Government Can’t Regulate Just One Side of the Market
The rest of the story.
I’ve spent the last week or so teaching price controls in my intro-to-economics class. One thing I tried to stress is that controls are often sold to the citizenry in a way that disguises what they really do. I don’t mean just the obvious point that there are unintended consequences. I mean that such laws appear to regulate only the “bad guys” while protecting the innocent folks on the other side of the transactions. In reality government can’t regulate just one side of the market: Regulations on sellers are necessarily regulations on buyers, and regulations on buyers are necessarily regulations on sellers.
Take a simple price ceiling, such as a maximum price for gasoline or maximum rent for Manhattan apartments. People who support such laws think that somehow those who are selling or renting the good have the power to charge a higher price than what is perceived as fair or just, and that legislating a maximum below what would be charged must therefore protect consumers. The traditional economic analysis rightly shows how this causes shortages and various other undesirable unintended consequences.
Buyers Limited Too
The point I want to make is that such laws also limit the behavior of buyers (or renters). In a genuinely free market, sellers who wish to maximize profits cannot charge any price they wish. They must be attentive to the intensity of consumer demand at various prices. Ultimately the price of a given good is high because buyers find the product very valuable. Price control says, “Sorry, buyers, you cannot express to sellers just how valuable you find this good, and therefore those of you who value it most highly will be unable to gain access to it.” So rather than view price ceilings as laws to protect hapless buyers from ruthless sellers, we would be more accurate in seeing them as laws that prevent motivated buyers from outcompeting other buyers and communicating to ignorant sellers just how intensely they value the good.
We can make the same argument about price floors, or minimum-price laws such as farm price supports or the minimum wage. Minimum-wage laws are normally couched in terms of protecting powerless sellers of labor against ruthless buyers, who have so much power, they can drive wages down to near-poverty levels. Again, we know how the minimum wage causes all kinds of problems, most importantly high levels of unemployment among the least-skilled workers. (In fact, many early proponents of the minimum wage recognized this, but saw it as a feature not a bug: It was a way to impoverish and eliminate the eugenically undesirable [pdf].)
However, like maximum-price laws, these laws really limit the other side of the market. A minimum wage does not just prevent employers from “exploiting” workers at “too low” a wage; it also prevents workers from offering their services at wages they think will make them employable. For lower-skilled workers, a minimum-wage law is effectively a minimum-productivity law that undermines their ability to outcompete other workers by offering to work for less when they can’t produce as much per hour as the minimum wage. And this is precisely the feature of the law that higher-skilled workers like: It enables them to shut out competition from other workers.
Who Competes?
The key is to remember that market competition is not between buyers and sellers, but rather among buyers and among sellers. As a result, all laws that limit prices necessarily limit the ability of both sides of the market to compete, regardless of how the law is framed or who its proponents say it will “limit.” All price controls choke off market communication by preventing the competitive process on each side of transactions from telling the other side how much goods are valued.
The next time someone tells you that price controls or minimum-wage laws put the brakes on powerful firms that sell necessities at too high a price or buy labor at unfairly low wages, don’t believe it. Those laws limit consumers and workers, especially lower skilled ones, at least as much as they limit powerful firms.
Comment by norman on 3 March 2011:
Excellent, eye-opening explanation. Thanks
Comment by Bil Welch on 3 March 2011:
When I understand this it seems so basic thaT I wonder why it needed to be stated. I thought that I was not so suseptable to the spin doctors and psuedo public servants.
Comment by Deefburger on 3 March 2011:
Economics in my understanding has much in common with Electronics. Force when applied is limited to the contact point of the application, but it will affect a change in potential throughout the circuit. It looks like you only touched the wire to one place, but the effect of the raised or lowered power at that point in the circuit causes unseen changes in other parts of the circuit.
In Electronics, we learn to use Superposition Theorem to calculate how a component sees the circuit, but what we don’t see in this calculation is the overall effect on the other components. All of the other components are lumped together into a single applied voltage, supplied current, and characteristic resistance, and the component being tested is set into this simpler circuit and analyzed.
Adding a component to a circuit by only considering it’s function, is the same as plugging a price control into the economic “circuit” without understanding the effect it will have on the larger functioning of the system. All too often we put a resistor into the circuit only to see the voltage driving a current elsewhere that damages the other part of the system.
Poking around inside your computer with wires and parts will not have the desired outcome no matter how careful you are at poking. You are much better off leaving it alone. Likewise, political poking into economic systems will inevitably result in unwanted outcomes. The Economy left alone will raise its own potentials when and where they are natural. Poking around in the Economy with limits and regulations creates new paths for existing potentials and currents and it is nearly impossible to determine when and where they will come from.
