Divine coincidence? By Scott Sumner

Some of my progressive friends argue that markets are not efficient because information is a public good. Thus research in equity values will be under-provided. Others argue the financial sector is inefficient because greedy Wall Street types convince the gullible public to pour money into expensive managed funds, which underperform indexed funds. Thus investment analysis will be over-provided.

I sometimes say that both are wrong, because these two inefficiencies exactly cancel out. (I usually have a twinkle in my eye, when making this claim.)

Matt Rognlie is a grad student who occasionally leaves comments in various blogs. His typical comment is usually more interesting than the average published paper in an economics journal. I particularly liked one he left after a post by Nick Rowe discussing Larry Summers advocacy of minimum wages on “efficiency wage” grounds. (The basic argument is that a minimum wage may boost worker productivity, and thus not cost jobs. Although it’s a bit more complicated than that.) Here’s Rognlie’s comment:

The Summers claim doesn’t hold up very well empirically either: most studies show roughly 100% pass-through of higher minimum wages to prices. This means that the “second-order effect on total costs” argument doesn’t hold when wages are increased across the board (presumably because of the fallacy you’re pointing out) — unless, for some reason, firms consistently pick the moment of a minimum wage increase to inflate their markups. This reflects an interesting internal tension among minimum wage advocates in economics. If clean identification is the standard, they have the empirical high ground on the direct policy question — “do minimum wages decrease unemployment?”. But once we move from direct estimates to the underlying mechanisms, very few of the ideas floating around have any empirical support, and most of them can easily be rejected. Neither the Summers story nor the simplest variant of the monopsony story (which would imply that a binding minimum wage lowers marginal costs) seem consistent with full pass-through to prices. Or, to take another example, search-based monopsony requires that marginal recruitment costs increase dramatically with the scale of a firm’s employee base — which is hard to rationalize either anecdotally or using the formal evidence in the literature. So it’s an amusing contrast. By prevailing standards, the minimum wage itself has great empirical support — but then pretty much every single explanation that’s offered to rationalize these findings crashes and burns when you subject it to data and a little light theory. An even more subtle but telling case of this disconnect is the following. The current empirical consensus among mainstream labor economists is that the employment effects of the minimum wage are close to zero. But most of the economic arguments offered to explain this finding do not specifically rationalize the zero — instead, they suggest some force that pushes opposite the traditional supply-and-demand logic, and could in principle offset it by 50% or 150%, rather than just 100%. In general, if X is some positive value and Y is some negative value — with no a priori relationship between the magnitudes — it’s a remarkable coincidence for X+Y to always come out near zero. Yet, if we substitute “the traditional downward-sloping component of labor demand” for X and “the added effects of search-based monopsony” for Y, that’s exactly what the minimum wage consensus seems to believe. After all, cleanly identified studies aren’t giving sizable negative estimates in some settings and sizable positive estimates in others — they’re basically just giving zeros. (Of course, one advantage of the Summers hypothesis is that — when drawn out under some very particular assumptions — it could explain a consistent zero. I’m curious whether this view is currently popular, despite its obvious other failings, because smart economists like Summers realize this advantage. My guess is no, and that this is all a little too subtle. It will take a while for everyone to realize that proposing a negative Y to offset the neoclassical X isn’t good enough — you also need to explain why Y is so consistently of a magnitude that cancels out the neoclassical X. Or else you need to acknowledge that your point estimates might be driven by attenuation bias a la Sorkin, and that the Credibility Revolution isn’t always and everywhere as credible as it purports to be.)

And as if that’s not enough, he also left several other extremely interesting comments, later on in the comment thread. I’d encourage people to read all of them. (Warning, some of his comments are a bit difficult if you haven’t studied economics.)