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Discovering Truths in Economics: Part II

Ideological blinders make it very difficult to seek and find some truths in economics. Consider, for example, the neoclassical economic prediction that an increase in the minimum wage will cause a loss of employment. This is a prediction almost universally believed to be true by neoclassical economists, and one that they claim is supported by hundreds of tests.

But in 1995, two prominent economists at Princeton University, David Card and Alan Kreuger, published a book, Myth and Measurement: The New Economics of the Minimum Wage. In this book, they subjected the neoclassical minimum wage prediction to the most rigorous testing ever done. They were helped in their tests by several ‘natural’ experiments. The minimum wage in the United States is set by Congress in accord with the terms of the 1937 Fair Labour Standards Act. However, the individual states are free to establish a state minimum wage higher than the federal minimum. In 1992, New Jersey increased its minimum wage above the national wage, while neighbouring Pennsylvania did not. This meant that, for minimum wage employers, such as fast food restaurants along the states’ common border, conditions would be pretty much the same except for the higher New Jersey minimum wage. That is, the situation could serve as a controlled experiment. The neoclassical theory predicts that fast food employment should be lower in New Jersey relative to Pennsylvania, as New Jersey employers laid off workers in response to the higher wage costs imposed by the new minimum wage. Put another way, employment growth should be slower in New Jersey fast food establishments than in those in Pennsylvania.

Using the most sophisticated statistical techniques available, Card and Kreuger found the opposite to be true: employment growth was higher in New Jersey, other things equal. Using other states and different data sets, they tested the neoclassical hypothesis repeatedly, never finding the neoclassical prediction to be correct. They reexamined previous minimum wage studies and found most of them gave similar results when done with better statistical devices. Most remarkably, Card and Kreuger found that professional journals in economics had practiced “selection bias”, tending to accept only articles that claimed to demonstrate that the neoclassical prediction was true.

Card and Kreuger, themselves trained as neoclassical economists, were shocked at the hostile responses to their book from mainstream economists. Within a few months, the Wall Street Journal reported that other economists had found Card and Kreuger’s conclusions unwarranted because their methodology was faulty. No one seemed to notice that the new study was funded by the fast foods lobbying group, a fact that should have immediately raised skeptical eyebrows. A perusal of current textbooks in labour economics shows that the neoclassical minimum wage doctrine is still presented as obviously correct, although Card and Kreuger’s book might receive some mention.

The difficulty in ascertaining the truth in economics is compounded by the power of what we might call the “monied interests”, the fast food industry in this case. Often the truth cannot overcome this power.

Consider another example. Since at least the years of the Reagan administration, powerful politicians, conservative commentators, and corporate leaders have been trying to convince us that the U.S. social security system should be radically changed. Its more fervent opponents want the system abolished, while more “realistic” enemies prefer a gradual privatization. Social security is a very popular program, and many recipients of funds from the various social security trust funds (in addition to retirement income, social security provides health care for the elderly, disability benefits, and child survivor’s insurance) would be financially devastated without them. This has led social security’s antagonists to resort to a host of false arguments. They have ignored critical data and made unfounded assumptions about the growth of the economy and the stock market to try to persuade people that the trust funds would soon be bankrupt and that today’s young people would be better off to eliminate the payroll taxes that fund the system and buy our own stocks and bonds.

Renowned neoclassical economists have lent intellectual support to the privatizers, none more prominent than Harvard professor Martin Feldstein. Feldstein has issued a barrage of articles, books, and op-ed pieces urging the abolition of social security. It is interesting to have a look at Professor Feldstein’s past. He became prominent in the 1970s for research he had done appearing to show that the social security program led the citizenry to save less money than they would have saved in the absence of social security. Feldstein argued that since a society’s ability to make investments (the production of capital goods) depends on its willingness to forego consuming goods and services (i.e. save money), his research implied that more investment and economic growth would have taken place had there not been a social security system. His findings matched his antipathy to social security (and all types of social welfare programs) and both no doubt attracted Reagan to him, since Reagan had been railing against social security for many years.

The new President made Feldstein the chairman of his Council of Economic Advisors. The Council of Economic Advisers was established by the Employment Act of 1946. Its function is to give economic advice to the president and to prepare the annual Economic Report to the President. Naturally a stint on the council helps an economist’s career, and often his or her pocketbook, immensely.

Two scholars at the Social Security Administration, the federal agency that oversees the system, asked Feldstein for his data. He sent it to them three years after they first requested it, and they went to work trying to replicate his results. They could not do this, and after a careful examination, discovered a computer program error in Feldstein’s original work. When they fixed this, they found that not only did social security not reduce savings, it actually increased them, something which others had also found but, lacking Feldstein’s political cachet, were not able to place clearly before the general public. Now, in a world in which the search for the truth is paramount, Feldstein would have been in some trouble, at least in the court of scientific opinion. However, his reputation escaped this scientific fraud (albeit inadvertent) unsullied. He returned to Harvard and has made lots of money as a consultant while remaining a virulent foe of social security. Not long after the barrenness of his research was revealed, he claimed to have reworked his data and achieved his original result.

The reason why false arguments and bogus research have survived in this case is not hard to find. The social security trust funds contain hundreds of billions of dollars. Wall Street wants this money, the largest pool of untapped reserves in the nation. Wall Street is home to the richest and most powerful business persons around, and they are using this power to promote a gigantic disinformation campaign to get their hands on the money. Economists like Feldstein are just willing, and well-paid, pawns in this enterprise.

Both of these examples illustrate a vexing problem for students who want to understand the economy. Not only are there technical difficulties. It takes skill to make useful assumptions and to trace out the logic of these assumptions to generate predictions. It is not easy to devise adequate tests of predictions. The definition of variables and the conversion of definitions into data present their own problems. But in addition to these formidable difficulties, the student also has to contend with the reality that in a capitalist economy, those who have the gold make the rules. They may obstruct the pursuit of truth, refusing to allow research that contradicts their interests to see the light of day or giving wide publicity to research that coincides with their needs. Economists, in turn, may either pander directly to the desires of the wealthy or they may become so enamoured with the elegance of their theory that they stop seeing the need to test hypotheses. Instead, they may come to accept the predictions themselves as the truth, acting in essentially the same way as a religious zealot. In either case, their careers are unlikely to suffer.

Readers then are advised to study economics with care. Be aware that not all research is what it claims to be. Be mindful that in economics the truth does not always win out. Understand that in economic matters, powerful private interests come into play. Above all, be skeptical. Your own beliefs, the predictions of economists, and every statement in my book must be put to the test.

By Michael D. Yates
Economist, Labour Educator and Assistant Editor of Monthly Review, New York.


REFERENCE Extracted and adapted from Yates, Michael D. 2003. Naming the System: Inequality and Work in the Global Economy. Monthly Review Press. New York.
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