The earth’s natural resources are finite, which means that if we use them continuously, we will eventually exhaust them. This basic observation is undeniable. But another way of looking at the issue is far more relevant to assessing people’s well-being. Our exhaustible and unreproducible natural resources, if measured in terms of their prospective contribution to human welfare, can actually increase year after year, perhaps never coming anywhere near exhaustion. How can this be? The answer lies in the fact that the effective stocks of natural resources are continually expanded by the same technological developments that have fueled the extraordinary growth in living standards since the Industrial Revolution. Innovation has increased the productivity of natural resources (e.g., increasing the gasoline mileage of cars). Innovation also increases the recycling of resources and reduces waste in their extraction and processing. And innovation affects the prospective output of natural resources (e.g., the coal still underneath the ground). If a scientific breakthrough in a given year increases the prospective output of the unused stocks of a resource by an amount greater than the reduction (via resources actually used up) in that year, then, in terms of human economic welfare, the stock of that resource will be larger at the end of the year than at the beginning. Of course, the remaining physical amount of the resource must continually decline,

A monopoly is an enterprise that is the only seller of a good or service. In the absence of government intervention, a monopoly is free to set any price it chooses and will usually set the price that yields the largest possible profit. Just being a monopoly need not make an enterprise more profitable than other enterprises that face competition: the market may be so small that it barely supports one enterprise. But if the monopoly is in fact more profitable than competitive enterprises, economists expect that other entrepreneurs will enter the business to capture some of the higher returns. If enough rivals enter, their competition will drive prices down and eliminate monopoly power. Before and during the period of the classical economics (roughly 1776–1850), most people believed that this process of monopolies being eroded by new competitors was pervasive. The only monopolies that could persist, they thought, were those that got the government to exclude rivals. This belief was well expressed in an excellent article on monopoly in the Penny Cyclopedia (1839, vol. 15, p. 741): It seems then that the word monopoly was never used in English law, except when there was a royal grant authorizing some one or more persons only to deal in or sell a certain commodity or article. If a number of individuals were to unite for the purpose of producing any particular article or commodity, and if they should succeed in selling such article very extensively, and almost solely, such individuals in popular language would be said to have a monopoly. Now, as these individuals have no advantage

Natural gas is the commercial name for methane, a hydrocarbon produced by the same geological processes that produce oil. Relatively abundant in North America, its production and combustion have fewer adverse environmental effects than those of coal or oil. The 23.1 trillion cubic feet (TCF) of gas that Americans consumed in 2002 accounted for 30.3 percent of all their energy use (measured in British thermal units), up from 21.5 percent in 1952.1 Households consumed 23.3 percent of delivered gas, electric utilities used 27.0 percent as generator fuel, and the remainder went to commercial and industrial users. In 2002, 3.8 TCF were imported from Canada and a negligible amount was exported.2 The U.S. output was produced in 383,000 wells owned by hundreds of producers and was transported through 285,000 miles of interstate pipelines.3 Before high-pressure pipelines were developed in the 1920s, gas was either consumed in the vicinity of its production or flared off as hazardous. Today, producers and marketers use interstate pipelines for deliveries to distributors and large consumers. The Federal Energy Regulatory Commission (FERC) determines cost-based pipeline rates, but pipelines are free to discount these (which they often do) in order to attract business. The rates of most local distribution companies (LDCs) that deliver and sell gas to final users are under state regulation, and the remainder are operated by municipal governments. Thus, gas is a vertically unintegrated industry in which dependable product flows require coordination among producers, pipelines, and LDCs. Since the 1970s, the industry has relied more heavily on coordination by market forces and less heavily on regulation, although the latter still plays a large role. Somewhat unusually, regulators themselves took major initiatives to bring competition to the industry, rather than protecting the status quo or imposing heavier regulations. The industry’s evolution is a case study in the replacement of inefficient economic institutions by efficient ones and the replacement of localized markets by national and global ones. 1938–1985: Pervasive Regulation and Shortages The Natural Gas Act of 1938 instituted pipeline regulation by the Federal Power Commission, which was