Fri, 6 October 2017
My guest today is Thomas Sampson of the London School of Economics.
Our topic for today is the economic impact of Brexit. Long-time listeners will recall that I did an interview with Sam Bowman on Brexit immediately after the vote occurred. Think of this as a follow-up to that episode now that the dust has settled and we have a better idea of what Brexit is going to look like. Thomas has written multiple papers on the subject, including Brexit: The Economics of International Disintegration, which is forthcoming in the Journal of Economic Perspectives. Its abstract follows:
This paper reviews the literature on the likely economic consequences of Brexit and considers the lessons of the Brexit vote for the future of European and global integration. Brexit will make the United Kingdom poorer because it will lead to new barriers to trade and migration between the United Kingdom and the European Union. Plausible estimates put the costs to the United Kingdom at between 1 and 10 percent of income per capita. Other European Union countries will also suffer economically, but their estimated losses are much smaller. Support for Brexit came from a coalition of less-educated, older, less economically successful and more socially conservative voters. Why these voters rejected the European Union is poorly understood, but will play an important role in determining whether Brexit proves to be merely a diversion on the path to greater international integration or a sign that globalization has reached its limits.
Globalization and economic integration have been on more or less a constant rise since WWII, and Brexit is a rare reversal of this trend. Thomas argues that it is important to understand the causes of Brexit to see if this is just a temporary blip on the way to global economic integration or the start of a reversal of the post-WWII trend.
Fri, 17 February 2017
What follows is an edited transcript of my conversation with Maxime Bernier. If you like his ideas, I encourage you to go to his website to learn more about them.
Petersen: You're listening to Economics Detective Radio. Before we start let me give a quick disclaimer that although today's guest is a politician this show is nonpartisan and doesn't endorse any particular candidate for office. My guest and I are also Canadian so we'll be talking about some Canada-specific issues. I know I have an international audience but sometimes it's fun to learn about what's going on in other countries. So I hope you'll listen nonetheless. And now on to the episode.
My guest today is Maxime Bernier, he is the Member of Parliament for Beauce, Quebec and a contender for the Conservative Party leadership race. Maxime, welcome to Economics Detective Radio.
Bernier: Thank you very much for having me.
Petersen: So, our topic today will be Canada's economy and its economic policy. There's a lot to get to on this topic but let's start with the positive. The Fraser Institute's Economic Freedom of the World Index ranks Canada as the fifth freest country in the world, actually tied for fifth. We're well ahead of our neighbors, the Americans, who come in at number 16. So, to start our discussion, Maxime, what is Canada doing right with respect to its economic policy?
Bernier: First of all, I think that this was the ranking that the Fraser Institute did a year ago, if I remember very well, and at that time we had a balanced budget when we were in government and also we were successful in lowering taxes for every Canadian. And I think that's a key when you speak about more freedom you must also have less government and a limited government in Ottawa. And I think that was the goal of the Conservative government when we were in government.
And also we have a lot of free trade. That's very important. We signed free-trade agreements with I think, if my memory is good, 45 countries. So, when you have more free trade like that, Canadians are able to buy goods from every country and they are able to also export products. So, that's helping also.
More free trade, less government, lower taxes and I think that's a big reason why we are there now.
Petersen: Yeah, there's a pretty general economic freedom, and you mentioned that that ranking came out last year and we have had a change of government recently so let's see if we can keep our high position.
But let's move on to some specific areas where we're not so free. Let's start with telecommunications. Canadians have some of the most expensive cell phone bills in the world. You personally did some work in deregulating the telecommunications sector when you were Industry Minister in 2006-2007. Can you talk a little bit about the changes that happened then and where we are now?
Bernier: Yeah, at that time we wanted to deregulate the telecom industry, mostly the regulation that was imposed by the CRTC. We were successful in doing that, and afterwards I think we had a little bit more competition in Canada in telecom.
But we didn't have time to also abolish the restriction on foreign investment in telecommunication. And so I think that would be the next step to take to have a bit more competition. And so that's why in my program I have a very strong platform about deregulating and also abolishing the prohibition on foreign investment in telecom and also in the aviation sector. So like that, corporations from outside Canada will be able to invest here in telecom and that will help Canadian consumers, who will have more choices and lower prices. But it was the deregulation that we did---that I did when I was Industry Minister---that was the first part of the deregulation. So now we must go ahead with abolishing the prohibition on foreign investment in telecom.
Petersen: Right. The vast majority of Canadians live right on the border with the United States and if you just step across the border suddenly you can buy a data plan for much less. One thing I was struck by when visiting the United States was that people just watch YouTube videos when they're on their mobile data. And you don't see that in Canada because it's so incredibly expensive. So, I wouldn't be surprised if we allow the American companies to sell to us if we wouldn't get exactly the same plan they're getting which would be great.
Bernier: Yes, I just want to add that Verizon, I think they wanted to come to Canada but they were not able to. They had created a Canadian corporation and all that and at the end, they decided not to come to Canada like their operations in the US. So, I think that will be a big step if we are successful in abolishing the restriction on foreign investments. That would make a difference for Canadian consumers.
Petersen: So, we have a similar issue with the airlines. It's very, very expensive to make a domestic flight within Canada, for instance, flying Vancouver to Toronto is about twice as much as flying L.A. to New York even though they are similar distances. So, do you want to comment on that situation? We only have the two airlines West-Jet and Air Canada. Could that be similarly fixed?
Bernier: Yes, you're absolutely right. If you want to fly from Canada to another country it is still competitive, but if you want to fly in Canada, inside the country, from example Montreal to Toronto, or other cities like that, it is very expensive. Because, like you said, we have only two main carriers in Canada: West-Jet and Air Canada. And we don't have like other countries a low-cost carrier.
So, we need to have one and I know that some business entrepreneurs want to create one low-cost carrier but their funding, their capital it's coming from the U.S. and from U.K. And you still have the same things in aviation, we have a restriction on foreign investment coming from other countries. So, that's why we must abolish that and like that we'll have a low-cost carrier and that will compete against Air Canada and West-Jet. That adds more competition, more choice and at the end lower prices.
So, I know that the Federal Government and the Minister of Transport, they're looking at it right now because these entrepreneurs want to create that corporation, a low-cost carrier. And they're ready for that. They're looking at it right now so, I hope they will abolish that but I'm not so sure. This is why for me, I have a platform that is based on more freedom and less government and it will be always good for Canadians. That is why I'm pushing that very hard, I wrote to the Minister about that to be sure that they will abolish foreign restriction in the investment in the aviation sector.
