The Age of Confusion; M. Skousen

-Milton Friedman, interview in Reason, June 1995 I s the economics profession moving to ward consensus or away from it? In a recent interview in Reason magazine, Pro fessor Friedman happily proclaims that most economists agree on certain funda mentals. "You won't find much difference of opinion on the proposition that raising the minimum wage will cost jobs. You won't find much difference of opinion on the de sirability of free trade." I wish Professor Friedman were right, but unfortunately, I'm afraid the profession is moving further away from consensus to ward an Age of Confusion. Judging from recent conflicting studies, they apparently can't even agree on the evils of the minimum wage and protectionism. Will increasing the minimum wage cost jobs? Economic theory asserts that if you raise the cost of labor, the demand for workers will decrease. Yet in a recent study of the minimum wage at fast-food restau rants in New Jersey and Pennsylvania, economists David Card and Alan Krueger claim just the opposite. Surprisingly, they conclude, "We find that the increase in the minimum wage increased employment." 1 Both teach at Princeton University, and Professor Card was recently honored with the John Bates Clark Award for the most outstanding economist under the age of 40.

The article has created a furor, however, with counter-studies questioning the reli ability of the Card-Krueger data, which was based entirely on telephone interviews with Dr. Skousen is an economist at Rollins College, Winter Park, Florida 32789, and editor of Fore casts & Strategies, an investment newsletter. by Mark Skousen restaurant managers. A similar study based on actual payroll records contradicts the Card-Krueger conclusions. 2 Nevertheless, the Clinton administration's support for an increase in the minimum wage is based in part on the controversial Card-Krueger study. Academic economists are also taking pot shots at another sacred cow, the virtue of free trade. A recent work by Paul Bairoch, professor of economic history at the Uni versity of Geneva, claims that protectionism is not at all bad and in fact has generally had a positive impact on economic growth. After surveying the relationship between tariff rates and GDP data for industrial nations since 1846, he asserts that many industrial nations often suffered recessions when free trade was adopted and recovery when pro tectionism was imposed. Great Britain is the only major exception, he notes. 3 The Flaw in Empirical Studies The problem with these historical studies is not just the data, but the whole issue of linking one set of data with another. In logic, it's known as the post hoc ergo propter hoc fallacy. Just because one observation oc curs at the same time as another doesn't necessarily mean one causes the other. It is sheer folly to isolate one factor among the complex mix of factors playing a role in economic activity. Correlation does not mean causation.

For example, several years ago, in the 527 528 THE FREEMAN • AUGUST 1995 midst of a recession, the state of Utah raised taxes. Since then, the economy has boomed. Did the tax increase cause the recovery in the Utah economy? In fact, it was outside forces that stimulated economic growth-in particular, a huge transfer of people and wealth from California to Utah and other Western states. Earthquakes, bad weather, crime, taxes, and a host of other problems caused Californians to flee the state. California's loss was Utah's gain. In other words, Utah recovered in spite of, not because of, the tax increase. No doubt Utah's economy would have grown faster had it not raised taxes. The debate over deficit spending is an other example of the post hoc fallacy. Sound economic theory states that deficit spending by the federal government raises interest rates and crowds out private investment, thereby retarding growth. Yet apologists for the deficit, including some supply-siders, use the 1980sto repudiate this view. During the 1980s the deficits ballooned but interest rates fell. Therefore, they argued, deficits don't matter.

They miss the point. Crowding out still took place. The economy could have grown significantly faster in the 1980s if govern ment spending had been cut sharply, elim inating the deficit and even running a sur plus. Interest rates could have fallen much more than they did, thereby stimulating more growth. The Battle Enjoined Back to the minimum wage issue. Even if we accept as valid the data from Messrs. Card and Krueger, how. is it possible for employment to rise following an increase in the minimum wage? One possible expla nation-and I emphasize the word "possi ble" because there could be a variety of explanations-is that New Jersey raised its minimum wage in early 1992,just when it was emerging from a recession. A suf ficiently strong recovery in the New Jer sey economy could easily -mask the ill effects of an 18 percent jump in the mini mum wage. Similarly, in Professor Bairoch's defense of protectionism, the fact that Great Britain is a glaring exception to his thesis demon strates the complexity of the issues in volved. Interestingly, he chooses the period 1870-92 in the United States as his best example: the U.S. increased its protection ism while· enjoying one of the most rapid periods of growth in its history. Yet he forgets that 1870-92followed after a devas tating civil war, where no growth occurred at all and over 600,000 soldiers lost their lives. During the postwar environment, the federal government shifted from an infla tionary greenback period to a gold standard, interest rates fell sharply, the population grew rapidly, transportation exploded, and manufacturing output increased dramati cally. How can Professor Bairoch tie tariff legislation to the vast changes in economic activity during this period, especially given the relatively small role of foreign trade in U.S. output?

Beware of False Relationships The above challenges to free-market fun damentals demonstrate a serious flaw in the way some economists conduct their re search. As I have shown, trying to prove or disprove a theory through empirical obser vation is highly problematic. It was Ludwig von Mises who first raised this fundamental methodological issue. "The truth is that the experience of a complex phenomenon . . . can always be interpreted on the ground of various antithetic theories."4 Laboratory experiments are proper in the physical sciences, but they are practically impossible to duplicate in economics. His tory cannot prove a theory, only deductive logic can. D 1. David Card and Alan B. Krueger, "Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania," American Economic Review (September 1994), p. 792. 2. Richard B. Berman, "Dog Bites Man: Minimum Wage Hikes Still Hurt," Wall StreetJournal, March 29, 1995.

3. Paul Bairoch, Economics and World History: Myths and Paradoxes (University of Chicago Press, 1993), pp. 44-55. 4. Ludwig von Mises, Human Action, 3rd ed. (Regnery, 1966), p. 41.