reconstituted as FERC in 1978. The government justified regulation by asserting that pipelines were “natural monopolies” with scale economies so pervasive that a single line (or a handful to guarantee reliability) was the most economical link between producing and consuming areas. At the same time, state-regulated LDCs were (and continue to be) monopoly franchises with cost-based rates and the ability to pass on gas costs dollar for dollar to end-users. Until the mid-1980s, pipelines purchased gas from producers and resold it, with no markup, to LDCs. In 1954, the Supreme Court ruled that federal regulation extended to the wellhead prices received by producers. Prices were to be determined using recorded costs. Regulators set the allowable costs of replacing exhausted wells at low levels that seriously discouraged exploration for new gas. Because oil prices remained unregulated through the 1960s (most gas is found in association with oil), gas shortages became serious only when new price controls on oil helped bring about the “energy crisis” of 1973–1975. Administrations of both political parties were unable or unwilling to acknowledge that the controls restricted the amount supplied and increased the amount demanded. Instead, they instituted direct controls on gas use, such as prohibiting construction of new gas-burning power plants, in the mistaken belief that falling reserves indicated the exhaustion of supply. In reality, reserves were falling because allowable prices were too low to make exploration profitable. Prior to 1978, intrastate markets were exempt from federal price controls, and they experienced no shortages. 1985–2000: A National Gas Market Emerges A complex series of events in the early 1980s led FERC to lift all price controls in 1985, a promarket policy that the Supreme Court subsequently ratified. The decontrol followed on 1984’s Order 436, which effectively ended the earlier role of pipelines as purchasers and resellers of gas to LDCs. Order 436 (followed by Order 636 in 1992) turned pipelines into “open access” transporters for gas owned by producers, LDCs, and others. FERC still set maximum

National income accounts (NIAs) are fundamental aggregate statistics in macroeconomic analysis. The ground-breaking development of national income and systems of NIAs was one of the most far-reaching innovations in applied

Paul Volcker, while chairman of the Board of Governors of the federal reserve system (1979–1987), was often called the second most powerful person in the United States. Volcker and company triggered the “double-dip” recessions of 1980 and 1981–1982, vanquishing the double-digit inflation of 1979–1980 and bringing the unemployment rate into double digits for the first time since 1940. Volcker then declared victory over inflation and piloted the economy through its long 1980s recovery, bringing unemployment below 5.5 percent, half a point lower than in the 1978–1979 boom. Volcker was powerful because he was making monetary policy. His predecessors were powerful too. At least five of the previous eight postwar recessions can be attributed to their anti-inflationary policies. Likewise, Alan Greenspan’s Federal Reserve bears the main responsibility for the 1990–1991 and 2001 recessions. Central banks are powerful everywhere, although few are as independent of their governments as the Fed is of Congress and the White House. Central bank actions are the most important government policies affecting economic activity from quarter to quarter or year to year. Monetary policy is the subject of a lively controversy between two schools of economics: monetarist and keynesian. Although they agree on goals, they disagree sharply on priorities, strategies, targets, and tactics. As I explain how monetary policy works, I shall discuss these disagreements. At the outset I disclose that I am a Keynesian. Common Goals Few monetarists or Keynesians would disagree with this dream scenario: • First, no business cycles. Instead, production—as measured by real (inflation-corrected) gross national product—would

Mercantilism is economic nationalism for the purpose of building a wealthy and powerful state. Adam Smith coined the term “mercantile system” to describe the system of political economy that sought to enrich the country by restraining imports and encouraging exports. This system dominated Western European economic thought and policies from the sixteenth to the late eighteenth centuries. The goal of these policies was, supposedly, to achieve a “favorable” balance of trade that would bring gold and silver into the country and also to maintain domestic employment. In contrast to the agricultural system of the physiocrats or the laissez-faire of the nineteenth and early twentieth centuries, the mercantile system served the interests of merchants and producers such as the British East India Company, whose activities were protected or encouraged by the state. The most important economic rationale for mercantilism in the sixteenth century was the consolidation of the regional power centers of the feudal era by large, competitive nation-states. Other contributing factors were the establishment of colonies outside Europe; the growth of European commerce and industry relative to agriculture; the increase in the volume and breadth of