The Price of Government Policies

The concept of unintended consequences happens everywhere in life. These consequences can take form as a drawback or can sometimes be surprisingly beneficial, but by its definition each consequence results from a purposive action. When individuals experience unintended consequences, rarely do they come close to the amount of harm that can be done by the unintended consequences of governments. Government policies, to their credit, usually have good intentions in mind; but good intentions don’t necessarily mean good outcomes, and indeed, they often mean the opposite.

Recently the Seattle city council passed a ban on plastic bags for environmental reasons, but what they didn’t expect was an increase in shoplifting. With reusable bags entering the stores more frequently, shoplifting became easier for thieves and much harder to track for storeowners. 

While this event only affects a small group of people, let’s take a look at a few devastating examples in history:

1)   The Dodd-Frank Act. With good intentions in mind, its unintended consequences have put US corporations at a competitive disadvantage with foreign firms, costing American jobs.

2)    Limits on free trade. For example, the US government has placed quotas on imports of steel in order to protect steel companies. The results: less cheap steel meant higher prices for automakers, putting them at a disadvantage with foreign companies.

3)   Social Security. In addition to it’s financial flaws, economist Martin Feldstien suggests that the economy would grow much more quickly without social security. Knowing that they will receive social security, workers save less for their old age. That means less savings are available and less investment takes place, thus leading to an economy that grows slower than it otherwise would.

4)   The Federal Reserve Act. While its intention was to stabilize the monetary system, its reality has been a devaluation of our dollar.

5)   Sarbanes-Oxley Act. Its intention was to set new or enhanced standards for public company boards, management and public accounting firms. The results: it provided an incentive for small US firms and foreign firms to deregister from US stock exchanges. 

A few more recent examples:

1)   Financial transaction taxes. Goal: eliminate wasteful trading and reduce market volatility.  Three democrats recently introduced legislation to institute a tax on financial transactions, but seem to have forgotten the lessons that can be learned from New York and Sweden on its unintended consequences. What happened in New York was actually an increase in the cost for capital for investors and an increase in trading volatility by 10%. 

2)   The housing bubble. The push for “affordable housing” caused government created institutions, Fannie Mae and Freddie Mac, to buy up sub-prime loans and securitize them. More and more risky buyers who otherwise would not have been able to receive a loan were able to become homeowners. The housing bubble burst as homeowners, who were risky borrowers to begin with, were not able to pay off their mortgage. As a result, foreclosures ran rampant and the price of housing started to plummet, which lead to the current recession.

The list could go on and on, but the point is that when governments make regulations and rules in order to design an economy to their liking, the unintended consequences can be devastating. Governments ignore the concepts of individual preferences and human nature, and it’s us, the citizens, who have to pay the price for it.

"The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."- FA Hayek

Minimum Wage, Maximum Folly

A few of my thoughts on an age-old argument (I could probably write on this all night...)

Minimum wage laws sounds like a good idea. I mean, who would be against guaranteeing someone a fair, living wage?! But like most economic issues, there’s more to it than what meets the eye.

Starting off with a simple supply and demand model for the labor market, we can see that a price mandated above the equilibrium price and quantity (called a price floor in econ terms) results in a shortage. That is, the amount of people who are willing to work at that price exceeds the amount of jobs that employers are willing to provide at that price. Herein lies the main problem: based on the simplest model taught in econ101, minimum wage laws are predicted to cause higher unemployment.

So why don’t we see our unemployment numbers skyrocket after the minimum wage is increased? After all, the minimum wage in many states rises quite frequently, albeit in small intervals. We seem to be caught in a vicious cycle. One in which inflation rules the game.

Many proponents of increasing the minimum wage support the idea of matching the new base wage to the current rate of inflation (called indexing).  Since your purchasing power goes down if your paycheck remains the same while inflation increases, this would make sense. But that’s only one side of the story.  An increase in the minimum wage increases the costs of production. With increased costs of production, producers must raise their prices (technically there’s another option where the company absorbs the costs, but realistically you should expect an increase in prices). This would cause an increase in the general level of prices, bringing us back, full-circle, to inflation (economists call this cost-push inflation).

So what we’re not seeing is a huge difference in unemployment because of minimum wage laws, but what we are seeing are unintended side effects. I should note, however, that minimum wage laws do cause a small amount of unemployment, particularly among teenagers; but like the small increases in wage, the unemployment numbers are also quite small.

With minimum wage increases causing an increase in the general level of prices, we seem to be sitting back at square one, just with higher prices. But wait, there’s more. My bold statement of the day: I think minimum wage laws are why we have unpaid internships. If I may add another, I think minimum wage laws not only hurt our teens, but also illegal immigrants (who are people too). Unskilled laborers now can’t have their wage fall below a certain level, but the illegals can!

There's also another problem with this inflation game. Let's face it, most of the minimum wage workers don't save at a very high rate, but for the people who do, inflation shrinks their future wealth. It may look like we're back at square one, but a weaker purchasing power means less bang for your saved bucks.

Another side effect brought to light by labor economist David Neumark is that oftentimes businesses will replace unskilled labor with skilled labor. Suppose that a job can be done by either 2 skilled workers, costing $8/hr a piece, or by 3 unskilled workers, costing $5/hr a piece. In this scenario the firm would prefer the 3 unskilled workers. With a rise in the minimum wage from $5 to $6/hr, the firm would no longer prefer the 3 unskilled workers, but would instead prefer to incur a cost of $16 rather than $18. 

Before I ramble on forever, here's my solution: I’d say, “abolish the minimum wage”, but I realize that we live in the real world. So maybe this is a better solution: stop allowing the Fed to print so much (explicit) money. Then maybe we wouldn’t feel the need to keep up with inflation, and then maybe we wouldn’t create more cost-push inflation. 

One final note: abolishing the state-mandated minimum wage would not result in businesses paying their employees $3/hr. Businesses have an incentive to keep their wages at this abstract idea of an equilibrium price. If their wage rates are too low and their particular market is pretty competitive, they'll lose a lot of their potential employees to their competition and/or incur higher turnover costs. And if a business is in a market that isn't very competitive, they'll have an incentive to keep their wages at a fair rate. If behavioral economics has taught me anything, it's that people love to appear fair and that they suffer - in business and in their personal life - when they're treating others unfairly.