(Bloomberg Opinion) -- Economics 101 is the name many colleges and universities use for their introductory undergraduate economics course. It’s also shorthand for the ideas at the heart of classical economics as they have been taught for generations. Some economists think it needs an overhaul. Michael R. Strain and Noah Smith, both professional economists and Bloomberg Opinion columnists, debated its strengths and weaknesses.
Michael R. Strain: Economics 101 matters. The standard introductory class for college students, and its textbooks, shapes the way millions of people think about markets, the economy and society. Indeed, they serve as the only formal exposure to economics for most people in a variety of professions.
Econ 101 kicked open a door in my mind that has never closed. In my view, it is filled with intellectual treasures that have great predictive power, are supported by data and are often right. I use that formulation because you recently wrote on Twitter that none of those things are true. I disagree with you. The theories of opportunity cost, incentive responses and thinking at the margin are just three examples of deep insights into human and social behavior that freshmen are taught in introductory economics.
You have long been critical of Econ 101. Why?
Noah Smith: We have to distinguish between actual introductory econ courses and the ideas that the public casually refers to as Econ 101.
When people say “Econ 101,” what they often mean is the theory of supply and demand. When it comes to labor markets — the biggest and most important market in the economy — that simple theory has failed dramatically. An increasing amount of data shows that companies have a lot of power to set wages lower than a competitive market would dictate. That has important implications for policy, since it means that minimum-wage laws will cause much less unemployment than the supply-and-demand theory would predict. This is only one example of many.
Does this mean Econ 101 failed? Only in the colloquial sense. A good introductory economics course will teach the theory of monopsony power as well as supply and demand — and in fact, most do.
MRS: I’m happy to focus our discussion on the 101 model of the labor market. I find it astounding that you argue it has “failed dramatically.” The model argues that companies demand labor services in order to make profit, and that workers supply their labor services in order to earn income. Wages adjust to balance supply and demand, and wages correspond to the value firms receive from workers.
Rather than a dramatic failure, this simple model has an incredible ability to explain very complex phenomena. Take income inequality. The model predicts that as the demand for higher-educated workers increases — due, for example, to advances in technology that make those workers more valuable to firms — their wages will increase. The wage gap between higher- and lower-educated workers — inequality — will therefore increase. But if the supply of workers with more education also increases, then inequality growth will slow.
In a 2014 paper, economist David Autor wrote: “This supply-demand explanation for the rise of U.S. inequality may appear almost too simple to be credible.” Then he explained, “But a host of rigorous studies … confirm the remarkable explanatory power of this simple supply-demand framework for explaining trends in the college-versus-high-school earnings gap over the course of nine decades of U.S. history.”
The model doesn’t explain everything. But if it did, it wouldn’t be a model — it would be reality.
NS: David Autor is a brilliant economist, but I’m not sure what he’s saying supports your case. First of all, Autor’s measure of “demand” in that 2014 paper is simply a time trend — in other words, he assumes that demand for college-educated workers is rising, instead of actually measuring it. Thus, the fact that his so-called model fits the upward trend in the college wage premium is hardly a surprise! But it doesn’t tell us much.
Second, we’re talking about two different models here. The simple theory of labor supply and demand that I described above involves only one type of worker, not two. In this theory, raising the minimum wage will throw a bunch of low-skilled workers out of their jobs. But all of our best evidence shows that this just doesn’t happen very much, if at all. Minimum wages tend to have only a small effect on employment — and, in fact, they occasionally even increase it. That’s a big failure for the supply-and-demand theory, and a win for monopsony power theory — which any good Econ 101 course should also teach.
As for Econ 101’s other insights, they provide a framework for thinking about the world. But mental frameworks can often lead us astray unless we remain grounded by hard data. Thus, I think Econ 101 classes should include empirical analysis.
MRS: Some — not “all” — of our best evidence suggests that minimum-wage increases do not reduce employment. The nonpartisan Congressional Budget Office is a critical referee in policy debates. They released a report this summer arguing that a $15-per-hour federal minimum wage would cost over 1 million jobs. According to the CBO, a $12 minimum wage would cost several hundred thousand jobs, as well.
In a 2018 paper with economist Jeffrey Clemens, I found that recently enacted and relatively large minimum-wage hikes reduce employment. But I also found some evidence that smaller increases might be associated with employment gains. It may be that during an economic expansion, firms can absorb small increases in the minimum wage through other channels, including raising prices. So the higher minimum pulls more workers into employment than it pushes out.
Does this invalidate the supply-demand model? Just the opposite. The basics of supply and demand are critical to making sense of the empirical finding.
But since you keep pushing “monopsony” as the superior model for college freshmen, let me turn the tables on you. The 101-level monopsony model predicts that raising the minimum wage will typically increase the number of jobs. Is that what you think we should expect? The basic monopsony model also predicts that employment will fall in the face of large minimum-wage hikes. How do you reconcile that prediction with your enthusiasm for it replacing supply-and-demand?
NS: The Congressional Budget Office study that you cite gathered a large number of studies, many of them old and outdated, and many of which did not use reliable methodologies. A 2018 paper by Kevin Rinz and John Voorheis of the Census Bureau, using the best available data and the most modern statistical methods, finds no detectable effect of minimum wage hikes in general.
As for your own paper with Clemens, it seems to back up my argument. In that paper you suggest that small increases in the minimum wage may actually raise employment. That implies there’s more than supply and demand going on, and we need to understand power in order to understand the labor market.
The fact that employers have significant power over their workers has plenty of consequences for how we regulate labor markets, not just in terms of minimum wage, but regarding unions, antitrust law and many other policies. Supply and demand just doesn’t cut the mustard here.
And that means we should stop referring to supply and demand as “Econ 101.” Good Econ 101 classes already include alternative theories that often work better. Our rhetoric needs to catch up with the textbooks.
To contact the editor responsible for this story: Jonathan Landman at jlandman4@bloomberg.net
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Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and resident scholar at the American Enterprise Institute. He is the editor of “The U.S. Labor Market: Questions and Challenges for Public Policy.”
Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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