Tapu Misa: Dealing with economic realities

Labour leader Phil Goff. Labour pledged to raise the minimum wage to $15 an hour. Photo / Mark Mitchell

It's always a good tactic to imply your opponents are dimwits who don't understand economics, as John Key did last week after Labour pledged to raise the minimum wage to $15 an hour.

That's after claiming 6000 people would be put out of their jobs as a result of such a rise, and that the Department of Labour had said so - which wasn't quite true.

The department had actually predicted a potential loss in job growth of between 4280 to 5710 jobs. This was based on a theoretical model, which may or may not be more accurate than a crystal ball. "It is not straightforward to estimate the impact on unemployment," it said cautiously.

Which was a long way short of the kind of cast-iron certainty that Key was conveying. "If anyone thinks we can just magically increase the minimum wage with no implication on either labour markets or costs to the employers," he said, "they don't understand basic economics."

If minimum wage proponents are out of touch with reality and don't understand economics, they're in good company.

Since the global financial crisis, I've wondered if even economists understand what Thomas Carlyle called "the Dismal Science".

As Brad DeLong, economics professor at the University of California, Berkeley, said recently, economists "are now looking back at our opinions and analytic judgments and statements and pronouncements of the past 15 years and thinking: 'How could I ever have been so stupid; how could I have missed so much?' - it is a bad time to be an economist."

How did economists get it so wrong? Nobel economics laureate Paul Krugman suggests his profession went astray because they "mistook beauty, clad in impressive-looking mathematics, for truth. Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. Unfortunately, this romanticised and sanitised vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets - especially financial markets - that can cause the economy's operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don't believe in regulation."

Modesty hasn't been a defining characteristic of economists. Yet, as Chris Worthington noted in the Herald recently, it's hard to forecast the economy a year into the future, let alone 30 years ahead. Confounding the economist's tidy formulae are those endless variables. It's hellishly difficult, too, to prove cause and effect.

"So even if our country was run by a dictatorship of macroeconomists, with unlimited power to make politically unpopular decisions to deliver long-term gains, there seems little guarantee that the optimal policy prescription would add much, if anything to trend economic growth."

It would be nice to think that economists had become more humble about the limitations of their field.

Yet economic myths (that tax cuts lead to growth, or magically "pay for themselves") continue to be trotted out as scientific truth, rather than articles of faith.

So what's the truth about minimum wage increases and the effect on employment? It's a lot more complicated than Key suggests.

The international evidence is mixed, as the Department of Labour noted in its advice to the Government.

It's true that most economists have believed that higher minimum wages invariably reduce employment among low-paid workers.

A number of US studies from the 1970s had suggested a significant negative link between the minimum wage and youth employment.

But more recent studies have undercut the conventional view, and questioned the evidence on which it was built.

One large study which analysed 64 US minimum wage studies found not only that there was bias in the selection of published studies towards those which showed negative effects on employment, but that once the bias was removed there were actually positive effects. Probably the strongest and most influential challenge to the traditional worldview came from the work of David Card and Allan Krueger, whose wide-ranging analysis of minimum wage increases in the US in the late 1980s and early 1990s turned conventional economic wisdom on its head and suggested, as one economist wrote, "that economists know less about what the invisible hand is up to than they let on".

In New Zealand, a study in 2007 by Dean Hyslop and Steve Stillman which looked at the effect of increases of between 41 per cent and 69 per cent in the youth minimum wage found "no major robust evidence of adverse effects on youth employment or hours worked", in fact, there was an increase in hours worked for those aged 16 and 17.

There isn't the space here for an exhaustive discussion of the research, but what is clear is that recent evidence is forcing a rethink about what was once accepted economic wisdom.

But while the debate rages about the negative impact a minimum wage increase might have, there's no doubt about the good it will do: it will put more money in the hands of the struggling low-paid, and lighten the load on Working for Families.

Tapu.Misa@gmail.com