A long-winded blag on economics.

I love economics, despite the fact that I know only the basics about how an economy is supposed to work. So it always amuses me when an economist makes mistakes that even I can spot.

Okay, so I actually have no idea if they guy writing for my local newspaper is an economist or not. I assume, however, that as he is writing an essay in the business section of the paper about the economy he must have some idea what he’s talking about. If not, then I heartily apologise to the Pretoria News for slandering the integrity and ability of the journalist whose mis-identified essay they simply stuck there for no reason at all. Unfortunately, this guy isn’t exactly alone. I’ve heard this argument plenty of times. Always, of course, the person doing the arguing is well-off enough not to need to worry about minimum wage issues.

The argument itself is essentially this: South Africa has a high unemployment rate. South Africa also has a minimum wage nominally tied to the lowest possible ‘liveable’ wage a worker can earn. This minimum wage prevents employers from hiring people by making labour too expensive. So, in order to lower the unemployment rate, we should eliminate the minimum wage.

Sounds sort of reasonable? Well, it’s wrong.

The idea rests on one of the basic assumptions of free-market economics: that the market will find an ideal balance between supply and demand (which, in most cases, can be directly related to the price of the goods/services in question). Under this assumption, the imposition of a minimum wage will skew the market, forcing supply down over time. This can be illustrated graphically:

Ideal SD curveThe ideal supply/demand relationship

Ideal SD curve econoThe ideal supply/demand curve

Note that, for simplicity, I’ve used a fractional measurement for supply/demand. I’ve also included a small lag (1 time unit) on supply, just to be a little realistic. Under this ideal system, skewing the demand/price/wage by adding a floor to the curve causes the market to tend, paradoxically, towards over-supply:

non-ideal SD curveThe non-ideal supply/demand relationship

Non-ideal SD curve econoThe non-ideal supply/demand curve

So far so good. The problem, of course, is that world is not ideal. If supply is erratic (illustrated by including a function which randomly alters supply by a small amount), then the entire system falls apart:

Ideal SD curve econo plus randomIdeal supply/demand curve under conditions of erratic supply.

It gets even worse when lag is increased (simulation what happens when the goods/services being supplied take a long time to produce), leading to a vicious cycle of over and under-supply:

Ideal SD curve econo plus random, long lagIdeal supply/demand curve under conditions of erratic supply and long lag.

Note that I managed to break my nice mathematical system by having the supply/demand actually go over 1 and under 0. A more sophisticated model could compensate, by the point is still valid as far as I can tell. Even starting from ideal conditions doesn’t help, as feedback soon develops:

Ideal SD curve from equi plus random, long lagIdeal supply/demand curve under conditions of erratic

supply and long lag, starting from equilibrium.

And what of the ‘non-ideal’ system? Well, it turns out that it makes no real difference to market behaviour under real conditions:

Non-ideal SD curve econo plus randomNon-ideal system with erratic supply

Non-ideal SD curve econo plus random, long lagNon-ideal system plus erratic supply, long lag.

So what is the lesson to be learned from this rather long-winded exercise? Well, I think it shows that basing your economic policy on the results of an idealised theoretical system is stupid. Or possibly that your economic opinion pages should be written by actual economists (who presumably spend some time debunking the core tenets of economics as part of their training) rather than journalists with the same economic qualifications as student scientists.

Finally, I think it shows the rather lamentable tendency for ideologues to use the legitimacy that economic theory bestows to simply push their agendas(cough-libertarianism-cough). After all, a moment’s thought would have shown that people are not simply products to be sold. We work on non-economic imperatives (love, charity, bloody-mindedness etc.) all the time, after all. Most obviously of all, a person on the bread line will simply not work if their pay is lower than the amount needed to survive.

PS – For the pedantic among you, here is the rough outline of the way in which I generated the graphs:

I used open office Calc to crunch the numbers. The data points themselves are calculated at each arbitrary time interval, which allowed me to include effects like lag. The market trend towards equilibrium was modelled by changing the supply by 10% of demand per round. This figure is arbitrary. The random factor was +- 1% of demand. This was also arbitrary, but low enough to be vaguely realistic. If anyone want to check my numbers, I can email the entire document to them.

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