Newsflash:Economic Policy is Hard

I am paraphrasing our President in the title obviously. At the point of making too much of a political observation, the President’s comments about insurance could be expanded into many other areas so I cut to the chase and suggest the larger lesson learned should be economic policy in general is not easy.

Why is this the case? This seems to be a relevant question for the times. Whether we are talking about health insurance, tax, trade, the relevant issues are complicated, no matter which political party promised you an easy solution. Easy solutions exist, but only rarely, and I find those espousing economic policy ideas as assuredly leading to definitive outcomes rarely considered the full range of possibilities along the way. There is something worse though. I find it more problematic when people consider possibilities but remove them on shaky grounds. Being willfully ignorant of a likely issue is a bigger problem than failing to consider it. That is my take, and I am sure others have different opinions on the matter.

Policy matters and is vitally important. With this post I am not arguing we should not have economic policy. I view this more as a plea for economic policy that is better thought out and less reliant on strictly dogmatic approaches to economics or worse, political and social preconceived notions masquerading as economics. As an example, think of minimum wage policy in Grand Forks.

The announcement of an increased minimum wage sent many callers to the phones to talk with me on my Jarrod Thomas Show radio time. Such a policy would surely lead to rising levels of unemployed all across the state. I was doubtful of that and had to discuss the issue multiple times and at some length. (This last comment is not really a complaint, though I recognize it sounds like one.)

A principles of microeconomics class where there is one labor supply and one labor demand curve could be made to show this would increase unemployment, but that is not always the case. Relevant questions here include:

  1. Is the minimum wage level above the equilibrium market wage in the local economy?
  2. Is there really only one labor supply and one labor demand curve?

Equilibrium Wage Levels

The minimum wage is only an issue for unemployment when the minimum wage level ends up being above the market wage level. The minimum wage is a price floor, a legal lower level for the wage, below which you cannot pay. So if the market already wants to pay people more than this does not really matter, the market can clear and there is no extra unemployment that results from the wage policy. The bigger issue is from our second question.

One Curve?

This is probably the biggest issue with attempting broad generalizations about the outcome of minimum wage policy. (It really is the issue with attempts to make generalizations about policy ideas in general too.) There really is not one, and only one, labor supply curve for Grand Forks, for North Dakota, or any area you want to consider. At a very real level we could think of labor supply and demand existing for all types of jobs, but we will still abstract away from that situation for our purposes in this post. What if we just thought about a market for high-skilled labor and one for low-skilled labor? Then we are talking about a set of supply and demand curves for labor in each. It is conceivable the minimum wage law is a binding price floor in the low-skilled market and not the high-skilled. This makes judging the impact of the law very interesting.

Brining the discussion back to the bigger picture facing Congress, the President, and really the entire US right now: Economic policy is not easy and you really need to define your areas of impact clearly and precisely. Unfortunately this is not enough too. Consider the issue of tax policy that will be undertaken at some point. (At the time of this writing the discussion seems to be Congress returning to the issue of healthcare policy). When you change taxes you actually change the various payouts individuals and companies experience associated with their activities. At a real level you change the incentives people and companies face. This seems to be overlooked by policy writers far too frequently, and I am not suggesting these changes are always bad. In the past I advocated for North Dakota to drop the income tax, as you remove a potential disincentive associated with working.

Over time people respond in what we economists generally think of as a “rational” manner. In the short run individuals may deviate from this or a combination of policy adjustments exhibit compound effects creating unanticipated net changes. Generally though, rational behavior wins out, which is why people are not wrong for thinking about labor supply and demand, but they need to ask if that replicates reality enough that you can trust the outcome of that model’s predictions.

If it is worth doing, it is worth doing right. Economic advisors (and I am not one) need to do a better job discussing the nature of policy outcomes and stop selling ideas as if they are going to always lead to the most desired outcome of the party paying their bills. At that point we can have a meaningful discussion of policy, rather than the seesaw outcomes we have now depending entirely on the party in power at the time.

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