trade; and the increase in the use of metallic monetary systems, particularly gold and silver, relative to barter transactions. During the mercantilist period, military conflict between nation-states was both more frequent and more extensive than at any other time in history. The armies and navies of the main protagonists were no longer temporary forces raised to address a specific threat or objective, but were full-time professional forces. Each government’s primary economic objective was to command a sufficient quantity of hard currency to support a military that would deter attacks by other countries and aid its own territorial expansion. Most of the mercantilist policies were the outgrowth of the relationship between the governments of the nation-states and their mercantile classes. In exchange for paying levies and taxes to support the armies of the nation-states, the mercantile classes induced governments to enact policies that would protect their business interests against foreign competition. These policies took many forms. Domestically, governments would provide capital to new industries, exempt new industries from guild rules and taxes, establish monopolies over local and colonial markets, and grant titles and pensions to successful producers. In trade policy the government assisted local industry by imposing tariffs, quotas, and prohibitions on imports of goods that competed with local manufacturers. Governments also prohibited the export of tools and capital equipment and the emigration of skilled labor that would allow foreign countries, and even the colonies of the home country, to compete in the production of manufactured goods. At the same time, diplomats encouraged foreign manufacturers to move to the diplomats’ own countries. Shipping was particularly important during the mercantile period. With the growth of colonies and the shipment of gold from the New World into Spain and Portugal, control of the oceans was considered vital to national power. Because ships could be used for merchant or military purposes, the governments of the era developed strong merchant marines. In France, Jean-Baptiste Colbert, the minister of finance under Louis XIV from 1661 to 1683, increased port duties on foreign vessels entering French ports and provided bounties to French shipbuilders. In England, the Navigation Act of 1651 prohibited foreign vessels from engaging in coastal trade in England and required that all goods imported from the continent of Europe be carried on either an English vessel or a vessel registered in the country of origin of the goods. Finally, all trade between England and its colonies had to be carried in either English or colonial vessels. The Staple Act of 1663 extended the Navigation Act by requiring that all colonial exports to Europe be landed through an English port before being re-exported to Europe. Navigation policies by France, England, and other powers were directed primarily against the Dutch, who dominated commercial marine activity in the sixteenth and seventeenth centuries. During the mercantilist era it was often suggested, if not actually believed, that the principal benefit of foreign trade was the importation of gold and silver. According to this view the benefits to one nation were matched by costs to the other nations that exported gold and silver, and there were no net gains from trade. For nations almost constantly on the verge of war, draining one another of valuable gold and silver was thought to be almost as desirable as the direct benefits of trade. Adam Smith refuted the idea that the wealth of a nation is measured by the size of the treasury in his famous treatise The Wealth of Nations, a book considered to be the foundation of modern economic theory. Smith made a number of important criticisms of mercantilist doctrine. First, he demonstrated that trade, when freely initiated, benefits both parties. Second, he argued that specialization in production allows for economies of scale, which improves efficiency and growth. Finally, Smith argued that the collusive relationship between government and industry was harmful to the general population. While the mercantilist policies were designed to benefit the government and the commercial class, the doctrines of laissez-faire, or free markets, which originated with Smith, interpreted economic welfare in a far wider sense of encompassing the entire population. While the publication of The Wealth of Nations is generally considered to mark the end of the mercantilist era, the laissez-faire doctrines of free-market economics also reflect a general disenchantment with the imperialist policies of nation-states. The Napoleonic Wars in Europe and the Revolutionary War in the United States heralded the end of the period of military confrontation in Europe and the mercantilist policies that supported it. Despite these policies and the wars with which they were associated, the mercantilist period was one of generally rapid growth, particularly in England. This is partly because the governments were not very effective at enforcing the policies they espoused. While the government could prohibit imports, for example, it lacked the resources to stop the smuggling that the prohibition would create. In addition, the variety of new products that were created during