I don't know if they will do it but if not I will do it when I will be the leader of the party and Prime Minister.
Petersen: Yes, I hope you succeed in that. This one is a particularly important one because if airfare is expensive then more people drive and driving is statistically much more dangerous. So, you have more highway fatalities. I personally drove over 1,200 kilometers to visit family over Christmas. So, I'd really love to have an option to fly cheaply but it's just out of reach at our current airfare prices.
We also have a problem here in Canada, a similar related problem with cartels. We tend to create cartels in a lot of industries and we have one set of policies called Supply Management that applies to poultry, dairy products, even maple syrup (which is very quintessentially Canadian) keeping these prices artificially high. So, could you talk a bit about Supply Management for those who maybe haven't heard of it?
Bernier: Yes, Supply Management it is a legal cartel for dairy, poultry and eggs and the like. The producers on the Supply Management are able to fix high prices for these products and they are fixing the production also. That's why it's a cartel, they're fixing the production for the Canadian market and they are fixing the price, every year they increase the price of these products.
So, I am the only candidate for the leadership of the Conservative Party of Canada and also the only member of Parliament who's speaking for Canadian consumers and that wants them to save $2.6 billion every year. Because that's the cost of keeping that cartel and for a family the cost is $500 every year. I want them to be able to buy poultry, eggs, and milk from other countries---they want to export that---but because we have tariffs at the border of 300% on products coming from other countries to be sure that the dairy producer in Canada will be able to fix high prices for their products.
So, for me, if you believe in a free market you must abolish that and I don't want to do work for 19,000 farmers that are on Supply Management, I want to work with 35 million Canadians. And I think that's the most important for me and actually, the farmers just represent 10% of the farmers and all the other farmers in Canada, like the beef producers and all the other farmers are not on the Supply Management, they are operating in a free market. So, it is not fair and to be fair we need to abolish that but because as a special interest group they are very powerful and they're very well connected with the politicians, they were able to keep that privilege for a very long time and I think now it's time to speak for Canadian consumers and that's what I'm doing so I hope to be successful with that.
Petersen: Ironically Facebook has been serving me advertisements from the Canadian milk producers and their tagline or slogan is Canadian milk is worth crying over, or spilt Canadian milk is worth crying over, or something like that. And the irony is that if they supply too much milk, because of Supply Management they actually have to dump it to keep the price high. So it is really just wasting perfectly good milk and poultry.
Bernier: Yes. If they produce too much they cannot export their surplus because it's a subsidized milk. So that's why it's bad for them. They are producing good products, good milk, good dairy, good poultry, and eggs and I want them to be able to export their products to other countries and right now on Supply Management they can't because they have the responsibility and the obligation to produce only for the Canadian market.
Petersen: You mentioned the 300% border tariff on U.S. dairy. I think in the U.S. they have a different policy where they actually subsidize it and keep the price artificially low. But we had this strange situation a few years back where Canadian pizzerias were smuggling in black market mozzarella over the border and got caught. You shouldn't have to smuggle mozzarella cheese. If we had a free market, there would just be one price for mozzarella cheese and you wouldn't get a benefit by smuggling it.
You mentioned that you're really the only one calling for an end to this Supply Management policy and yet our Prime Minister for almost a decade, Stephen Harper, has a Master's degree in economics. He must have known that this policy was not good for Canadians. And most of the MPs are smart people, they must realize it, but is it as simple as the cartels themselves just making big donations and buying protection for this policy?
Bernier: First of all, you're right, when we were in government that was the policy of our government to keep that cartel, that Supply Management system. All the members of the Conservative Party of Canada voted in 2004 in a convention to protect these farmers and after that when we were in government in 2006-2007, that was the policy of the government, and that was the policy of the government until the end, until 2015.
And I think that at that time we didn't want to displease the cartel and that special interest group. And I tried to fight for that on the cabinet table but I wasn't successful. Most importantly, I think now I'm able to do it and I will ask---if I'm the leader of the Conservative Party---I will ask the members to decide on that and to review their policy statement that they did more than 12 years ago, and I hope the members will abolish that and they will believe in a free market also for producers on Supply Management.
Petersen: Have the supply managed industries been pushing back against you? Have they been taking out ads or funding your opponents? How are they trying to protect their cartel status?
Bernier: For sure. It's an important cartel in Quebec and in Ontario, they want to do everything for Maxime Bernier to not be elected. And so I think they are buying memberships to vote for the leadership of our party to be able to vote because, as you know, you need to be a member.
If you want to be a member and support my candidacy you can go on my website www.maximebernier.com and you'll be able to become a member for only $15. But, yes, the dairy producers are working to be sure that I won't be elected.
But there's more Canadians than dairy producers. So, I'm working hard to be sure to be successful because they want to keep their privilege and we'll see what will happen. And it's easy for them because I'm the only candidate who wants to abolish that and speaking for Canadian consumers, so they can vote for all the other candidates and they will have somebody who will support their special interest.
Petersen: I hope you succeed. And you're right there are more Canadians than supply managed firms or farmers that benefit from this particular policy. But you have this issue of the cost being dispersed and so although there are fewer farmers who benefit from the cartel and from Supply Management there may be a lot more motivated per capita. So, I hope you can succeed in getting over that, sort of, public choice hurdle. But my cynicism kind of says that it's an uphill battle.
Bernier: Absolutely. But also, I must say that the other farmers that are not on Supply Management, they have a huge interest also for that cartel to be abolished because it's not fair for them. Each time Canada is negotiating a free trade agreement with another country they have access, for example, Canadian beef will have access to the other country's market, but they won't have the full access because we're not giving full access to their milk, poultry, and eggs. So at the end, they are paying a little bit for that and they don't have the access that they would have otherwise. And they understand that. So the other farmers that are not on Supply Management have the interest to be sure that we have all these steps that can counterbalance the special interest group.
Petersen: I wonder about that because if beef and poultry are substitutes then you would think that the beef producers would want their competitor to have higher prices than they do so people would maybe buy more beef. But there is the issue of the international agreements.
You've called for the privatization of Canada Post and the removal of its monopoly on letter mail. That's another area where Canadians pay more, not just for letters but also parcels shipping to and from and within Canada is much more expensive than it is in the United States and other places. So could you talk about what the legal status of Canada Post is and what both parcel shipping and regular mail are, what the legal status of both of those is?
Bernier: Yes, you're absolutely right. Canada Post is a state-owned enterprise and I think in 2017 we must do like other countries and privatized that. They are charging at a huge cost because they are not competitive, they have huge expenses and they're not so efficient.
