one thing only in aggregate and that is to push ROI toward zero across all asset classes.

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  8. How to overcome the manifest silliness of Econ 101 and save the economy
    Comment on Noah Smith on ‘Why the 101 model doesn’t work for labor markets’

    The Econ 101 labor market theory does not work because it is based on microfoundations. Microfoundations are given with the neo-Walrasian axiom set: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub)

    From these axioms together with some auxiliary assumptions follows what Leijonhufvud famously called the Totem of Micro/Macro, that is, SS-curve―DD-curve―equilibrium, which is the representative economist’s all-purpose tool.

    This approach is false on all methodological counts, that is, supply-demand-equilibrium is a NONENTITY. General inapplicability implies that it is also inapplicable to the labor market.

    Microfoundations is the wrong approach. This explains why economics is a failed science. The correct approach is macrofoundations.#1

    The elementary version of the correct (objective, systemic, behavior-free, macrofounded) employment equation is shown on Wikimedia:#2
    https://commons.wikimedia.org/wiki/File:AXEC62.png

    From this equation follows:
    (i) An increase of the expenditure ratio rhoE leads to higher employment L (the Greek letter rho stands for ratio). An expenditure ratio rhoE greater than 1 indicates credit expansion, a ratio rhoE less than 1 indicates credit contraction.
    (ii) Increasing investment expenditures I exert a positive influence on employment.
    (iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment.

    The complete employment equation contains in addition profit distribution, the public sector and foreign trade.

    Item (i) and (ii) cover Keynes’s familiar arguments about aggregate demand. The factor cost ratio rhoF as defined in (iii) embodies the price mechanism. The fact of the matter is that overall employment INCREASES if the AVERAGE wage rate W INCREASES relative to average price P and productivity R. This is the OPPOSITE of what standard economics teaches: “We economists have all learned, and many of us teach, that the remedy for excess supply in any market is a reduction in price.” (Tobin)

    False theory leads to false policy guidance. Scientifically incompetent economists bear the intellectual responsibility for the social devastation of mass unemployment.

    The systemic employment equation contains nothing but measurable variables and is therefore readily testable. There is no need for further brain-dead supply-demand-equilibrium blather: as always in science, a test decides the matter.

    Egmont Kakarot-Handtke

    #1 The macrofoundations approach starts with three systemic (= behavior-free) axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

    #2 For details see cross-references Employment
    http://axecorg.blogspot.de/2015/08/employmentphillips-curve-cross.html

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    1. "The fact of the matter is that overall employment INCREASES if the AVERAGE wage rate W INCREASES relative to average price P and productivity R. This is the OPPOSITE of what standard economics teaches: “We economists have all learned, and many of us teach, that the remedy for excess supply in any market is a reduction in price.” (Tobin)"

      I don't really understand all of what you wrote here, but the above sounds a lot like conclusions I have reached.

      Unfortunately I had to figure much of this stuff out on my own because it seems like no-one who talks on the public circuit gets things right. Even the excellent historical reference "Free trade doesn't work" get's the math wrong.

      One systematic problem I have seen in at least the front for the public in the economics community is a refusal to use an internally consistent terminology. For example, if you split the concept of "capital" into two distinct concepts - "physical capital" (that would go up if you build a new taco bell but would be unchanged if the price of taco bells changed) and "financial capital" (that would go up if the price of taco bells went up).

      Admittedly, physical capital is very hard to measure, but if you just shove financial capital in as an approximation you get into really absurd conclusions really quickly. "Productivity" is another such weird term, as if all the companies in your city made their production lines twice as efficient and this caused an underemployment spike that decreased spending and caused restaurants to sit empty, these monotonic increases in productivity actually cause BLS productivity to go down.

      "False theory leads to false policy guidance. Scientifically incompetent economists bear the intellectual responsibility for the social devastation of mass unemployment."

      It is worse than that even. They bear the responsibility for a million people dead in Iraq. Search "Iraq Naomi Klein" for details and prepare for your heart to drop.