the industrial revolution made it difficult to enforce the industrial policies that were associated with mercantilist doctrine. By 1860 England had removed the last vestiges of the mercantile era. Industrial regulations, monopolies, and tariffs were abolished, and emigration and machinery exports were freed. In large part because of its free trade policies, England became the dominant economic power in Europe. England’s success as a manufacturing and financial power, coupled with the United States as an emerging agricultural powerhouse, led to the resumption of protectionist pressures in Europe and the arms race between Germany, France, and England that ultimately resulted in World War I. Protectionism remained important in the interwar period. World War I had destroyed the international monetary system based on the gold standard. After the war, manipulation of the exchange rate was added to governments’ lists of trade weapons. A country could simultaneously lower the international prices of its exports and increase the local currency price of its imports by devaluing its currency against the currencies of its trading partners. This “competitive devaluation” was practiced by many countries during the Great Depression of the 1930s and led to a sharp reduction in world trade. A number of factors led to the reemergence of mercantilist policies after World War II. The Great Depression created doubts about the efficacy and stability of free-market economies, and an emerging body of economic thought ranging from Keynesian countercyclical policies to Marxist centrally planned systems created a new role for governments in the control of economic affairs. In addition, the wartime partnership between government and industry in the United States created a relationship—the military-industrial complex, in Dwight D. Eisenhower’s words—that also encouraged activist government policies. In Europe, the shortage of dollars after the war induced governments to restrict imports and negotiate bilateral trading agreements to economize on scarce foreign exchange resources. These policies severely restricted the volume of intra-Europe trade and impeded the recovery process in Europe in the immediate postwar period. The economic strength of the United States, however, provided the stability that permitted the world to emerge from the postwar chaos into a new era of prosperity and growth. The Marshall Plan provided American resources that overcame the most acute dollar shortages. The Bretton Woods agreement established a new system of relatively stable exchange rates that encouraged the free flow of goods and capital. Finally, the signing of the GATT (General Agreement on Tariffs and Trade) in 1947 marked the official recognition of the need to establish an international order of multilateral free trade. The mercantilist era has passed. Modern economists accept Adam Smith’s insight that free trade leads to international specialization of labor and, usually, to greater economic well-being for all nations. But some mercantilist policies continue to exist. Indeed, the surge of protectionist sentiment that began with the oil crisis in the mid-1970s and expanded with the global recession of the early 1980s has led some economists to label the modern pro-export, anti-import attitude “neomercantilism.” Since the GATT went into effect in 1948, eight rounds of multilateral trade negotiations have resulted in a significant liberalization of trade in manufactured goods, the signing of the General Agreement on Trade in Services (GATS) in 1994, and the establishment of the World Trade Organization (WTO) to enforce the agreed-on rules of international trade. Yet numerous exceptions exist, giving rise to discriminatory antidumping actions, countervailing duties, and emergency safeguard measures when imports suddenly threaten to disrupt or “unfairly” compete with a domestic industry. Agricultural trade is still heavily protected by quotas, subsidies, and tariffs, and is a key topic on the agenda of the ninth (Doha) round of negotiations. And cabotage laws, such as the U.S. Jones Act, enacted in 1920 and successfully defended against liberalizing reform in the 1990s, are the modern counterpart of England’s Navigation Laws. The Jones Act requires all ships carrying cargo between U.S. ports to be U.S. built, owned, and documented. Modern mercantilist practices arise from the same source as the mercantilist policies of the sixteenth through eighteenth centuries. Groups with political power use that power to secure government intervention to protect their interests while claiming to seek benefits for the nation as a whole. In their recent interpretation of historical mercantilism, Robert B. Ekelund and Robert D. Tollison (1997) focused on the privilege-seeking activities of monarchs and merchants. The mercantile regulations protected the privileged positions of monopolists and cartels, which in turn provided revenue to the monarch or state. According to this interpretation, the reason England was so prosperous during the mercantilist era was that mercantilism was not well enforced. Parliament and the common-law judges competed with the monarchy and royal courts to share in the monopoly or cartel profits created by mercantilist restrictions on trade. This made it less worthwhile