So, my thinking about that is, these are not services that Canadians need to be delivered by a government entity. We have a private sector for delivery and I think that it is not an essential service for Canadians any more. And they are using Canada Post less and less with emails and all that, and so we must do like in Belgium, like in U.K., like in France and privatized it.
Also, they're charging very high prices for their products. So, if we have more competition, that will help and at the end that's the solution. But they want to keep that and for me if you want to speak for Canadian consumers you must go ahead and do that reform, that's my proposal.
Petersen: Yes, it's such a big issue because in other countries that have much cheaper shipping, people are opened up to the whole global marketplace, you don't have to go to your local store to buy any particular good, you can buy it online and have it shipped to you. But for Canadians, you're adding $10-$15 to the price and so Canadians aren't really online buying things nearly as much as, for instance, our neighbors the Americans.
And when Canadians want to run online businesses and maybe ship things to other people to stay competitive they often have to drive across the border and ship from the United States because it is just so much cheaper.
And Canada Post has a legal monopoly on letter mail which is a little bit odd. Why should one particular government entity have the legal right to ship our mail? It's kind of an odd historical anomaly that we could be rid of.
Bernier: And you have to think the price also. It's not a free market. It is them who are fixing the price because, like you said, they have a legal monopoly. That's what I want to do, I want to be sure that we can have competition there.
Petersen: You've also called for reducing trade restrictions within Canada. This is one of those things that is so odd, is that we're one country, ten provinces, but we restrict many goods from being shipped within our own country across borders. So for instance alcohol. If you have a craft brewery or a winery in British Columbia it's very hard to ship it to even Alberta right next door. Can you talk about some of the internal trade restrictions that we have in Canada?
Bernier: Yes. We have a lot of them in these kinds of industries, but for me it is a bit of a shame that after 150 years we don't have an economy of exchange in Canada, because that was the goal of the Fathers of our Constitution. The fathers of our country, they wanted to have an economic union and we don't have that because of some restrictions, legislation, and regulation by provinces.
So, my goal is to be sure that we'll have an economic union. And to do that, it's against the Constitution and so I want to be sure to have a team in Ottawa of civil servants that will look at all the regulations and the legislations that are imposed by provinces and to bring provinces in front of the court when they don't respect the Constitution. Nobody has had the courage to do that and I think it's time to do it. And that will be the only solution because I cannot change the legislation or regulation at the provincial level and at the federal level we must respect the Constitution.
But I can assure Canadians that we'll do everything for the provinces to respect the Constitution. That's why we're going to bring the province in front of the court and the court will decide if it's constitutional or not. And I think it won't be because it's clear in the Constitution that we must be able to sell and buy goods from any province in Canada. That would be the solution. Because if you ask the provinces to do that, they have the problem and they cannot find the solution. So, that's why every year you have a meeting with the premier at the provincial level and they're saying, you know, we will abolish trade barriers and all that and it is not happening.
And they're the problem and they're not able to do that. They want to protect their own little market it is not good for Canadians, so we must do something at the federal level and that's what I want to do. I want to do a strong analysis of every regulation, legislation that provinces are imposing, legislations that are against free trade and after that bring them in court and the court will decide. And in the end I'm sure it will be unconstitutional and maybe when you do that, in five years after that, you have a real economic union in Canada like the fathers of our Constitution wanted.
Petersen: Yes. One wonders what is even the point of having a country if you're not going to have at least free trade within your borders? That seems to be the main benefit of all confederating and joining into one country instead of being 10 smaller countries.
Do you have any concluding thoughts, anything we didn't cover that you'd like to say?
Bernier: First of all I want to thank you for giving me that opportunity to speak with your people and if they want to know a little a bit more about our economic policy, they can go on my website www.maximebernier.com. Everything is there and I'm very proud of our platform. It's a platform that is based on individual freedom, personal responsibility, respect, and fairness and it is a platform that is based on real conservative values and the values of Western Civilization. So, if people like that they can become a member and they can vote for the leadership. I appreciate that you gave me this opportunity and maybe another time we can go on and speak about other economic issues.
Petersen: My guest today has been Maxime Bernier. Maxime, thanks for being part of Economics Detective Radio.
Bernier: Thank you very much and have a nice day.
Fri, 9 December 2016
What follows is an edited transcript of my conversation with Otto Lehto.
Petersen: You're listening to Economics Detective Radio. My guest today is Otto Lehto of King's College London. He is formerly the chair of Finland's Basic Income Network. Otto, welcome to Economics Detective Radio.
Lehto: Oh it's my pleasure to be here.
Petersen: So our topic for today is the basic income guarantee. Otto, you approach this idea from the perspective of political philosophy, so let's start by discussing that. How about we start by talking about two of the major figures in political philosophy: John Rawls and Robert Nozick. What do each of them have to say about the welfare state and where do your views diverge from theirs?
Lehto: That is a good point to start indeed, although it is I think a bit lamentable that we have to start from those two figures because they have dominated the discussion so much during the last 50 years. In fact, it's very hard to have a conversation outside the boundaries set by those two figures, but they're both geniuses. They set the stage for the discussion, certainly in philosophy but also in public policy in many respects.
So, let's start with John Rawls. John Rawls really was a towering figure in Harvard, really starting from the 60's and throughout the 70's. He wrote this book, A Theory of Justice, which is considered one of the really truly great books in political philosophy that revolutionized the way we think about these subjects. But the short version of his theory, which is very influential even up to this day, is that people in societies should look at the framework of living with each other as a cooperative game where we all try to sort of not only maximize our own position but also to make the whole game fair for everybody. And so he called his theory Justice as Fairness, where people are entitled to a certain respect and autonomy, certain liberties as members of the democratic community where they can pursue their own ends. But they're also entitled to a redistributive scheme if they happen to be among the worst-off people in the society. They are entitled to redistributive transfers.
This framework sounds very familiar and indeed it should because it reflects the social democratic reality in which most Western societies operate. And even in later years he said that actually his philosophy, even though it starts from first principles and proceeds from there, is actually meant to be a philosophical justification of the intuitions that people in Western democracies---liberal democracies---have.
So, you combine liberal ideas of individual freedom with these notions of the welfare state and so on. So that was the foundation of Rawls' system.
So that's Rawls' system but Nozick came along and he found a place for himself in the same institution, that is Harvard, and he wrote a critique---a respectful critique---but a very thorough and deep critique of Rawls' theory. And he ended up justifying a minimal state that libertarians are very fond of. And he effectively said that no, people should just be seen as individuals who have some fundamental rights---he calls them side constrains---that people have a certain respect that they are owed by other people and it is very wrong for people to violate their personal boundaries and this includes the State.
