Economic Science, The Fossil Fuel Divestment Movement and the Role of Universities in Political Debate

Students and Faculty at some universities are calling upon such institutions to sell investments in companies that extract or refine so-called "fossil fuels."  These advocates invoke scientific evidence purporting to establish that reliance on such fuels is causing "Global Climate Change," previously known as "Global Warming."  They also claim that, by investing in such companies, endowments are "funding climate change," and that divestment by various universities will visit economic harm on such firms, discouraging the production of such fuels.

Science is often a useful guide to Public Policy.  However, as previously explained on this blog (see here, here and here), so-called Progressives often reject the dictates of basic economic science when formulating policy recommendations or interpreting economic events. Unfortunately, proponents of such divestment have invoked science selectively.  The purchase of common stock traded on a national exchange does not "fund" that firm, which presumably issued the shares in question long ago in an initial public offering. Moreover, as Professor Todd Henderson at the University of Chicago Law School explains, divestment will not alter firms' stock prices and thus will not put financial pressure on publicly-traded firms.  Stock prices reflect "an estimate of the cash flow that ownership of the stock will produce in the future."  Moreover, sales by university endowments or other investors do not impact the demand or supply of coal or oil and thus have no impact on any firm's future cash flow.  Thus, as Henderson points out, after any divestment, the economic value of individual stocks will remain unchanged, and "others will stand ready to buy the shares at the current market price."

Henderson also explains how divestment will force schools "to accept lower returns than would otherwise be available" and thus deprive schools of much-needed endowment income.  As Henderson points out, Swathmore, with an endowment of $1.5 billion, estimates that such divestment would cost the school $20 million annually, or over $12,000 per student.  (See here for the size of Swathmore's student body.)  Thus, divestment would require schools to raise tuition significantly and/or substantially reduce the quality of their teaching and/or research.  So far as this author is aware, proponents of divestment have not identified alternate sources of revenue to replace that which would disappear following divestment.

It should go without saying that debates within the academy about institutional policies should consist of reasoned argument supported by evidence and logic. As the divestment movement spreads, Henderson has done Higher Education a useful service by reminding us that the economic logic behind much pro-divestment rhetoric does not withstand scrutiny.  Hopefully academic proponents of divestment will adhere to academic norms, heed the teachings of economic science, and develop alternative rationales to support their demands and/or channel their efforts to reduce carbon emissions in other directions.  Indeed, Henderson himself suggests that, in lieu of divestment, schools could "source their energy from more renewable sources[.]"  Presumably such re-sourcing would increase schools' energy costs --- otherwise schools would have already engaged in such re-sourcing simply to reduce costs.  In fact, many schools have already followed Henderson's advice, overtly investing resources in efforts to reduce carbon emissions for the sake of doing so, independent of whether such efforts reduce energy costs.

Should schools embrace Henderson suggestion and invest resources in reducing their carbon emissions?  This blogger respectfully disagrees with any suggestion that schools invest scarce resources in reducing their carbon emissions unless, of course, such investments produce net reductions in the school's energy costs.  Such investments necessarily divert resources from teaching and research, in service of ideological objectives entirely unrelated to the academic mission of a university.  As Henderson's colleague Geoffrey Stone recently explained "universities should not take ideological or political positions."  Moreover, as previously explained on this blog, a university that purports to provide a liberal education should not consider itself authorized to inculcate its students with the school's own version of moral or political virtue.  In the same way, such universities should not consider themselves authorized to expend scarce resources furthering ideological objectives unrelated to teaching and research.  Universities are not politically-oriented think tanks or service organizations. Instead, they exist to create and transmit knowledge, including knowledge about the existence, causes and possible cures for social problems like climate change.  Diversion of resources away from academic programs to unrelated projects hampers the achievement of this core mission and blurs the lines between research and education, on the one hand, and political activism, on the other.

The Minimum Wage As Economic Alchemy

 

 

Believed in (Chemical) Alchemy

 

 

Touts Economic Alchemy Instead

 

A few days ago President Obama issued an executive order requiring firms that provide goods or services to the federal government to pay employees working pursuant to such contracts a "minimum wage" of $10.10 per hour, substantially higher than the current federal minimum wage of $7.25 per hour. (See here for the story.)   The requirement will take effect slowly, over time, as new contracts are awarded and current contracts renewed in the ordinary course of business. 

The President also used the event announcing the order to advocate national legislation raising the minimum wage to the same level, $10.10 per hour, which he said, was "just like" what he had done with his executive order.  The President claimed that such legislation would "is not going to depress the economy.  It boost the economy [because] it will give more businesses more customers with more money to spend.  It will grow the economy for everybody."  (See here for a video of the President's remarks.)