to seek, and to enforce, mercantilist restrictions. Greater monarchical power and uncertain property rights in France and Spain, by contrast, were accompanied by slower growth and even stagnation during this period. And the various cabotage laws can be understood as an efficient tool to police the trading cartels. By this view, the establishment of the WTO will have a liberalizing effect if it succeeds in raising the costs or reducing the benefits of those seeking mercantilist profits through trade restrictions. Of the false tenets of mercantilism that remain today, the most pernicious is the idea that imports reduce domestic employment. Labor unions have used this argument to justify protection from imports originating in low-wage countries, and there has been much political and media debate about the implications of offshoring of service sector jobs for national employment. Many opponents have claimed that offshoring of services puts U.S. jobs at risk. While it does threaten some U.S. jobs, it puts no jobs at risk in the aggregate, however, but simply causes a reallocation of jobs among industries. Another mercantilist view that persists today is that a current account deficit is bad. When a country runs a current account deficit, it is either borrowing from or selling assets to the rest of the world to finance expenditure on imports in excess of export revenue. However, even when this results in an increase of net foreign indebtedness, and associated future debtservicing requirements, it will promote economic wealth if the spending is for productive purposes that yield a greater return than is forgone on the assets exchanged to finance the spending. Many developing countries with high rates of return on capital have run current account deficits for extremely long periods while enjoying rapid growth and solvency. The United States was one of these for a large part of the nineteenth century, borrowing from English investors to build railroads (see international capital flows). Furthermore, persistent surpluses may primarily reflect a lack of viable investment opportunities at home or a growing demand for money in a rapidly developing country, and not a “mercantile” accumulation of international reserves at the expense of the trading partners. About the Author Laura LaHaye is an adjunct professor at the Illinois Institute of Technology. She was a visiting scholar from 2004 to 2005 at the University of Illinois in Chicago and an economics professor there from 1981 to 1990. In 1981, she was a research economist with the General Agreement on Tariffs and Trade. Further Reading   Allen, William R. “Mercantilism.” In John Eatwell, Murray Milgate, and Peter Newman, eds., The New Palgrave: A Dictionary of Economics. Vol. 3. London: Macmillan, 1987. Pp. 445–448. Ekelund, Robert B. Jr., and Robert D. Tollison. Politicized Economies: Monarchy, Monopoly and Mercantilism. College Station: Texas A&M University Press, 1997. Heckscher, Eli. Mercantilism. 2 vols. London: Allen and Unwin, 1934. Magnusson, Lars. Mercantilism: The Shaping of an Economic Language. London: Routledge, 1994. Salvatore, Dominick, ed. The New Protectionist Threat to World Welfare. New York: North-Holland, 1987. Smith, Adam. The Wealth of Nations. Edwin Cannan edition. 1937. Available online at: http://www.econlib.org/library/Smith/smWN.html Viner, Jacob. Studies in the Theory of International Trade. New York: Harper and Brothers, 1937.   (0 COMMENTS)

Until the so-called Keynesian revolution of the late 1930s and 1940s, the two main parts of economic theory were typically labeled “monetary theory” and “price theory.” Today, the corresponding dichotomy is between “macroeconomics” and “microeconomics.” The motivating force for the change came from the macro side, with modern macroeconomics being far more explicit than old-fashioned monetary theory about fluctuations in income and employment (as well as the price level). In contrast, no revolution separates today’s microeconomics from old-fashioned price theory; one evolved from the other naturally and without significant controversy. The strength of microeconomics comes from the simplicity of its underlying structure and its close touch with the real world. In a nutshell, microeconomics has to do with supply and demand, and with the way they interact in various markets. Microeconomic analysis moves easily and painlessly from one topic to another and lies at the center of most of the recognized subfields of economics. Labor economics, for example, is built largely on the analysis of the supply and demand for labor of different types. The field of industrial organization deals with the different mechanisms (monopoly, cartels, different types of competitive behavior) by which goods and services are sold. International economics worries about the demand and supply of individual traded commodities, as well as of a country’s exports and imports taken as a whole, and the consequent demand for and supply of foreign exchange. Agricultural economics deals with the demand and supply of agricultural products and of farmland, farm labor, and the other factors of production involved in agriculture. Public finance (see public choice) looks at how the government enters the scene. Traditionally, its focus was on taxes, which automatically introduce “wedges” (differences between the price the buyer pays and the price the seller receives) and cause inefficiency. More recently, public finance has reached into the expenditure side as well, attempting to analyze (and sometimes actually to measure) the costs and benefits of various government outlays and programs. Applied welfare economics is the fruition of microeconomics. It deals with the costs and benefits of just about anything—government projects, taxes on commodities, taxes on factors of production (corporation income taxes, payroll taxes), agricultural programs (like price supports and acreage controls), tariffs on imports, foreign exchange controls, various forms of industrial organization (like monopoly and oligopoly), and various aspects of labor market behavior (like minimum wages, the monopoly power of labor unions, and so on). It is hard to imagine a basic course in microeconomics failing to include numerous cases and examples drawn from all of the fields listed above. This is because microeconomics is so basic. It represents the trunk of the tree from which all the listed subfields have branched. At the root of everything is supply and demand. It is not at all farfetched to think of these as basically human characteristics. If human beings are not going to be totally self-sufficient, they will end up producing certain things that they trade in order to fulfill their demands for other things. The specialization of production and the institutions of trade, commerce, and markets long antedated the science of economics. Indeed, one can fairly say that from the very outset the science of economics entailed the study of the market forms that arose quite naturally (and without any help from economists) out of human behavior. People specialize in what they think they can do best—or more existentially,

Although labor unions have been celebrated in folk songs and stories as fearless champions of the downtrodden working man, this is not how economists see them. Economists who study unions—including some who are avowedly prounion—analyze them as cartels that raise wages above competitive levels by restricting the supply of labor to various firms and industries. Many unions have won higher wages and better working conditions for their members. In doing so, however, they have reduced the number of jobs available in unionized companies. That second effect occurs because of the basic law of demand: if unions successfully raise the price of labor, employers will purchase less of it. Thus, unions are a major anticompetitive force in labor markets. Their gains come at the expense of consumers, nonunion workers, the jobless, taxpayers, and owners of corporations. According to Harvard economists Richard Freeman and James Medoff, who look favorably on unions, “Most, if not all, unions have monopoly power, which they can use to raise wages above competitive levels” (1984, p. 6). Unions’ power to fix high prices for their members’ labor rests on legal privileges and immunities that they get from government, both by statute and by nonenforcement of other laws. The purpose of these legal privileges is to restrict others from working for lower wages. As antiunion economist Ludwig von Mises wrote in 1922, “The long and short of trade union rights is in fact the right to proceed against the strikebreaker with primitive violence.” Interestingly, those who are expected to enforce the laws evenhandedly, the police, are themselves heavily unionized. U.S. unions enjoy many legal privileges. Unions are immune from taxation and from antitrust laws. Companies are legally compelled to bargain with unions in “good faith.” This innocent-sounding term is interpreted by the National Labor Relations Board to suppress such practices as Boulwarism, named for a former General Electric personnel director. To shorten the collective bargaining process, Lemuel Boulware communicated the “reasonableness” of GE’s wage offer directly to employees, shareholders, and the public. Unions also can force companies to make their property available for union use. Once the government ratifies a union’s position as representing a group of workers, it represents them exclusively, whether or not particular employees want collective representation. In 2002, unions represented about 1.7 million waged and salaried employees who were not union members. Also, union officials can force compulsory union dues from employees—members and nonmembers alike—as a condition for keeping their jobs. Unions often use these funds for political purposes—political campaigns and voter registration, for example—unrelated to collective bargaining or to employee grievances, despite the illegality of this under federal law. Unions are relatively immune from payment of tort damages for injuries inflicted in labor disputes, from federal court injunctions, and from many state laws under the “federal preemption” doctrine. Nobel laureate Friedrich A. Hayek summed it up as follows: “We have now reached a state where [unions] have become uniquely privileged institutions to which the general rules of law do not apply” (1960, p. 267). Labor unions cannot prosper in a competitive environment. Like other successful cartels, they depend on government