The state has actually no right to violate the sort of inviolable right to property rights that individuals have. So every form of taxation, that features very prominently even in Rawls' system, is theft. So, that is of course a very prominent theme in libertarianism. So his book---which by the way is really brilliant philosophically, it's not only just a standard justification of libertarianism but it's actually one of the great books in philosophy because it's so rich and powerful and full of interesting ideas and strange examples and brilliant footnotes and all that---but that lay down the other side. And so the debate in intellectual philosophy and history in the last 50 years or so has been largely dominated by these two figures: Rawls' Theory of Justice on the one hand, a justification of social democracy with a liberal bent, and then on the other hand Nozick's Anarchy, State and Utopia, which is a justification of libertarian taxation-is-theft ideology. So that is the framework in which we find ourselves.
Petersen: So there are these two competing extremes. You quote John Tomasi's critique of both of them. Would you like to summarize that for me?
Lehto: Yes. John Tomasi wrote a wonderful book in 2012 called Free Market Fairness where he actually tries to combine these two perspectives. And he says that actually there's a whole tradition that we're forgetting here when we focus only on these two---as you put it, they are both at extremes---although at least for Rawls himself, he's often considered a centrist. But in many ways, he represents this kind of---from a perspective that Tomasi points out---the perspective of classical liberalism even though the Rawlsian center-left position, he's actually seen going fundamentally wrong in many ways, even though that is the unquestionable framework in which people today operate.
And I should say, when I say that Rawls and Nozick laid a framework, it's not as if there is 50% on one side and 50% on the other side. Perhaps in politics, like the left-wing and right-wing ideologies have maybe about 50% on each side depending on the circumstances. But in philosophy certainly, Rawls has been the one that dominated the discussion and there are actually very few Nozickians around.
But Tomasi points out that even with this seemingly very credible and too wonderful system that Rawls lays out, there is very little attention paid to issues like individual freedom especially in the domain of economy. And the lack of respect for people's freedom of choices in economic matters is actually a major shortcoming in Rawls' system. And this is exactly what Tomasi points out and from the perspective of classical liberalism which he raises to the standard of something that we should actually take more seriously than we have today. He points out that actually economic liberty is something we should insert back into the conversation in a serious way without however on the other side falling down the assumption that Nozick makes---and a lot of libertarians make---that the only justification for all economic liberty necessarily leads to a justification for the night watchman state or the minimal state of libertarianism where there is no role for government to provide public services and all that.
And so this false dichotomy that Rawls and Nozick have put out has sort of made it difficult for people like myself and Tomasi and Matt Zwolinsky and people who consider themselves followers of the legacy of classical liberalism to lay out the more complicated, but I think more interesting, case for a system where robust economic liberties are combined with certain welfare state elements. Certain elements of taking seriously the power of the state to actually increase the real opportunities of people rather than just being a system of theft as Nozick calls it.
Petersen: So that's where something like the basic income guarantee comes in. Can you summarize what that is and how is that different from the welfare states most countries currently have?
Lehto: Right. Basic income guarantee, first of all, is defined as a regular payment to all citizens or residents of a political community that is given uniformly to all citizens. All people get the same amount and people get it without bureaucratic discretion. So it is given automatically or almost automatically to all people either in the form of a direct cash transfer to their bank account or in the form of a tax break system as in the form of negative income tax which is actually a form of basic income.
So this system is supposed to, and it is a way, to replace the bureaucratic complexity and the nightmarish disrespect for human autonomy and human freedom that lies in the center of the current welfare state system in my opinion and certainly in the opinion of Tomasi and other people who I'm referring to. So the basic income guarantee is superior to the current system and it differs from the current system in the sense that it actually operates under the principle that we shouldn't use the state to guarantee specific favors to specific people, we shouldn't use the state as a one-upmanship mechanism whereby one group of recipients carries for the favor of bureaucracies, tries to---and in a way infiltrate---the mechanisms of the state to redistribute money and resources to themselves or to groups that they favor against the interests and desires of other groups because this leads to a spiral of negative-sum game in the political economy. And I think welfare states today in this sense have become victim to this overzealous one-upmanship of special interest group politics and basic income is a way to overcome this problem.
Petersen: So the basic income guarantee, is it really a break from business as usual? It seems like it's a marginal improvement on the system we have now, but I guess you're suggesting that the system we have now encourages a lot of rent seeking, it has a lot of payments to different groups, it's needlessly complex. I could list some other problems with it. There are the so-called welfare cliffs where poor people face implicit marginal tax rates sometimes of a thousand percent, or some absurdly high amount because their benefits are clawed back when they earn a little more income. So there seems like there's a good economic justification for basic income. Is your work focused on the classical liberal philosophical justification for having a hands-off welfare state?
Lehto: Yes, in a way. The fundamental debate is truly between these two perspectives of whether it's a pragmatic justification for reform towards a slightly saner and slightly more useful and purposeful and beneficial system, or on the other hand, is it a requirement of justice that we have something like a basic income guarantee. And I think that really the truth is somewhere in between.
First of all, I think it certainly is a pragmatic improvement over the current system but I should point out already at this point that when I'm advocating for basic income I'm not advocating for basic income without demanding widespread reforms in other areas of life in the welfare state. I am indeed calling for massive restructuring of many of the mechanisms of the welfare state partially just to accommodate for the fact that we are taking basic income as the policy paradigm that we're trying to implement. Because if we take that as the policy paradigm, then we necessarily must reform the existing bureaucracies, tax system just to accommodate for the fact that we are taking this new system into effect.
In addition to this, I think that the whole framework of regulations, the whole framework of massive interventions into the economy, into the private life of citizens have to be addressed as serious violations of the capacity of the welfare state to truly increase the welfare of its people. Because my opinion is that the welfare state has failed because it has failed to address the proper means to achieve its own ends that it claims to have. Use of improper means to achieve its ends is the reason why the welfare state is failing so miserably everywhere in the world today. That it's claiming to be for the welfare of its citizens, but if you look at it in terms of its overall effect in many ways it fails.
