Must-Read: Noah Smith: An Econ Theory, Falsified

Must-Read: Edward Hastings Chamberlain wrote his Theory of Monopolistic Competition and Joan Robinson wrote her Economics of Imperfect Competition back in 1933. The enterprise of building the tools to help us understand such markets is now 84 years old. And yet…

Noah Smith: An Econ Theory, Falsified: “Almost every theory is falsifiable to some degree… since almost every theory is just an approximation…

…What falsification really means… is that a theory is shown to not work as well as we’d like it to under a well-known set of conditions…. There are some pretty clear-cut cases. One of them is the “Econ 101” theory of the labor market… one labor supply curve and one labor demand curve, one undifferentiated type of labor and one single wage…. Here are two stylized facts…

  1. A surge of immigration does not have a big immediate negative impact on wages.
  2. Modest minimum wage hikes do not have a big immediate negative impact on employment.

George Borjas disputes the first of these, but he’s just wrong. A few economists (and MANY pundits dispute the second, but the consensus among academic economists is pretty solid.

The first… alone does not falsify… Econ 101…. It could… that short-run labor demand is simply very elastic…. BUT, this is impossible to reconcile with the second stylized fact. If labor demand is very elastic, minimum wage should have big noticeable negative effects on employment. By the same token, if you try to explain the second stylized fact by making both labor supply and demand very inelastic, then you contradict the first stylized fact. You just can’t explain both of these facts at the same time with this theory. It cannot be done. So the Econ 101 theory of labor supply and labor demand has been falsified. It’s just not a useful theory… in the short term… not a good approximation… doesn’t give good qualitative intuition… is especially bad for explaining the market for low-wage labor….

If econ pundits, policy advisors, and other public-facing econ folks were scientifically minded, we’d stop using this model in our discussions of labor markets. We’d stop casually throwing out terms like “labor demand” without first thinking very carefully…. We’d stop using this framework to think about other policies…. Sadly, though… we will continue using this falsified theory to “organize our thoughts”–i.e., we’ll keep treating it as if it were true… [and] continue to make highly questionable policy recommendations….

That’s what James Kwak calls “economism”, and I call “101ism”. Whatever it’s called, it’s not very scientific.


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