Real Clear Politics
By Edward Conard | December 31, 2014
With oil prices plunging below $60 a barrel, the U.S. economy growing at an annualized 5 percent last quarter, and the Dow soaring above 18,000, it’s easy to overlook academic research published in 2014 that will likely have a lasting impact on economic debate. In particular, a half-dozen highly credible studies debunked widely-held economic myths. Each of these studies illustrate the need to confront wishful thinking with a great deal of skepticism.
The year began with Harvard’s Raj Chetty and Emmanuel Saez, of the famed Piketty and Saez duo, publishing a landmark study on U.S. economic mobility. They concluded: “Contrary to the popular perception, we find that percentile rank-based measures of intergenerational mobility have remained extremely stable for the 1971-1993 birth cohorts.” In fact, “the probability that a child from a low-income family [e.g., the bottom 20%] reaches a fixed upper income threshold [e.g., $100,000]…has increased.” Were mobility declining, it could be construed as evidence of rising cronyism.
In April, Thomas Piketty published the English version of his book Capital in the Twenty-First Century, in which he tried to create a new myth, namely that cronyism has created a self-perpetuating accumulation of wealth that will compound faster than the economy, substitute for labor, and exert downward pressure on wages. While Paul Krugman described Piketty’s theory that cronyism has predominantly driven the accumulation of capital as “an intellectual sleight of hand” and Larry Summers described Piketty’s theory that capital can produce a higher return than the economy’s growth rate independent of the supply and demand for capital as a “misreading of the literature,” two studies did the heavy lifting.
Four French economists published a paper in May that challenged the basis of Piketty’s argument—that productive capital is accumulating faster than GDP. They concluded: “[Piketty’s] result is based on the rise of only one of the components of capital, namely housing capital…‘Productive’ capital, excluding housing, has only risen weakly relative to income over the last few decades…Over the longer run, the ‘productive’ capital/income ratio has not increased at all.”
Later in the year, Tino Sanandaji scrutinized Piketty’s sources and concluded: “Piketty…cites the relevant research on top earners incorrectly…‘Hierarchical relationships’ and ‘relative bargaining power’ do not explain rising top incomes in America…because the largest segment of the group Piketty calls ‘supermanagers’ do not work in hierarchical organizations to begin with— they are business owners running their own firms. The earnings of business owners are determined by market forces and equity prices, not bargaining with their ‘hierarchical superiors’…In 2010, self-employed business owners account for an astonishing 70 percent of the wealth of the top 0.1 percent…Salaried corporate executives are too few in number to account for more than 2 or 3 percent of the earnings of the top 0.1 percent. CEOs with excessive compensation packages negotiated in smoky rooms are an easy target, but they do not constitute an economically significant group.” Soon after, Paul Krugman admitted: “I’m actually a skeptic on the inequality-is-bad-for-performance proposition…[I’m] worried that the evidence for some popular stories is weaker than I’d like.”
Just in time for “Equal Pay Day,” Claudia Goldin, one of Harvard’s renowned labor economists, found that, beyond the lower-paying professions women tend to choose-e.g., social work rather than computer programing-differences in cumulative career hours worked accounts for the remaining gender pay gap. Goldin concluded: “In many occupations earnings have a nonlinear relationship with respect to hours. A flexible schedule often comes at a high price, particularly in the corporate, financial, and legal worlds.” In professions, like pharmacology and computer programing, where working part time or taking time off does not diminish productivity, Goldin found little, if any, gender pay gap between comparable workers.
In June, another of Harvard’s renowned labor economists, George Borjas, published Immigration Economics, which confronted the hard-to-believe claim that immigrant high school dropouts complement native high school dropouts by performing work that Americans refuse to do. Borjas finds that where immigration increases the number of workers in a skill group by 10 percent, it reduces wages by 4 percent. Rather than claiming that immigrants perform work Americans are unwilling to do, perhaps it is more accurate to say they perform tasks at wages Americans are unwilling to take.
As the year drew to a close, Jeffery Clemens and Michael Withers, both from the University of California-San Diego, published a study that used data from the Survey of Income and Program Participation to track the employment and earning histories of individuals most affected by increases in the minimum wage. Their approach contrasted with prior studies that examined groups of workers which contain individuals affected in varying degrees—fast-food industry workers, for example, where some workers earn more than the minimum wage. This approach allowed for more careful comparisons between more- and less-affected workers. The study found that increases in the minimum wage over the last 10 years have reduced employment among low-skilled workers 6 to 9 percentage points and subsequently reducing the chances of low-skilled workers transitioning to lower-middle class employment (i.e. $1,500 of monthly income) 3 to 4 years hence by 25 to 50 percent.
The study also found that employers replace lower-skilled low-skilled workers with higher-skilled low-skilled workers when minimum wages rise. These offsets mask reductions in the lowest-skilled workers, especially in studies of industries that employs both types of low-skilled workers, like the fast-food industry.
Our desire to help others is a powerful instinct, especially when we can help without significant cost to ourselves. We are eager to believe that we can help disadvantaged workers by raising minimum wages, even though the law of supply and demand counsels us otherwise. We are quick to deny immigration’s adverse effect on low-skilled wages. We are keen to believe we can raise the wages of women despite employers logically hiring lower-priced women to do the equivalent work of men until they are no longer available. We are inclined to believe the gains of those more successful than ourselves are ill-gotten and therefore can be taxed and redistributed without diminishing incentives to take entrepreneurial risks that grow our economy, even though entrepreneurialism and employment growth are greatly diminished in Europe and Japan where incomes are more equally distributed. Each of these studies show us that we should confront our wishful thinking with a great deal of skepticism. That’s a New Year’s resolution worth making.
Edward Conard; Author, Unintended Consequences: Why Everything You’ve Been Told About the Economy is Wrong; Visiting Scholar, American Enterprise Institute; former partner, Bain Capital