Petersen: So, when I think of the policies that I'd like to see replaced by a basic income guarantee they're not just strictly welfare transfers. There's a theorem in economics called the Atkinson-Stiglitz theorem. It says that when you have an optimally designed progressive income tax scheme, basic income with a progressive income tax would be something like that, then it doesn't make sense to have additional programs designed to redistribute. And some of the programs that I think are basically focused on redistribution are things like protecting taxi drivers from competition from companies like Uber and Lyft, or a lot of the interventions into medicine are designed to make sure that people who get sick don't also become poor. And of course, if you had something like a basic income, every taxi driver could lose his job, he wouldn't fall below that minimum level. And so could at least in principle---if we were going to make sort of an ideal political bargain---a basic income guarantee would come with a lot of free market reforms ideally. Is that basically a big part of the reason why so many libertarians---such as Milton Friedman and Friedrich Hayek---have supported versions of a basic income?
Lehto: Well yes indeed, it has the feature of being compatible with a total abolition of the rest of the welfare state, or major portions of the welfare state. And in fact people like Charles Murray have recently proposed exactly that, a replacement of the welfare state by the means of a basic income given to all citizens as the second-best option to a complete free-market society. And people like Hayek and Friedman were also of the opinion that the majority of those transfers could be replaced.
So the thing with money is that money is a universal means of exchange and the uses of money and the need for money are as varied as people and situations. And when we think of basic income we don't think of it in terms of being for a particular purpose or for particular people or for particular circumstances unlike the current measures. And so it has the virtue---and perhaps the vice depending on your point of view---of being this universal situation, a neutral ground. And so indeed we can come up with hundreds of scenarios where a basic income could be useful for people. Obviously, some of those are covered by the current redistributive schemes within which by the way I would include things like farm subsidies, many forms of corporate welfare and so on.
So basic income has the virtue and vice of being neutral as regards purposes and situations. The only thing really is that if you don't have any other sources of income then you will get a basic income without having to beg for it from anybody either in the government or in the world of charity for example. So, yes indeed, people who are forced out of work to circumstances---whatever those circumstances happen to be---are able to survive, the people who are forced out of the labor market entirely for a reason---one reason or another---people who have temporary or permanent conditions that affect their capacity to find work will be covered up to this level, and people who perhaps want to take some time off to take care of their family, people who want to take some time off to study, to plan ahead, to perhaps think about starting a new company, they have some ideas but they don't have the means of funding yet, that allows people to focus on doing what they think is best for them at the moment. So it has almost an infinity of purposes precisely because there is an infinity of human beings and human desires that in a pure realistic society will have to be taken into account. And a welfare state that tries to measure what people truly need, or what circumstances need to be taken care of, fails precisely because it can never count the infinity of the variety of ways in which people end up in need of money in society.
Petersen: So before this welfare state that we currently have---the welfare state as it currently exists largely is a creation of the 20th century. But in the 19th century and early 20th century a lot of what you had was mutual aid societies and things like that. And I think a hard core maybe a Rothbardian libertarian who maybe still cares a lot about the poorest among us might say, why have a basic income? If we just had nothing there would still be the civil society and we could create something like a mutual aid society. Are there advantages of---is there reason to do this through the state, I guess is my question.
Lehto: As a very wide-going and deep-reaching utilitarian, for me it's all about checking what robustness criteria institutions might have, and what institutional arrangements we could come up with and seeing how they perform in the real world rather than in the realm of ideal theory. And we have some evidence of places where mutual aid societies worked and we have some evidence of places where forms of welfare state that are highly bureaucratic and oppressive and paternalistic have operated and both of those have several features that I think we can wish to want to get rid of.
So I think that if we look at societies where mutual aid societies were the sole means for people to survive I think they actually did a relatively good job in many cases but I think they failed to provide the sort of guarantee of security that I think a good society would wish to provide for people. That is, if we rely on the means of mutual aid societies you will get perhaps even a superior alternative to many forms of welfare state in the long run and I'm completely open to the idea that free markets can provide a very robust system of welfare. And actually that to me is one of the reasons why I consider myself a libertarian defender of a welfare state because I think that the libertarian part comes from actually understanding that markets are a good way of producing welfare and the opportunities available for markets and other forms of voluntary transfer, including mutual aid societies, are a way of providing a wide framework of security and services and other forms of protection.
But I think that they provide a patchwork which leaves a lot of people outside in a number of circumstances. And I think this fact that they have a lot of holes in the way into the system, they have a lot of uncertainty about guaranteed income and lot of uncertainty about who gets covered, who is seen as being worthy of being helped, who is seen as being worthy of being protected by a benevolent charity and so on, means that we need to have a system of making sure that people don't---perhaps out of no fault of their own---fall through the cracks of the free market system and the same goes for the welfare state. I think they actually are surprisingly similar the welfare state and the free market utopia, they both provide this patchwork framework where some people are protected, some people are not, there's a lot of uncertainty about who gets what, who gets protected, and who doesn't. And so actually in both systems, people fall through the cracks and this is exactly the reason why I think basic income guarantee can be a superior alternative to either of those.
But again we have to see what happens when we actually implement basic income, there could be a lot of unintended consequences. So we need to take those into account as well but at least on the side of theory, I think the idea of guaranteeing basic income, I think it's both desirable and practicable because we know how to do it technocratically and theoretically. I mean there's nothing so difficult with guaranteeing basic income via bank transfer to all citizens for example.
Petersen: So one virtue of the basic income guarantee is that it seems to be actually politically feasible within our current system and it has got some interest in recent years. We mentioned at the start of the episode that you were part of the effort to bring a basic income to Finland so could you tell me about the political situation there? I've heard that they're looking at bringing in a basic income guarantee.
Lehto: Yes, indeed. And here I'm being brutally pragmatic. Finland is not going to turn into any sort of libertarian utopia that I would wish for and certainly there are elements of paternalism there that are not going to go away. We still regulate the sale of alcohol in a very, I think, outrageous fashion for example and there are a lot of elements in the system that probably will keep us on the level of adult children for a long time. But as far as the welfare system is concerned, there is considerable consensus now that something like basic income would be a desirable reform. And this is seen by the majority of the population and by more than 50% of the M.P.'s in the parliament, basically from all parties with of course different proportions in different parties.
But yes indeed the center-right government is actually going with the basic income pilot experiment starting next year. It's I think a well-planned pilot. They have a lot of experts because we believe in experts in this country and in Finland the sort of reliance on experts is both good and bad in many ways. It always seems to suggest that there is a group of people who can define the perfect system but in this case I think they've done a pretty good job with planning this two-year pilot. We shall see what happens. It's certainly not ideal and the government is already bungling with some of its promises and how it is going to be organized.
