This year’s Nobel Prize in economics was awarded to David Card of the University of California, Berkeley, Joshua Angrist of Massachusetts Institute of Technology, and Guido Imbens of Stanford University. The laureates, according to the Nobel Committee have made an important contribution as to how to ascertain cause and effect from observational data.
For instance, how does the imposition of a minimum wage affect employment? In answering these types of questions, economists rely on observational data, but with observational data a fundamental identification problem arises: the underlying cause of any correlation remains unclear.
If we observe that minimum wages and unemployment correlate, is this because a minimum wage causes unemployment? Or because unemployment and lower wage growth at the bottom of the wage distribution leads to the introduction of a minimum wage? Or because of a myriad of other factors that affect both unemployment and the decision to introduce a minimum wage? A key concern with the structural equation approach, however, is that in order to establish a causal relationship, the proposed structure has to be correctly specified.1
By most commentators, the increase in the minimum wage is going to harm the labor market by raising the unemployment. In a study conducted in the 1990s, economists David Card and Alan Krueger examined a minimum wage rise in New Jersey by comparing fast-food restaurants there and in an adjacent part of Pennsylvania.2 They found no impact on employment.
By modifying the randomized controlled trials (RCT) our Nobel laureates in particular, Ingrist and Imbens, have supposedly solved the problem of how to ascertain causality from the data. For the purpose of this article, we will not discuss the details employed by the laureates to ascertain cause and effect from the data.
Can Historical Data Tell Us How the Economy Works?
Note that the so-called data that analysts are utilizing is a display of historical information.
According to Ludwig von Mises in Human Action (pp. 41–49),
History cannot teach us any general rule, principle, or law. There is no means to abstract from a historical experience a posteriori any theories or theorems concerning human conduct and policies.
Also, in The Ultimate Foundation of Economic Science (p. 74) Mises argued that
[w]hat we can “observe” is always only complex phenomena. What economic history, observation, or experience can tell us is facts like these: Over a definite period of the past the miner John in the coal mines of the X company in the village of Y earned p dollars for a working day of n hours. There is no way that would lead from the assemblage of such and similar data to any theory concerning the factors determining the height of wage rates.
In the natural sciences, while a scientist can isolate various facts, he does not know the laws that govern these facts.
All that he can do is hypothesize regarding the “true law” that governs the behavior of the various particles identified. He can never be certain, however, regarding the “true” laws of nature. On this Murray N. Rothbard wrote,
The laws may only be hypothecated. Their validity can only be determined by logically deducing consequents from them, which can be verified by appeal to the laboratory facts. Even if the laws explain the facts, however, and their inferences are consistent with them, the laws of physics can never be absolutely established. For some other law may prove more elegant or capable of explaining a wider range of facts. In physics, therefore, postulated explanations have to be hypothecated in such a way that they or their consequents can be empirically tested. Even then, the laws are only tentatively rather than absolutely valid.3
In economics, however, we do not need to hypothesize, for in economics we can ascertain the essence and the meaning of people’s conduct.
For instance, one can observe that people are engaged in a variety of activities. They may be performing manual work, driving cars, walking on the street, or dining in restaurants. The essence of these activities is that they are all purposeful.
Furthermore, we can establish the meaning of these activities. Thus, manual work may be a means for some people to earn money, which in turn enables them to achieve various goals like buying food or clothing.
Dining in a restaurant can be a means for establishing business relationships. Driving a car may be a means for reaching a particular destination. People operate within a framework of means and ends; they use various means to secure ends. We can also establish from the above that people’s actions are conscious and purposeful.
The knowledge that human action is conscious and purposeful is certain and not tentative. Anyone who tries to object to this in fact contradicts himself, for he is engaged in the purposeful and conscious act of arguing that human actions are not conscious and purposeful. Various conclusions derived from this knowledge of conscious and purposeful action are valid as well.
The theory that human action is conscious and purposeful stands on its own regardless of what the so-called data is showing.
Needless to say, the established theory does not require any statistical verification. In contrast to the natural sciences, in economics we do not hypothesize. We know the essence of things, i.e., that human action is conscious and purposeful. Hence, in economics we do not have to set a hypothesis and then test it.
Given that economics is about conscious, purposeful human actions, we can establish that causality emanates from human beings and not from outside factors. For instance, individuals do not respond mechanically to changes in personal income. Every individual does so in accordance with his goals.
The Minimum Wage and Unemployment
Given that each individual’s ultimate goal is their life maintenance and well-being, a businessperson is unlikely to pay a worker more than the value of the product that the worker generates. If a worker generates per hour a value of $10 toward the business, then the businessperson is not going to pay more than this amount.
If the minimum wage is set at $15 per hour while the worker can only generate a value of $10 per hour, it is then illegal for the business to pay the worker less than the minimum wage of $15 per hour. In such a scenario, the business would be forced into retrenching the worker, since employing the worker for $15 per hour is going to undermine the profitability of the business.
A study that employs advanced quantitative methods and concludes that lifting minimum wages is harmless to the labor market is questionable. Such a study implies that individuals do not seek to better their lives and well-being.
Note that there is no need for quantitative studies to ascertain that the increase in the minimum wage is going to result in an increase in unemployment. All that required is a logical discussion that most human beings could follow.
Contrary to the popular way of thinking, we do not assess a theory in respect to whether it corresponds to the data as such, but on the contrary, we assess data by means of a theory.
The purpose of a theory is to provide the essence of the subject of investigation. It is like a road map that provides information about a particular location while disregarding various nonessential factors. Thus, it tells the reader how to reach point B from point A. The map, however, does not provide various details, such as the surrounding trees and houses.
There is no need for statistical verification to establish the effect of the increase in the minimum wage on the unemployment. A simple logical analysis shows that an increase in the minimum wage is going to undermine the labor market.
Given that economics is about conscious, purposeful human actions we can establish that causality emanates from human beings and not from outside factors.
1. Answering Causal Questions Using Observational Data (Committee for the Prize in Economics Sciences in Memory of Alfred Nobel, 2021).
2. David Card and Alan Krueger, “Minimum Wages and Employment,” American Economic Review 84 (1994): 772–93.
3. Murray N. Rothbard, “Towards a Reconstruction of Utility and Welfare Economics,” in On Freedom and Free Enterprise: The Economics of Free Enterprise, ed. May Sennholz (Princeton, N.J.: D. Van Nostrand, 1956), p. 3.