Any parallel between the President's Executive Order, on the one hand, and the proposed increase in the national minimum wage is illusory.  Indeed, the juxtaposition of the two policies will help illustrate why raising the minimum wage applicable to private markets will, if anything, reduce overall employment and stunt economic growth.  Assertions to the contrary, as explained below, are reminiscent of arguments by alchemists that, with enough practice, humans could learn how to transform lead into gold. 
 

Take the Executive Order first.  Presumably such contractors will simply pass the costs of higher wages on to the federal government.  (The Secretary of Labor claims this will not be necessary, because paying workers more will increase their productivity.  But of course if this were true firms would increase wages voluntarily so as to reap such gains.).  The federal government, in turn, will spend more to receive the same services.  If one subscribes to the Keynesian macroeconomic paradigm, the net impact of such additional spending will depend upon the method of financing it.  For instance, the government could simply raise taxes or cut spending elsewhere, thereby offsetting the stimulatory impact of increased spending for the services provided by such contractors.  However, the government could finance such additional spending by borrowing, in which case the net impact of the Executive Order on aggregate demand could be positive, partly offset, of course, by the impact of higher interest rates resulting from more government borrowing.
 

What, though, about the proposed legislation raising the minimum wage to $10.10 per hour in private markets? Unlike federal contractors, other private employers cannot simply pass along the entire cost of higher wages to their customers who, after all, lack the power to raise taxes or issue ever-increasing debt.  Thus, as Nobel Laureate George Stigler explained long ago, basic price theory predicts that increasing wages by legislative fiat will reduce current employment. See George J. Stigler, The Economics of Minimum Wage Legislation, 36 American Econ. Rev. 358 (1946).   After all, firms will hire any employee whose marginal product equals or exceeds the prevailing market wage. At some firms, the marginal product of the firm's least productive employee will just equal or barely exceed the prevailing wage. Legislation that coercively raises the prevailing wage by a non-trivial amount will thus force some firms to pay one or more employees more than their marginal product, an irrational decision for firms free to lay off one or more workers. As a result, the minimum wage will cause some firms to discharge one or more employees, just as a state-imposed increase in the price of steel or electricity will cause firms to reduce their consumption of such inputs.  Thus, two economists recently estimated that a ten percent increase in the minimum wage would reduce employment among minimum wage workers by between two and four percent. See Eric French and Daniel Aronson, Product Market Evidence on the Employment Effects of the Minimum Wage, 25 J. Labor Economics 167 (2007).   Some individuals will lose their jobs altogether, while some will work fewer hours in the same jobs.  The President's proposal, of course, would raise the minimum wage by far more than that, namely, by thirty-nine percent.

Of course, some on the political left continue to resist the predictions of basic microeconomic science, claiming that raising the minimum wage will have little if any impact on employment for low wage workers.  A recent post by William Poole at the Cato Institute provides some additional confirmation of the predictions that some on the left reject, as if such confirmation was necessary.  In particular a recent paper for the National Bureau of Economic Research concluded, after surveying numerous studies of the impact of minimum wage increases, that such coercive increases reduce employment, particular for low-skilled workers.  Poole's post quotes from the abstract of the paper, which summarizes its findings:

"[T]he oft-stated assertion that recent research fails to support the traditional view that the minimum wage reduces the employment of low-wage workers is clearly incorrect. A sizable majority of the studies surveyed in this monograph give a relatively consistent (although not always statistically significant) indication of negative employment effects of minimum wages. In addition, among the papers we view as providing the most credible evidence, almost all point to negative employment effects, both for the United States as well as for many other countries. Two other important conclusions emerge from our review. First, we see very few - if any - studies that provide convincing evidence of positive employment effects of minimum wages, especially from those studies that focus on the broader groups (rather than a narrow industry) for which the competitive model predicts disemployment effects. Second, the studies that focus on the least-skilled groups provide relatively overwhelming evidence of stronger disemployment effects for these groups."  (emphases added).

Thus, minimum wage legislation will, to paraphrase the President, mean fewer, not more, "customers with money to spend."

One might still argue that raising the minimum wage will, despite these disemployment effects, still stimulate the economy.  After all,  raising the federal minimum wage will increase the income of some of those employees fortunate enough to keep their jobs.  Such increased wages may even reflect a more just remuneration for these individuals' hard work than a purely competitive market would products.  Perhaps increased spending by these workers will offset the reduced spending by those who lose their jobs.

Unfortunately, legislation that raises the minimum wage does not magically create the money necessary to pay those employees who retain their jobs higher wages.  If it did, Congress should increase the minimum wage to $25 per hour or more!   Instead, to pay higher wages, business must reduce their profits (assuming they have profits), increase their prices (and suffer reduced sales), or both.  In other words, even if one assumes away negative employment effects,  increasing the minimum wage is  a zero sum game.  Yes, some workers will have more money to spend.  However, businesses and their customers will have less money to spend.  To be sure, low wage workers may spend a higher percentage of their income than business firms or their consumers, but even this is not certain. After all, many minimum wage workers are members of middle class or even upper middle class households. Indeed, according to one study, a significant majority of minimum wage workers are in the middle and upper classes, with the result that low income individuals receive only a small fraction (fifteen percent) of the benefits of higher wages, even assuming no negative employment effects.