But the basic premise for people who may not have an understanding or an idea in their mind of what this actually means, it means that basic income in the Finnish context would be the guarantee of something on the order of 500 to 600 to perhaps 800 Euros per month per person. And this would replace the various forms of unemployment benefits, sick leave benefits, student benefits and various other forms of benefits and Finland obviously has a lot of those already in place. And the complexity of the bureaucracy is such that even the experts who run it are surprisingly candid about their ignorance, about the complexities and mutual dependencies of the various benefit structures so that it's a maze that not even the experts can navigate, let alone regular ordinary people who are supposed to be the beneficiaries of the system. So a lot of people don't know how to apply for help, a lot of people don't know what benefits they're entitled to, and there's a long delay in getting the results of one's application for particular benefits---months, sometimes even the years. And a lot of people fall through the cracks in that fashion that I mentioned earlier.
And so I think we've come to the point almost by necessity, where this system is seen almost universally by all as in need of reform and basic income happens to be the form of this reform that is most universally seen as the one we should pursue even though of course there are still people who are very skeptical of it in many ways. But yes, indeed they're planning this experiment where they're giving something like 500 Euros to a few thousand people across Finland. It's a very small experiment, but there are people who will call for its expansion I'm sure in the years to come. That will be definitely a very interesting experiment to see how that goes.
Petersen: It seems like with the current system being so complex, it's almost like a part-time job just to collect benefits. You need to build expertise and you need to fill out the right forms and it takes a lot of your time and in many ways that makes it something that competes with the labor market for your time and your efforts and your human capital development. Seems like a basic income would be a good way to get people back into the labor market simply by virtue of freeing up their time to pursue something else. Do you see the political movement towards basic income making progress in other countries as well?
Lehto: So yes experiments are undergoing in a number of countries. In addition to these, Netherlands, Canada and U.S. experiments and the Finnish case of obviously which I'm most familiar with, there is a very interesting experiment going to start in a few years in East Africa organized by the charity Give Directly who are already advocates of this idea of giving cash transfers to people. They have been doing that for a number of years now with quite good results according to many independent researchers. They've been giving cash transfers directly to people and they've shown great results. So they are actually expanding this idea and organizing again a privately funded experiment that they planned around for ten years, I think, or at least a number of years in East Africa.
And this should be quite interesting to see how the basic income experiments in rich countries and poor countries compare and perhaps they can help both in different ways, because obviously countries where welfare states exist are quite different from places where they don't. So any help or any form of monetary transfer will help people in African countries proportionally more than they do in rich countries, but I think both situations and both contexts can certainly benefit from direct cash transfers and basic income.
Petersen: Give Directly is a charity that I support and I really like what they're doing. I especially like how they take such a quantitative approach. There are so many charities that just start with "wouldn't it be nice if people in this village had this thing?" And then they bring it to them and they don't really stop to say can we measure, were we cost effective in improving their lives? Did we do a good job? Could something else of equivalent cost have made them better off? Give Directly is doing a great thing by bringing a lot of this sort of quantitative approach to charitable giving and I'll have a link at the show notes page to Give Directly if you want to contribute, if any of the listeners want to contribute, I highly recommend it.
Lehto: Absolutely. For a little bit, just to say about the reasons why cash transfers are so great. By the way, I should say that there are perhaps a few charities that are even more helpful in certain contexts. For example, direct malaria helping efforts, efforts to eradicate diseases perhaps, have an even higher rate of efficiency but those are pretty much the only ones that are more effective than giving people cash. And the reason why giving people cash is very good is that first of all, they stimulate markets where they don't exist and where markets do exist they operate in a way that maximizes the preferences and satisfaction of the people concerned. They operate as a way of giving people welfare in the most efficient way possible.
And the theoretical foundations of these can be found for example in neoclassical economics, of course, where the superiority of cash transfers have been posited for example in the Chicago School since George Stigler and Milton Friedman and others. There's a wonderful paper by Brennan and Walsh on the desirability of cash transfers over in-kind transfers from a game theoretical Pareto perspective. So that's also quite interesting how the theory also matches the empirical research here.
And just again to go back to the very foundation of the welfare state. I think that's been the biggest mistake of the welfare states today that they fail to take into account how welfare truly fundamentally is the satisfaction of the desired ends and needs of the people themselves as they themselves see them. It shouldn't be the satisfaction of some criteria of goodness that the state bureaucrats measure and determine. It really should be ultimately up to the people themselves what they value, what they pursue, and what needs they see themselves as having and thus giving money to them is the best way to make sure that they actually get to satisfy those preferences which they have rather than those preferences which some bureaucrats think that they should have.
Petersen: If I may ask one final question. Some supporters of the basic income guarantee have suggested that we could do it as a swap. We get rid of our current costly welfare system and bring in the basic income guarantee and often you'll hear the suggestion that this could be revenue neutral. Is that a realistic possibility?
Lehto: It is a realistic possibility in cases where quite extensive welfare states already exist. And obviously it depends on the level of basic income and I'm actually in favor of starting low where that is the most politically feasible option. But I'm also quite a quite supportive of the idea of starting high where that is politically feasible. So in countries like the welfare state in Canada and many other places. Starting from the level of where the current welfare state benefits are it is compatible with the goal of making it neutral as far as the effect on state budget is concerned. Although I think that it will be very hard to make it completely neutral in that regard. I think it will by necessity always cost something.
But what it will cost is heavily overblown in many estimations because many people simply do not understand how to calculate the costs and they simply add up some figures of everybody gets this amount of money and multiply that by the number of people and voila you get the proposed cost of this program. But that's obviously nonsense that they don't understand what they're talking about. And they really should have a look at the actual models because in all models what happens is you reform the tax system at the same time which means that for most people, middle-class and upper-class people---or middle income and upper-income people, to be more politically correct---the income that they get from basic income actually is a zero sum addition because actually, they ended up paying their basic income back in the form of taxes that I've been raised to match accordingly the need for basic income funding. So, even if there is no criteria that you don't give basic income to people above a certain range of income, nonetheless those people in the upper brackets will end up paying back their basic income due to the taxes that have been raised. But the taxes that are raised do not have to impose unbearable burdens on those people either, because again for most people it is just a nominal transfer of funds and it's withdrawn from their bank accounts at the same time.
Petersen: So are there websites, books? What can you recommend to people interested in this topic? What should they read?
Lehto: Well I think for those who are philosophically minded, I certainly recommend reading the classics of the libertarian welfare state stuff. Things like Friedman's Capitalism and Freedom where the negative income tax fee is featured. Friedrich Hayek's Constitution of Liberty is a great book and it also features a defense of guaranteed minimum income. And more recently John Tomasi's Free Market Fairness, and I would recommend people to read the blog Bleeding Heart Libertarians they have been advocating for basic income but also debating it. And also proposing this similar thing that I'm doing which is trying to combine Rawls' and Nozick's intuitions into something like a new coherent whole.
