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Economics Advances One Iconoclast at a Time

Economics Advances One Iconoclast at a Time

Wednesday, 25 April, 2018 - 05:00
In recent years, a number of economic ideas once considered unassailable have been called into question. The financial crisis and Great Recession threw much of macroeconomic and financial wisdom out the window, and now new evidence is challenging orthodoxy in a variety of areas. For example, recent studies suggests that labor markets don’t work the way economists traditionally believed, and that advanced economies are far less competitive than had been thought.

It will be a while yet before economics textbooks throw decades of orthodoxy out the window -- as a general rule, economists are not quick to embrace change. But already, there is a sense that attitudes toward policies like minimum wages and antitrust are starting to shift within the profession. And since those are big, important policies that affect the livelihoods of millions, even a slow shift in the professional consensus can have big consequences.

What forces allowed this change to happen? Many will say that it’s a result of the empirical revolution in economics. As information technology has made it possible to process oceans of high-quality data, economists are able to directly observe the way the world works instead of simply intuiting how they think it ought to work. As a result, empirical research is taking over from theory.

That’s certainly true. But it’s also the case that empirical data is limited in what it can tell us about the inner workings of the economy. As every internet smart-aleck knows, correlation doesn’t equal causation. If you see inflation go up when the economy grows faster, it could be because growth causes inflation, or inflation causes growth, or neither.

To really tell what causes what, you need what economists call a natural experiment. Essentially, this means you need policy to change randomly. If that happens, you can be much more confident that the changes you see are actually the result of the change in policy.

For example, suppose you want to tell whether immigration reduces wages for native-born workers. The ideal experiment would be if a whimsical dictator suddenly decided to send large numbers of poor people flooding into an American city. That’s what happened in 1980, in the Mariel Boatlift. When economists found that Fidel Castro’s sudden banishment of tens of thousands of Cubans to Miami didn’t reduce wages for native-born Americans in that city -- and when a large number of studies of later refugee waves around the world showed the same -- it made economists much less worried about the costs of immigration.

With policies like minimum wages, it’s a bit harder. In a reasonably well-functioning democratic nation like the US, mad dictators are in short supply. If a city such as Seattle or San Francisco decides to raise its wage floor, the timing might be random -- for example, the local Democratic party might have picked a charismatic candidate who started agitating for higher wages after winning an election -- or it might be because the local economy is so strong that politicians figure it can withstand a bit of government meddling.

That’s where activist campaigns come in. In Seattle and elsewhere, the recent minimum wage hikes have come partly as a result of grassroots pressure from activists. “Fight for 15,” the popular campaign to raise the minimum wage to $15 an hour, emerged more from a wave of national anger over stagnant pay than out of confidence in a booming economy. As a result, the recent wave of minimum wage increases provides an especially good experiment.

There may be an even deeper reason why activists and dissidents are the key to helping economists learn about the world. If policy makers just abide by the existing economic consensus, new things won’t be tried. Theories won’t get tested very often if nobody tries something at odds with the theory. But when pugnacious individuals and ideologically motivated campaigners push for policies that go beyond what the existing consensus would sanction, it’s possible to learn something.

Minimum wages are a good example of this -- skeptics regularly heap scorn upon activists and accuse them of ignoring basic economics, but the minimum wage boosters just keep pushing, and so far things seem to be working out OK; instead of costing workers jobs, it’s increasing their pay. Basic income is another -- opponents of the welfare state worry that this will give people an incentive to drop out of the labor force, but so far the evidence shows that a moderate basic income doesn’t discourage work.

Of course, it’s only natural that sometimes the experiments don’t work out. Rent control, for example, helps some existing tenants, but has substantial negative effects on many other urban residents. Sometimes the existing consensus gets it right.

But it’s important to acknowledge that doubters and ideologues are an essential part of the laboratory by which economists hope to approximate the practice of real science.

Bloomberg View

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