The United States' astronomical levels of economic inequality are poised to become further entrenched in the coming years.
It was the perfect “natural experiment:” in April 1992, New Jersey’s minimum-wage was scheduled to rise from $4.25 an hour to $5.05, while neighboring Pennsylvania’s minimum wage remained unchanged. Princeton economists David Card and Alan Krueger surveyed over 400 fast food outlets in both states, before and after the increase, in order to test the conventional economic wisdom that minimum wages cause unemployment. What did they find? No apparent effect on employment. None. Zip. Economic hell broke loose; Card and Krueger were accused of practicing “politically correct” economics, slanting or faking their results. But a number of subsequent studies have confirmed their results; others have supported the conventional model. What’s going on?
In their entertaining and readable “Anti-Textbook,” Canadian economists Rod Hill and Tony Myatt first present the conventional models of introductory microeconomics textbooks and then skewer them, drawing on a wide range of resources.
Let’s start where textbooks start, with “perfect competition.” This model assumes a single product—such as a “widget”—sold and bought by a vast number of sellers and buyers, no one of them large enough to influence the price. It assumes these sellers and buyers are fully informed and perfectly rational. It also assumes no spillovers from the market such as pollution. Under these assumptions a market will generate maximum consumer satisfaction with maximally efficient use of resources. Textbook authors of course know that no such market has ever existed. But they justify assuming perfect competition on the grounds that it is simple and illustrates the basic tendency of markets.
In the real world, even with the Internet, markets are mostly local, with only a handful of sellers or buyers. Products are not uniform; even the textbook example of wheat collides with the reality of many different grades of wheat growing in different locations and ripening in different seasons. Virtually all consumer products in come in distinct brands, such as Land O’ Lakes and Breakstone butter. Market participants come in different sizes and may include monopolists – single sellers – and monopsonists – single buyers – who can push prices up or down to their own advantage. Moreover these monopolists and monopsonists often have political power sufficient to write regulatory and tax rules to their advantage.
But does it really make a difference? Return to the case of New Jersey’s minimum-wage. Fast food outlets like McDonald’s or Burger King have some monopsony power in the low-wage labor market. That means they don’t face a single “market” wage; they can choose pay rates within a range. Lower rates save money; at higher rates employees will work harder and quit less often. Thus even a significant increase in the minimum wage may simply push employers up the wage range without measurably affecting employment. The same argument in reverse goes for that other nemesis of economists: rent control. Because landlords have at least some local monopoly power—I’m speaking as a former New York City landlord—there’s a range of rents that will keep apartments full without creating an obvious “shortage.” (Of course there’s one big difference between minimum wages and rent control: steady inflation can simultaneously take the bite out of minimum wages and push rent control to destructive levels.)
What about the assumption of perfect rationality and perfect information—including perfect foresight? For decades behavioral economists have demonstrated that we humans often yield to emotions and operate on rules of thumb because it’s too difficult to get full information. Does it matter? Hill and Myatt detail how emotion and mental shortcuts brought us the bubble and crash of 2008. And the assumption that humans behave rationally—in the aggregate at least—blinded most economists, including Fed chair Alan Greenspan.
Textbooks assume we must judge markets solely by efficiency, not fairness or effect on inequality. But wait a moment, what about economists’ favorite measure of fairness, “Pareto optimality,” originated by Italian nobleman Vilfredo Pareto? A situation is “Pareto optimal” if there’s no change that can make one person better off without making someone else worse off. Sounds fair, doesn’t it? But by that logic the North should have paid the South to free the slaves! In short, Pareto optimality starts with the status quo, no matter how cruel or illegitimate.
I especially recommend Hill and Myatt’s last chapter, on Trade and Globalization. The British classical economists like Adam Smith and David Ricardo clearly meant by “free trade” the arm’s length trade in commodities like wheat, iron, coal, cloth or wine—trade that could bring huge cost savings through specialization and breaking of monopolies. Ironically they were promoting free trade at the same time that England led the pack of Europeans in conquering and exploiting overseas colonies. Today, the colonial empires are gone in name but not in reality, as multinational corporations collaborate in secret with national governments to write the rules of trade in their favor—for example in the so-called Trans-Pacific Partnership.
So why, Hill and Myatt ask, do introductory textbooks stick to such outworn myths? The primary reason must be the need to appear objective and apolitical—to keep up the pretense that economics is a “science.” Thus controversial subjects like monopoly, or political power, or global warming, or inequality appear, if at all, in final chapters that the instructor may not reach. That may sit just fine with the giant publishers like Macmillan/McGraw-Hill, who extract $150 to over $200 from Ec. 1 students. Fortunately, The Economics Anti-Textbook sells on (monopolist) Amazon for $24.57 paperback and $23.34 Kindle, and half or less from used booksellers like abebooks.com. Now there’s real competition!
Polly Cleveland is Adjunct Professor of Environmental Economics at Columbia University’s School of International and Public Affairs