In short, basic economic science informed by empirical evidence predicts that increasing the minimum wage will reduce employment, thereby reducing the number of customers "with money in their pockets."  Moreover, additional spending by those employees who retain their jobs will not offset the combination of reduced spending by those who lose their jobs, businesses who see profits fall and consumers who pay higher prices.  Arguments to the contrary rest on some form of economic Alchemy, whereby legislation that does not increase output or income but instead reduces employment magically rearranges purchasing patterns of consumers and business so as to increase aggregate demand.   The theory of chemical alchemy did not work for Rudolf II (pictured above) who, as Holy Roman Emperor, subsidized research on the topic.  Nor will it work for President Obama and those members of Congress who vote for such legislation, once again rejecting economic science.  (See also here.)

One need not rely solely upon scientific theory to rebut the claim that increasing the minimum wage will stimulate the economy. After all, the Nation has in the past experimented with the manipulation of wages as a means of inducing economic recovery, and the results were not encouraging. In particular, during the Great Depression, Congress, via the National Industrial Recovery Act ("NIRA"), imposed so-called "Codes of Fair Competition," including minimum wages, on over 500 American industries.  By coercively raising wages, it was said, enforcement of the Codes would increase "purchasing power" and thus increase workers' demand for goods and services, stimulating the economy and counter-acting the Depression.

While the Supreme Court unanimously invalidated the NIRA in 1935, see Schechter Poultry v. United States, 295 U.S. 495 (1935), Congress doubled-down on this approach to macroeconomic stabilization,  passing the National Labor Relations Act that same year.    The Act, whose preamble asserted that free market wage setting had the effect of  "depressing wage rates and the purchasing power of wage earners" required private firms to allow employees to form unions --- labor cartels --- if they wished, as a means of increasing purchasing power and thus aggregate demand.   Three years later, Congress passed Federal minimum wage legislation as part of the Fair Labor Standards Act.

While there was some popular enthusiasm for these policies, those who knew better predicted they would make things worse.   For instance, a report commissioned by Columbia University concluded that the NIRA "would make for general impoverishment and would solve the problem of 'poverty in the midst of plenty' by removing the plenty."  See Economic Reconstruction: Report of the Columbia University Commission, 20 (1934).  Moreover, as previously explained on this blog, in an open letter to President Roosevelt, John Maynard Keynes argued that the NIRA probably impeded recovery and that FDR's sympathizers in England wondered "whether some of the advice you get is not crack-brained."  Henry Simons at the University of Chicago also argued, again in 1934, that labor unions and other monopolistic combinations exacerbated the Depression by artificially raising wages and prices.   See Henry Simons, A Positive Program for Laissez Faire (1934). 

Empirical research by economic historians confirms the prediction by the Columbia Report, Keynes and Simons.  For instance, President Obama's first Chair of the Council of Economic Advisers, Christina Romer, concluded that the NIRA raised prices and wages and thus slowed economic recovery. See Christina D. Romer, Why Did Prices Rise in the 1930s?, 59 J. Econ. Hist. 167, 187-93, 197 (1999).   More recently, two UCLA economists, Harold Cole and Lee Ohanian, concluded that various New Deal policies, including the NIRA and NLRA, both deepened and lengthened the Great Depression, particularly by artificially increasing wages. Indeed, these scholars conclude that these policies prolonged the Depression by seven years.  (See also pp. 1664-66 of this source summarizing the findings of Professors Romer, Cole and Ohanian.)

None of this is to say that States or even the national government should stand idly by while some individuals are unable to earn enough income to lift themselves and their families out of poverty.  Instead, in the opinion of this blogger, society should take steps to increase the rewards that individuals receive for work.  Fortunately, society has already put into place a mechanism to do just that, namely, the Earned Income Tax Credit.  Indeed, according to this tax calculator, an individual with two children who earned the minimum wage at a full time job would pay no federal income tax and also receive a $5,372 refundable tax credit in 2012.  The same individual would also receive $2000 in refundable child tax credits combined,  thereby increasing his or her effecive wage to over $10.00 per hour and household income by more than 40 percent.  It is thus no surprise that, in a 2013 Op-Ed, Professor Romer, mentioned above, endorsed increasing the Earned Income Tax Credit instead of increasing the minimum wage.  Such an approach would also help stimulate the economy, at least according the Keynesian paradigm, so long as the government borrowed the money necessary to pay for such increased spending.   Hopefully "cooler heads will prevail," and Congress and the President will follow Professor Romer's advice instead of clinging to economic theories that, like Alchemy, were debunked long ago.
 