Minimum wage laws set legal minimums for the hourly wages paid to certain groups of workers. In the United States, amendments to the Fair Labor Standards Act have increased the federal minimum wage from $.25 per hour in 1938 to $5.15 in 1997.1 Minimum wage laws were invented in Australia and New Zealand with the purpose of guaranteeing a minimum standard of living for unskilled workers. Most noneconomists believe that minimum wage laws protect workers from exploitation by employers and reduce poverty. Most economists believe that minimum wage laws cause unnecessary hardship for the very people they are supposed to help. The reason is simple: although minimum wage laws can set wages, they cannot guarantee jobs. In practice they often price low-skilled workers out of the labor market. Employers typically are not willing to pay a worker more than the value of the additional product that he produces. This means that an unskilled youth who produces $4.00 worth of goods in an hour will have a very difficult time finding a job if he must, by law, be paid $5.15 an hour. As Princeton economist David F. Bradford wrote, “The minimum wage law can be described as saying to the potential worker: ‘Unless you can find a job paying at least the minimum wage, you may not accept employment.’”2 Several decades of studies using aggregate time-series data from a variety of countries have found that minimum wage laws reduce employment. At current U.S. wage levels, estimates of job losses suggest that a 10 percent in crease in the minimum wage would decrease employment of low-skilled workers by 1 or 2 percent. The job losses for black U.S. teenagers have been found to be even greater, presumably because, on average, they have fewer skills. As liberal economist Paul A. Samuelson wrote in 1973, “What good does it do a black youth to know that an employer must pay him $2.00 per hour if the fact that he must be paid that amount is what keeps him from getting a job?”3 In a 1997 response to a request from the Irish National Minimum Wage Commission, economists for the Organization for Economic Cooperation and Development (OECD) summarized economic research results on the minimum wage: “If the wage floor set by statutory minimum wages is too high, this may have detrimental effects on employment, especially among young people.”4 This agreement over the general effect of minimum wages is long-standing. According to a 1978 article in American Economic Review, 90 percent of the economists surveyed agreed that the minimum wage increases unemployment among low-skilled workers.5 Australia provided one of the earliest practical demonstrations of the harmful effects of minimum wage laws when the federal court created a minimum wage for unskilled men in 1921. The court set the wage at what it thought employees needed for a decent living, independent of what employers would willingly pay. Laborers whose productivity was worth less than the mandated wage could find work only in occupations not covered by the law or with employers willing to break it. Aggressive reporting of violations by vigilant unions made evasion difficult. The historical record shows that unemployment remained a particular problem for unskilled laborers for the rest of the decade. At about the same time, a hospital in the United States fired a group of women after the Minimum Wage Board in the District of Columbia ordered that their wages be raised to the legal minimum. The women sued to halt enforcement of the minimum wage law. In 1923, the U.S. Supreme Court, in Adkins v. Children’s Hospital, ruled that the minimum wage law was price fixing and that it represented an unreasonable infringement on individuals’ freedom to determine the price at which they would sell their services. In addition to making jobs hard to find, minimum wage laws may also harm workers by changing how they are compensated. Fringe benefits—such as paid vacation, free room and board, inexpensive insurance, subsidized child care, and on-the-job training—are an important part of the total compensation package for many low-wage workers. When minimum wages rise, employers can control total compensation costs by cutting benefits. In extreme cases, employers convert low-wage full-time jobs with benefits to high-wage part-time jobs with no benefits and fewer hours. David Neumark and William Wascher found that a 10 percent increase in minimum wages decreased on-the-job training for young people by 1.5–1.8 percent.6 Since on-the-job training is the way most people build their salable skills, these findings suggest that minimum wage laws also reduce future opportunities for the unskilled. A particularly graphic example of benefits reduction occurred in 1990, when the U.S. Department of Labor ordered the Salvation Army to pay the minimum wage to voluntary participants in its work therapy programs. In exchange for processing donated goods, the programs provided participants, many of whom were homeless alcoholics and drug addicts, with a small weekly stipend and up to ninety days of food, shelter, and counseling. The Salvation Army said that the expense of complying with the minimum wage order would force it to close the programs. Ignoring both the fact that the beneficiaries of the program could leave to take higher-paying jobs at any time and the cash value of the food, shelter, and supervision, the Labor