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  9. and this is why I took a few more courses at Cal in the 1970s that covered more interdisciplinary approaches to mainly resource economics. Those were more systemic approaches. Not doing me much good as a video editor but it help a makes for better reading and understanding of the news

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  10. The problem is that firms compete, not labor. Firms hire labor but the market derives from serving consumers. Firms typically try to maximize market share by lowering prices to consumers. But the number of firms divides up consumer spending to the point where volume necessary to cover fixed costs limits the number of firms. A higher minimum wage makes inefficient firms leave the market, but their volume now goes to the remaining firms and this increase in volume to the remaining firms allows them to lower prices to gain greater market share. Lower prices draws greater overall volume as consumers shift priorities when prices decline. Greater overall volume results in the need for increased labor to service the increased volume. The key is that variable costs, such as labor, affect price while fixed costs do not. Fixed costs determine the number of firms that can achieve enough volume to survive. But whether you have 10 firms or 100 firms, they will need essentially the same labor to service the consumer demand.

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  11. Oddly enough, we're saying pretty much the same thing.

    Here's why BOTH the 'lump of labor' AND the fallacy claim are wrong.

    http://econospeak.blogspot.com/2017/04/boundless-thirst-for-surplus-labor.html …

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  12. Some undergrad education outside of the US include frictional markets, which is the standard view of economists right now. Still Econ 101 teachers should warn their students about the limitations of the models they use, as teachers of Physics 101 tell their students that Newton's laws would only apply in an ideal experimental setting.

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  13. Good post as always.

    But I don't agree with Noah. Every model is unrealistic. All his his critiques apply equally well to every model ever written because economic models are always massive simplifications of reality. The question is whether they are useful at helping us understand what's going. Of course all other models of labor markets contain a part of the truth, but a simple S&D model takes you farther than all the others because they soon reach diminishing returns.

    I see no reason to believe that usually we can't know which curve is affected by a shock. I rarely experience the problem. Moreover, it applies to most models no less than labor markets.

    And minimum wages don't raise demand. We know this from natural experiments in the 1930s due to FDR's wage shocks.. All of them dramatically reduced industrial production. See Scott Sumner on this.

    Concerning the ontological reality of demand curves in labor markets, Noah is partially right, but this criticism applies to just about every assumption of every economic model I've ever seen. The assumptions are very often and if not usually huge simplifications of reality that we cannot readily observe, if at all, but we test them by seeing if their predicted implications turn true. In other words, virtually all assumptions in economics models I have seen are ontologically suspect.

    Just because we can't easily quantify the aspects of the model it tells us nothing about the model's truth. That's just a part of life.

    However, I agree with Noah that a simple partial equilibrium model of labor markets is incorrect. The contradiction between the immigration and minimum wage literature can be easily addressed with GE models. We should use a simple S&D for the labor market, but the correct way to do it is just a simple GE model with S&D for both product and labor markets. That accounts for most of the evidence and Noah's issues.

    Apologies for my terrible grammar.

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    1. "Every model is unrealistic."

      Every model is also rhetorical. One needs to ask whether the particular model in the particular context is being deployed to try to "help us understand" what's going on or to persuade an audience with tendentious "evidence."

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    2. JoeMac

      “Every model is unrealistic” is an argument from the list of economists’ silliest excuses.#1 Time to bring yourself methodologically up to speed.

      The point is NOT that Econ 101 is ‘unrealistic’ but that it is PROVABLE FALSE.#2 And the fact of the matter is that economists in their abysmal scientific incompetence have NOT realized it in the past 60 years.#3

      Egmont Kakarot-Handtke

      #1 Failed economics: The losers’ long list of lame excuses
      http://axecorg.blogspot.de/2017/01/failed-economics-losers-long-list-of.html

      #2 All models are false because all economists are stupid
      http://axecorg.blogspot.de/2016/09/all-models-are-false-because-all.html

      #3 The father of modern economics and his imbecile kids
      http://axecorg.blogspot.de/2016/11/the-father-of-modern-economics-and-his.html

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    3. I don't understand your point. No one is against using empirical evidence to refute models. We're saying that its not enough to show that a model has unrealistic assumptions because ALL models have unrealistic assumptions. You have to show that a model's assumptions are so incredibly unrealistic that the model will not yield accurate predictions, explanations, and applications. It's a distinction between the realist and pragmatic view of truth. I follow the latter.

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    4. JoeMac

      I said: “The point is NOT that Econ 101 is ‘unrealistic’ but that it is PROVABLE FALSE.”