Conservatives Embracing Science, While the Left Balks

Accepts Science 

Ditto

Rejects Science/Thinks He Knows Better

Senator Marco Rubio (R-Florida) and Pat Robertson, both pictured above, have made news recently, both embracing the scientific consensus that the earth is 4.5 Billion years old.   As Senator Rubio, a Roman Catholic,   put it:  "Science says (the earth) is about 4.5 billion years old.  My faith teaches that's not inconsistent. . . . God created the heavens and the earth, and science has given us insight into when he did it and how he did it."   Mr. Robertson, a Southern Baptist and the Chancellor of Regent University, put things this way:

"Bishop Ussher [who opined that the Earth was created in 4004 BC] wasn't inspired by the Lord when he said that it all [creation of the Earth and Man] took 6,000 years. It just didn't. You go back in time, you've got radiocarbon dating. You got all these things and you've got the carcasses of dinosaurs frozen in time out in the Dakotas.  They're out there. So, there was a time when these giant reptiles were on the Earth and it was before the time of the Bible. So, don't try and cover it up and make like everything was 6,000 years. That's not the Bible."

Mr. Robertson's remarks won the praise of national luminary "Bill Nye the Science Guy," who expressed hope that Mr. Robertson would continue to press his view on the age of the Earth.  Previously Mr. Nye had argued that the belief that the Earth is 6,000 years old "threatens science."

Unfortunately, some public officials still reject basic scientific teachings.  For instance, as previously explained on this blog, President Obama's repeated claim that tax cuts caused the recent "Great Recession" contradicts basic economic science of the sort taught to thousands of college freshmen each year in the United States and around the world.  More recently, Vice President Biden (pictured above) joined the anti-science chorus, claiming, again contrary to basic economic science, that tax cuts and increased spending during the G.W. Bush Administration caused the Great Recession.  Here's what the Vice President said, during his debate with Congressman Paul Ryan.  According to the Vice President:

"And, by the way, they [Republicans] talk about this Great Recession [of 2008-2009] as if it fell out of the sky, like, 'Oh, my goodness, where did it come from?' It came from this man [Congressman Ryan] voting to put two wars on a credit card, to at the same time put a prescription drug benefit on the credit card, a trillion-dollar tax cut for the very wealthy. I was there. I voted against them. I said, no, we can’t afford that."

Like President Obama's claim about tax cuts, Vice President Biden's claim that deficit spending caused the recent recession is economic nonsense, akin to a claim that the Earth is flat or the center of the Universe.  Just as there is a scientific consensus that the Earth is 4.5 Billion years old, there is a longstanding scientific consensus that increasing the deficit, whether by tax cuts, increased spending or both will stimulate aggregate demand, increase employment and increase the nation's real economic output.  See e.g. N. Gregory Mankiw, Macroeconomics, 296 (7th Edition 2010) (explaining how tax cuts increase the budget deficit and thus aggregate demand and national output); Rudiger Dornbusch and Stanley Fischer, Macroeconomics, 73-83, 401-11 (2d Edition 1981) (explaining how tax cuts and spending increases can increase aggregate demand and thus national output).  The only exception is for cases in which the economy is already at full employment.  In such cases, deficit spending cannot increase output but can only result in inflation.  However, so far as I know, no one contends that the economy was at full employment when, say, Congress enacted the so-called Bush tax cuts in 2001.  In the same way, the economy was at less than full employment when President Kennedy proposed across-the-board tax cuts in an effort to "get the economy moving again."

Of course, there are other reasons to oppose budget deficits and the resulting increase in the national debt.  For instance, government borrowing to encourage consumption can crowd out private investment, thereby partly (but only partly) offsetting any resulting increase in national output.  A nation could decide to forgo higher GDP in the short run in the hopes that, in the longer run, increased private investment will increase national productivity and thus potential national output.  But it bears emphasis that this argument against increased deficits assumes that such deficits increase national output, contrary to Vice President Biden's assertion.

Oddly the economics profession has been relatively silent in the face of this Administration's rejection of basic economic science.  To be sure, hundreds of economists endorsed Mitt Romney in the recent general election.  Six of these individuals were past recipients of the Nobel Prize in Economic Science.  However, so far as I know, no such economist has called out President Obama or Vice President Biden for their rejection of basic science.  This is surprising, because the rejection of economic science can have serious real world consequences for millions of ordinary Americans.  (Imagine if, instead, the President and Vice President claimed that vaccinations do not work or that smoking does not harm your health.  Surely the relevant scientific professionals would (properly) be up in arms.)

Perhaps the economics profession needs its own "Bill Nye the Science Guy" to shame public figures who reject basic economic science.