When workers lash out for higher minimum wages, traditional economic thinking suggests this is not a good idea. In economic jargon, a price floor on the price of a unit labor means competitive firms will cut jobs. So even though some workers earn more, economy wide the new minimum wage leads to "dead-weight loss." The problem is that the theory does not match up to reality; economists don't understand the labor market as well as they think they do.
Dominant economic theory suggests minimum wages are always bad for workers and employers alike. In The American Economic Review, Alan Krueger and David Card looked at what happens to employment in fast food restaurants when the minimum wage goes up. Their study looks at the effects of a higher minimum wage in New Jersey, which raised the minimum from $4.25 per hour to $5.05 per hour. Krueger and Card found a subsequent increase in levels of employment.
How can increased wages lead to higher employment? Krueger and Card even compared the increase in employment to nearby Pennsylvania; New Jersey firms grew in size after the wage increase relative to their Pennsylvania counterparts. Wages increased, and yet employment did not fall. The notion flies in the face of standard economic thinking.
In other science disciplines, if the theory doesn't match the results, the theory is garbage. The eloquence of orthodox economic arguments does not mask this simple reality.
If economics is to consider itself a science, it must be able to predict what will actually happen in reality. Economists have widely debated Krueger and Card's study. The bottom line, however, is that changes in the minimum wage do not correspond to a consistent change in employment.
Nevertheless, in 2010 economists Dube, Lester, and Reich wanted to see if the new results were falsifiable, a key attribute of anything wanting to call itself "science." With a more advanced approach, the took down Economics 101 with one fell swoop: "We find strong earnings effects and no employment effects of minimum wage."
Further, despite constant clamoring of economic experts, unemployment in current America remains a nagging thorn. Although July's job report shows a drop in unemployment to 7.4%, this represents what we might call a "false positive." The fall in unemployment doesn't really inform in a meaningful way how the economy is doing.
Take for instance the fact the number of employees relative to the size of the population is the lowest its been in almost 30 years.
Credit: Business Insider.
While policymakers use the unemployment figure as a basis to suggest the economy is getting better, this just does not seem to correspond to reality. Wages have been falling in America for quite some time, but yet no policy has been taken to address the problem that less Americans are getting up for work everyday, and the ones that do are getting paid less.
Credit: This figure appeared in the May 26, 2013 edition of the Journal Sentinel.
This is not to blame economic woes on economists, but rather suggests there is so much variety of opinion its hard to say we really know anything about what is going on in the labor market. Theories need to adjust to empirical reality if we are to believe economic arguments. Lack of consensus on the effects minimum wage changes is only the tip of the ice berg. Maybe the fast-food workers should get a living wage.
Much of what we thought we knew about economics is being undermined by what goes on around us everyday. A more holistic approach, including the embrace of behavioral economics is needed for economics to secure legitimacy in the policy-making process.