      You said: “I don’t understand your point. No one is against using empirical evidence to refute models.”

      Provable false means false in the SAME way false as the Geo-centric theory is false, that is TOTALLY false, that is, logically and empirically false. The consequence is that Econ 101 is OUT of science just as the Geo-centric theory or the flat-earth theory or the phlogiston theory are out of science.

      Econ 101 is based on microfoundations which are given with the neo-Walrasian axiom set: “HC1 economic agents have preferences over outcomes; HC2 agents individually optimize subject to constraints; HC3 agent choice is manifest in interrelated markets; HC4 agents have full relevant knowledge; HC5 observable outcomes are coordinated, and must be discussed with reference to equilibrium states.” (Weintraub)

      This axiom set contains three nonentities. Every theory/model that contains a nonentity is a priori false. In other words, Econ 101 is axiomatically false since Walras/Jevons/Menger. In still other words, economics from supply-demand-equilibrium to DSGE is false as clearly as 2+2=5 is false.

      There is NO choice between partial equilibrium or total equilibrium because ALL models that contain equilibrium (HC5) are false. The same holds for (HC2) and (HC4).

      From this follows that the microfoundations paradigm has to be FULLY replaced just as the Geo-centric paradigm had to be fully replaced by the Helio-centric paradigm.

      In simple terms: axiomatically false is as different from ‘unrealistic’ as a death sentence is from a traffic ticket.

      Econ 101 is one of the most annoying constructs since the ancient Greeks invented science 2000+ years ago but the representative economist has not realized it until this day. Econ 101 is out of science, the representative economist is out of science, and JoeMac is out of science. Which part of ‘out of science’ do you not understand?

      Egmont Kakarot-Handtke

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  14. "If you raise the minimum wage, the increased income to those with jobs will also boost labor demand indirectly (somehow, activist and businessman Nick Hanauer figured this out when a whole lot of econ-trained think-tankers missed it!)."

    But Noah why stop here? How about you and I meet up with a bag of rocks and go break some windows?

    Sure there is an indirect effect but what you're essentially saying is "let's make production less efficient" and "let's re-distribute part of the proceeds over other sectors." I don't see how this will offset the negative effects of such a policy. There is no multiplier here, or is there?

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    1. General equilibrium effects are not the same thing as Keynesian multipliers.

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    2. "the increased income to those with jobs will also boost labor demand indirectly"

      Consider another bag of rocks, Toby. Not to break windows with but to decorate fingers and necks. I.e., diamonds, luxury goods. As our old friend J.-B. Say pointed out, "misery is the inseparable companion of luxury." I call that Say's second law.

      Consider what happens if an increasing PROPORTION of production shifts from producing luxury goods for the wealthy to producing subsistence goods for workers because of a shift in income shares from capital to labor. And increase in the supply of subsistence goods enables an increase in the supply of labor...

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    3. I think it is very dangerous to bring up Keynesian multipliers into microeconomics analysis. There is an unwritten rule in mainstream economics that when analyzing microeconomic models we assume that the economy as a whole is in the long-term full employment/output equilibrium. So, we don't consider the multiplier effects of exogenous shocks on such models.

      It's difficult enough to analyze the affects of microeconomic models but to bring in Keyneisan multipliers would essentially make it impossible to do microeconomics. The result would be a kind of empirical nihilism. That's why we split up analyzing business cycle dynamics from household/firm/market level dynamics.

      Plus, the multiplier argument is just terrible theoretically and empirically in its own right. Even ADube rejected it.

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    4. @Noah,

      I didn't say anything about a Keynesian multiplier. But why would making production less efficient shift the labor demand curve out by more than it reduces the quantity of labor demanded? Wouldn't it make us poorer overall?


      @Sandwhichman,

      I don't understand what you're saying there. How would that work and what's the relevance that diamonds are different kind of rocks?

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  15. Anonymous1:05 PM

    The problem with econ 101 models is attempting to address complexity with generalities. By treating labor in a generic fashion, the generic model fails. The labor demand curve is actually demand for knowledge, skills, and abilities.

    The demand for labor is not homogeneous; therefore, treating labor supply as generically homogeneous leads to bad models. The generic approach to labor supply and demand results in bad public policy and both public and private malinvestment for future KSA availability.