And just follow the news, read up on the models, follow up on what the governments and many of these countries---Finland, Netherlands, Canada---are doing. And go to basic income networks website. Just Google basic income earth network. B.I.E.N it's called---Basic Income Earth Network---and you will find more about basic income.
Petersen: My guest today has been Otto Lehto. Otto thanks for being part of Economics Detective Radio.
Lehto: My pleasure. It's been fun.
Fri, 30 September 2016
My guest today is Jason Brennan of the McDonough School of Business at Georgetown University. He is the author of Against Democracy, which is our topic for this episode. The first chapter is available on the publisher's website.
John Stuart Mill believed that getting more people involved in politics would make them smarter, more concerned for the common good, better educated, and nobler. In the intervening century and a half, we've gathered much more data on Mill's hypothesis, and the results don't look good:
The test results are now in. They are, I will hold, largely negative. I think Mill would agree. Most common forms of political engagement not only fail to educate or ennoble us but also tend to stultify and corrupt us." (p. 2)
Diana Mutz performed a study that found that people's belief that their political adversaries were evil and stupid predicted high political engagement. Many studies show similar results, where politics seems to exacerbate our biases along with our meanness and contempt for the other side.
Jason splits democratic citizens into three broad categories: Hobbits, hooligans, and Vulcans.
Hobbits are your average non-voter. They don't care or know much about politics, and they're happy to just live their normal lives without thinking about politics.
Hooligans are your typical political partisans. They are the die-hard sports fans of their preferred party. They are typically well-informed, but the information they consume is extremely biased towards their own side. They cannot pass an ideological Turing test.
Vulcans are people who see clearly through the morass of politics, understanding the arguments from both sides and possessing the social scientific knowledge necessary to select the best options. And just like the Vulcans from Star Trek, they're completely fictional! Or at least they're very rare.
While most of us like to think of ourselves as Vulcans, we're probably more like hooligans.
What if the Knowledgeable Chose our Policies?
Jason's preferred alternative to democracy is epistocracy, a system where more knowledgeable people have more control over politics. There are many forms this could take.
One way of instituting epistocracy is to impose a basic knowledge test on voters. While an econ 101 test would be desirable, it might raise objections from people who view economics as an ideological discipline. But there are many ideologically neutral facts that a voter really ought to know. For instance, someone who doesn't know which party currently holds power probably doesn't have enough information to decide which party is most fit to govern.
You could then restrict votes to only the people who pass the test, or you could weight votes from knowledgeable people more heavily.
Another option is the "enfranchisement lottery" where a random subset of the population (perhaps a few thousand) are selected to vote, but only if they undergo exercises to build their competence as voters. This is somewhat similar to how a jury trial works, where a legal decision is left to a random group of citizens, but only once they have received extensive instruction from a judge, lawyers, expert witnesses, etc.
Finally, you can set up a hybrid system with democratic and epistocratic elements. For instance, you could have a democratic body decide policy while an epistocratic body retains a veto. The Supreme Court functions in this way, since it grants a group of highly educated judges the power to overturn democratically supported laws.
Democracy is Not an End in Itself
Jason encourages his fellow philosophers to think more like social scientists. While philosophers tend to view democracy as an end in itself, social scientists are more interested in whether it has good outcomes. Does democracy promote economic growth more than other systems? Are fewer people persecuted under democracy than under other systems? Are people happier in a democratic system than they would be in an alternative system?
These are the sorts of questions we should be asking about our system of government.
Fri, 22 July 2016
Garett Jones returns to the podcast to discuss the issue of ethnic diversity. There is a wide body of research showing that ethnic diversity can reduce the productivity of teams, firms, and even whole countries.
Williams and O'Reilly (1996) review dozens of studies showing that ethnic diversity has a negative impact on group performance. In the two decades since, more research has reinforced that result. Alesina and La Ferrara (2005) find that increasing ethnic diversity from 0 (only one ethnic group) to 1 (each individual is a different ethnicity) would reduce a country's annual growth by 2 percent. Multiple studies (La Porta et al., 1999; Alesina et al., 2003; Habyarimana et al., 2007) have shown that ethnic diversity negatively affects public good provision. Stazyk et al. (2012) find that ethnic diversity reduces job satisfaction among government workers. Parrotta et al. (2014a) find that ethnic diversity is significantly and negatively correlated with firm productivity.
This may seem strange to you. If you're like me, you probably enjoy diversity. You probably don't observe the problems of low morale and high marginal costs that researchers have found in ethnically diverse workplaces.
If that's the case then you, like me, live in a bubble. An apparent exception to the rule that ethnic diversity lowers productivity comes in high-human-capital groups. I say "apparent" because there hasn't been much in the way of direct study of this particular issue. However, some results are suggestive. For instance, the same researchers who found that ethnic diversity reduces firm productivity in general found that it increases firms' level of innovation as measured by patents (Parrotta et al., 2014b). Most of the people I know fall into this category of highly skilled, highly educated individuals, so it shouldn't be surprising that my experience (and maybe yours) is not the norm.
Given that diversity is so costly for organizations, there is a huge industry dedicated to diversity training to mitigate these effects. However, a recent issue of the Harvard Business Review argues that diversity training seems to be a general failure.
To the extent that diversity is a plus for firm profitability, firms will tend to seize this opportunity without the need for legal intervention. And indeed, there are some types of diversity that seem to have positive impacts on firm profit. For instance, a recent study by Alesina, Harnoss, and Rapoport (2016) indicates that birthplace diversity improves productivity. This is different from (and in this sample, uncorrelated with) ethnic diversity. People might all share the same ethnicity, but the evidence indicates that if they come from different places they tend to have complimentary skills that make them better at working together.
As Garett points out, this is roughly the plot of every movie and TV show ever made by Joss Whedon.
The causes of all these effects have been studied by experimental economists. (For an overview of the history of experimental economics, listen to my interview with Erik Kimbrough.) One way to test this is to look at how ethnically diverse groups play various games. In a study looking at the different ethnicities in Israel, Fershtman and Gneezy (2001) found that people did not discriminate against Sephardic Jews in the dictator game but they did discriminate in the trust game, indicating that discrimination was driven by a (mistaken) lack of trust in the minority ethnicity. Surprisingly, even members of the minority tended to discriminate in this way.
Glaeser et al. (2000) found that pairs are less trustworthy when they have different ethnicities or nationalities. The really shocking thing about this is that this study was performed on Harvard undergraduates, who we might think of as the people least likely to discriminate in this way.