A functioning economy is one where the individual components within it find their own place and potential, much like stem cells in the body. Political limits and regulations will be gone around and bypassed as stones are passed by the water in a river, or they are sinks for power which will raise the temperature in that part of the circuit until the circuit breaks down or reaches the limits it can withstand. No one has the ability to predict when and where the lightening will strike that ends the whole mal-investment in law and power. Better to leave it alone and not assume you have the requisite omniscience to predict the outcome of a system larger and more complex than your self. One component can only be tested against the whole system reduced to one other. Political action has a knowledge problem by default mathematically and logically. Application of limited knowledge is no better than a shot in the dark, or poking inside a computer with a live wire.
Comment by Benjamin Smith on 3 March 2011:
In a truly unexpected way, you’ve just explained to me exactly how extremely valuable the minimum wage actually is. For the first time, I get just how critical this concept is to a modern, 1st world country! Why do pretty much ALL 1st world countries have a minimum wage?
You say “And this is precisely the feature of the law that higher-skilled workers like: It enables them to shut out competition from other workers.”
… so it provides an extremely strong incentive to become more skilled, and thus more capable of contributing to a 1st world country rather than remain indigents incapable of providing more value than a handful of rice in an 8-hour day. Far better, it seems, to socially require more competence from workers AND provide means for them to become more competent. Since more overall wealth gets created, everybody wins.
I’ve long been opposed to the minimum wage for the reasons that you state, but I’ve never taken this to the logical conclusion. Much like the phrase “serious bidders only please” in an online ad, it raises the bar for everyone.
Strangely, I think you’ve just moved my political position towards the liberal!
Comment by Jonathon Schwartz on 3 March 2011:
@deefburger:
Quote: “Poking around inside your computer with wires and parts will not have the desired outcome no matter how careful you are at poking.”
As an engineer, I would have to strongly disagree. How do you think the computer was put together in the first place? I routinely “poke around” circuit designs with wires and parts, it’s part of my very well-paying job!
Really, just how do you think your computer came to exist? A stork?
Comment by Dave b on 3 March 2011:
This is a simple but great piece explaining how price controls in wages or product valuation hurts those it’s intended to help. I find it funny that the people who legislate these controls today frequently forget the negative consequences. They claim a policy’s “intention” is to help the poor, minorities or the very unskilled workers when the opposite actually results and the progressives in the past knew the REAL results but thought of them as a positive outcome. Today, they just ignore history and try to make it sound good.
As the progressive (socialist) Sidney and Beatrice Webb ([1897] 1920, 785) stated:
“With regard to certain sections of the population [“unemployables”],this unemployment is not a mark of social disease, but actually of social health.”
When Mr. Walter Williams said “Minimum-wage laws are one of the most powerful tools in the arsenal of racists,” I now get it.
I also read how Beatrice Webb also coined the phrase “collective bargaining.” I think of that phrase a bit differently now…
http://www.princeton.edu/~tleonard/papers/Eugenics.pdf
On a side note, It might be nice to see an article clarifying social Darwinism but differentiating between the collectivist (reform or eugenic) form and individualist form. Thomas Leonard has done some great work’s on that. It can all be tied into economics and the State. That topic or the “The Progressive Case for Regulating Women’s Work”
http://www.princeton.edu/~tleonard/research.htm
Comment by Steve Horwitz on 3 March 2011:
Ben,
Perhaps the minimum wage does create an incentive to get more skilled, but in the meantime, millions of employable people with low skills are unemployed and suffering, not to mention not getting the entry level skills that they need to move up. If you think that’s a good thing, then I’ll have to politely disagree.
Plus, even without min wage laws, there’s plenty of incentive to gain skills because more skills equals higher wage even without such a law. All the law does is make it HARDER to get those skills by cutting off the bottom rungs of the ladder.
Comment by Joker on 3 March 2011:
Benjamin Smith: You almost got there. Almost. You’re right in that minimum wage laws create incentive to become educated, but you fall short one last step.
Min. wage laws create unemployment in the lower skilled workers that Horwitz talks about in both the article and his response above, and last time I checked, even community college is getting expensive. When you have no job, you have no money to pull yourself out of the category of “low-skilled.”
Deefburger: Unbelievably beautiful analogy. I barely know a thing about electronics, but understood your entire post perfectly.
Comment by Frank on 3 March 2011:
I know it was subtle but I’m pretty sure Ben was being sarcastic to make a point. If he really believed in using the state to harm people for their own good, he probably wouldn’t come out and say “I want the state to punish a group of people for their own good”. It seems like the comment was purposely composed to make its absurdity jump out at the reader (making a point using a type of reverse psychology). Of course, I could be wrong.
Comment by Beth on 5 March 2011:
Walter Williams has made some good points about the minimum wage in the past. One that sticks out in my mind is that there is more to a low paying job than just the wage itself. It perhaps provides something even more valuable to the least skilled workers: a chance to learn and improve skills that will lead to a increased ability to compete and thus higher wages. Mr Horowitz touched on this in his comments too.
Jobs that can be had at lower than minimum wages are actually good ways to help poor and skilless people climb out of poverty. But, every time the minimum wage rises, it means less chance for them.
Unintended consequences are truly ironic. The road to Hell is paved with good intentions.