    Wage floors are about consumption; not labor. Government taxes compete with consumption in the economy. Government intervention with minimum wage policy is intended to manipulate the demand curve to maintain consumption while also providing revenue to the government.

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  16. The econ 101 model says that the demand for labor is downward sloping and the a wage increase will lead to lower demand for labor.

    Interesting. We have data on labor compensation going back to 1948 and it rose in each and every year since. So the econ 101 model would imply that the demand for labor should have fallen each and every year since 1948 and the US should now have less employment now than it did in 1948.

    Obviously, that did not happen. So how do the advocates of the econ 101 model explain why their theory has been so wrong.

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    1. Because the compensation rose in the first place due to either an increase in the worker's productivity or a demand for labor.

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  17. I must be missing something here. As I recall the Econ 101 model for supply-and-demand, it would suggest that if a town had 10 chimney sweeps, each of whom charged $50 per fireplace, and then 5 more chimney sweeps arrived, that the price per fireplace should go down. Right?

    It doesn't speak to the question of what happens if 50 clockmakers arrive in town, or how many new fireplaces will be build the following year due to the availability of lower-cost chimney sweeping services.

    I wouldn't conclude from the model's failure to make those predictions that the model "doesn't work," but rather that those are not Econ 101 supply-and-demand questions - or at least they aren't properly formed questions.

    So what am I missing here? Why would the Econ 101 supply-and-demand model be useful in evaluating the aggregate impact of immigration on an economy, say, when that's clearly not an Econ 101 supply-and-demand question?



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  18. First reading this post I wondered if Noah Smith would be ready to read Karl Polanyi's discussion of fictitious commodities in the Great Transformation. At least that answered a lot of my questions about when the market model was or was not applicable in any useful way.

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  19. Against the entire notion of a marginal productivity theory of labor demand:
    http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2017/04/against-marginal-product.html

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  20. What Hanauer ostensibly 'figured out' is in Marx. If Schumpeter was up for reading Marx, why not the former's followers? (fwiw, I wouldn't describe myself as a doctrinaire Marxist/Marxian, but why don't economists read classical political economy?)

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  21. Even if markets were competitive, labor was homogeneous, there were no information asymmetries, there were no principal agent problems, and one confined oneself to a partial framework - well-behaved labor demand curves would not exist. See, for example, Opocher and Steedman's 2015 book, Full Industry Equilibrium.

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  22. Also, Noah isn't being clear about what he is against. It is clear that he is against using the simple partial equilibrium model of S&D for the labor market.

    But is he also against using a general equilibrium model of the product and labor markets with S&D for both? In a previous post he proposed this as a possible remedy. But this post makes it sound as if he is against using S&D for the labor market in ANY context.

    What exactly does he claim is falsified, the PE model of labor markets as shown in 101 textbooks or even the GE model I just proposed?

    An excellent example of such a model is used in the paper "Who Pays for the Minimum Wage?" by Péter Harasztosi and Attila Lindner. This is my favorite paper on minimum wages. Their analysis is not the PE model used in 101 textbooks, but it is merely an extension of the 101 model, so it is in the same spirit. So, I think most libertarians would have no problem accepting it for analysis of labor market policies.

    Noah should clarify.

    Happy Passover to Noah!

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    1. ""Who Pays for the Minimum Wage?""

      Isn't this artificially imposing a zero-sum game where there isn't one?

      You can make a pretty good argument for a zero-sum game when talking about the total number of dollars that exist in the consumption pool of society. This is a clear category that can be contrasted with the investment pool because ROI across all asset classes gives you a very direct way to measure this.

      Wages are far less zero sum because increasing the wages of the poor also increase the velocity of money, so an assumption of zero change to velocity of money starts you out with the wrong answer before you even begin.

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  23. You don't have to take the argument that the supply and demand curve don't apply to start seeing the problems when applying this logic to labor.

    For example, even within "normal" supply and demand logic, if you accept a "V-shaped" supply curve, you get a convergent solution when you are in the "right side" of the V and a divergent solution (suppliers and demanders both pushing downward on prices in harmony) in the "left side" of the V. This incredibly simple thought experiment goes a long way toward explaining what happened in 1929.

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