Easterly, Ritzen, and Woolcock (2006) show that ethnolinguistic fractionalization has a negative impact on the rule of law:
The basic story that Easterly, Ritzen, and Woolcock tell is that ethnic conflict makes it difficult to achieve a consensus on how the government should be run, thus leading to worse government.
Alesina, A., Devleeschauwer, A., Easterly, W., Kurlat, S., & Wacziarg, R. (2003). Fractionalization. Journal of Economic growth, 8(2), 155-194.
Alesina, A., & Ferrara, E. L. (2005). Ethnic diversity and economic performance. Journal of economic literature, 43(3), 762-800.
Alesina, A., Harnoss, J., & Rapoport, H. (2016). Birthplace diversity and economic prosperity. Journal of Economic Growth, 21(2), 101-138.
Easterly, W., Ritzen, J., & Woolcock, M. (2006). Social cohesion, institutions, and growth. Economics & Politics, 18(2), 103-120.
Fershtman, C., & Gneezy, U. (2001). Discrimination in a segmented society: An experimental approach. Quarterly Journal of Economics, 351-377.
Glaeser, E. L., Laibson, D. I., Scheinkman, J. A., & Soutter, C. L. (2000). Measuring trust. Quarterly Journal of Economics, 811-846.
Habyarimana, J., Humphreys, M., Posner, D. N., & Weinstein, J. M. (2007). Why does ethnic diversity undermine public goods provision?. American Political Science Review, 101(04), 709-725.
La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. (1999). The quality of government. Journal of Law, Economics, and organization, 15(1), 222-279.
Parrotta, P., Pozzoli, D., & Pytlikova, M. (2014a). Labor diversity and firm productivity. European Economic Review, 66, 144-179.
Parrotta, P., Pozzoli, D., & Pytlikova, M. (2014b). The nexus between labor diversity and firm’s innovation. Journal of Population Economics, 27(2), 303-364.
Stazyk, E. C., Davis, R., & Liang, J. (2012). Examining the Links between Workforce Diversity, Organizational Goal Clarity, and Job Satisfaction. In APSA 2012 Annual Meeting Paper.
Williams, K. Y., & O’Reilly III, C. A. (1998). A review of 40 years of research. Res Organ Behav, 20, 77-140.
Sat, 25 June 2016
Two days ago, Britain voted to leave the European Union (EU). The "leave" option won with 52 percent of the vote, leaving elites and the media frustrated with voters for choosing what they perceive to be the "wrong" option.
The EU can be thought of as three things: A trade union known as the European Economic Area (or EEA), a currency union (the Euro) which Britain was never a part of, and a central regulatory body.
The EU has been around in one form or another since the 1950s. Although its primary function was always to facilitate trade among European states, its ultimate goal was to prevent Europe from falling back into the brutal wars that had consumed it during the first half of the twentieth century. The Union brought freedom of movement for goods and services and for people across member states.
This freedom of migration only became controversial after the fall of the Berlin Wall. Many poorer states in Eastern Europe joined the EU in the 1990s, creating the opportunity for large numbers of economic migrants to enter the wealthier states of Western Europe (a good thing, from my perspective!). Opposition to open migration was one motivating factor for some in the Leave campaign, but it wasn't the only factor.
Many older Brits who voted to leave did so out of a desire for national sovereignty. The most important legislative body in the EU is the European Commission, the members of which are appointed by the various states. There's a democratically elected European Parliament, but it is less influential than the Commission, having only the power to approve or reject proposals by the Commission.
The members of the Commission are appointed to specific roles. So, for instance, a Slovenian is in charge of transport policy for the entire EU, a Lithuanian is in charge of health and food safety, and a Portuguese politician is in charge of research, science, and innovation. Many in the Leave camp resented having British policy set by unelected politicians from other countries.
What's next for the UK?
While the Leave campaign may have won the referendum, they don't control policy going forward. The only thing that must occur is for Britain to exit the EU. It doesn't have to adopt any other of the Leave campaign's policy goals.
Sam argues that the best option for the UK would be to stay in the European Economic Area (EEA) and the European Free Trade Association (EFTA). This EEA option would maintain the economic benefits of free trade with the EU. This would place Britain in a similar position to Norway and Iceland, which both chose not to become EU member states while participating in the EEA. Britain could also aim for a trade agreement that is tailored to its particular needs, like that of Switzerland.
Brexit puts the EU in a bit of a bind. If they work out a favourable deal with Britain, other states might try to leave once they observe how painless it is. But if the EU adopts a punitive stance towards the UK it could send a bad signal to the other states. Just how voluntary is this club if you're punished for quitting?
More details about the institutions of the European Union.
Fri, 12 September 2014
The minimum wage is a contentious issue among economists, and yet it enjoys near-universal support among the public. In my view, public views of the minimum wage are simply the result of a lack of careful thought by most people. Daniel Kahneman’s theory that people, when faced with a difficult question, substitute a simpler question that they can easily answer, applies particularly well in this case. People answer the question of whether they would like people to earn more when the real question is whether government should mandate higher wages (I first heard this argument from Bryan Caplan on EconLog).
A purely empirical argument for or against the minimum wage is methodologically wrong-headed because empirics do not speak for themselves. Sound theory must be the economist’s first tool in understanding the effect of a policy such as the minimum wage.
Before we can understand something like the minimum wage, we must understand the role of prices in allocating factors of production to their various uses. The price of a factor signals to entrepreneurs that that factor is scarce, that it is needed elsewhere in the economy, and that the entrepreneur who can reduce his usage of relatively more scarce factors in favour of relatively less scarce ones can earn profits, while entrepreneurs who fail to do so earn losses. I give the example of a sandwich shop during an oil boom; the high price of labour caused by the oil boom leads the sandwich shop to substitute away from labour in various ways.
The oil boom in my illustration is irrelevant to the story. The sandwich shop would adapt to an increased price of labour no matter what caused it. If the cause is a minimum wage law, the people no longer employed making sandwiches are involuntarily unemployed rather than finding employment in some other industry.
Minimum wage opponents sometimes get into trouble when they draw supply and demand curves to illustrate the impact of the price floor. The problem with this is that supply and demand diagrams come with built-in assumptions that do not hold true in the case of labour markets. Low-skilled labour is not a homogeneous quantity being sold in a centralized market. The simple supply-and-demand story does not capture all the effects of the minimum wage. For instance, firms substitute between different sorts of workers affected by the minimum wage. In addition, the other terms of employment contracts can change in response to a minimum wage law, such as training and benefits.