Department insisted that it was protecting workers’ rights by enforcing the minimum wage. After a public outcry, the Labor Department backed down.7 Its Wage and Hour Division Field Operations Handbook now contains a special section on minimum wage enforcement and the Salvation Army.8 Minimum wage increases make unskilled workers more expensive relative to all other factors of production. If skilled workers make fifteen dollars an hour and unskilled workers make three dollars an hour, skilled workers are five times as expensive as the unskilled. Imposing a minimum wage of five dollars an hour makes skilled workers relatively more attractive by making them only three times as expensive as unskilled workers. This explains why unions, whose members have historically been highly skilled and seldom hold minimum wage jobs, invariably support legislation increasing minimum wages. As in the Australian case, unions also protect themselves against competitive threats by assiduously helping labor authorities find and prosecute suspected violators. Many employers in the U.S. construction industry have found it less expensive to hire unskilled workers at low wages and train them on the job. By accepting lower wages in return for training, unskilled workers increase their expected future income. With high minimum wages like those specified for government construction by the Davis-Bacon Act, the cost of wages and training for the unskilled may rise enough to make employers prefer more productive union members. In effect, higher minimum wages reduce the competition faced by union members while leaving the unskilled unemployed. Of course, employers may also respond to minimum wage laws by decreasing overall employment, substituting machines for people, moving production abroad, or shutting down labor-intensive businesses. While those rendered unemployed by a minimum wage increase are largely invisible, it is easy to calculate the increased income enjoyed by those who keep their jobs after an increase. This asymmetry has led many advocates to mistakenly assume that increasing the minimum wage is an effective way to fight poverty. Using 1997 Census data, D. Mark Wilson found that only 11.7 percent of minimum-wage workers were the sole breadwinners in their families, and that more than 40 percent of the sole breadwinners earning the minimum wage were voluntary part-time workers.9 Richard Burkhauser used 1996 U.S. Census data to identify the likely beneficiaries from the 1996 increase in the federal minimum wage. He concluded that the “20.9 percent of minimum wage workers who lived in poor families only received 16.8 percent of the benefits.”10 Additional evidence on the distributional effect of minimum wages comes from David Neumark, Mark Schweitzer, and William Wascher. Raising the minimum wage increases both the probability that a poor family will escape poverty through higher wages and the probability that another nonpoor family will become poor as minimum wage increases price it out of the labor market. They found that the unemployment caused by minimum wage increases is concentrated among low-income families. This suggests that minimum wage increases generally redistribute income among low-income families rather than moving it from those with high incomes to those with low incomes. The authors found that although some families do benefit, minimum wage increases generally increase the proportion of families that are poor and near-poor. Minimum wage increases also decrease the proportion of families with incomes between one and a half and three times the poverty level, suggesting that they make it more difficult to escape poverty.11 In the early 1990s, after a telephone survey of 410 fast-food restaurants in New Jersey and Pennsylvania, economists David Card and Alan B. Krueger challenged the consensus view that higher minimum wages shrink employment opportunities. Their results appeared to demonstrate that a minimum wage increase resulted in increased employment.12 Because telephone survey data are notoriously prone to measurement error, Neumark and Wascher repeated Card and Krueger’s analysis using payroll records from a similar sample of restaurants over the same time period. The results from the payroll data showed that “the minimum-wage increase led to a decline in employment in New Jersey fast food restaurants relative to the Pennsylvania control group.”13 After an extended academic debate, Card and Krueger retreated from their earlier position, writing that “the increase in New Jersey’s minimum wage probably had no effect on total employment in New Jersey’s fast-food industry, and possibly had a small positive effect.”14 Even without the results from the payroll data, the contrary results from the Card and Krueger study would have had a limited impact on economists’ belief that increasing the minimum wage increases unemployment. As labor economist Finis Welch pointed out, the consensus theory does not predict how any one firm or industry is affected by minimum wage increases.15 Even if nationally recognized fast-food restaurants did not reduce hiring in response to higher minimum wages, Card and Krueger were silent about what happened at less-visible businesses, such as small retailers and local pizza and sandwich shops. Furthermore, estimates of the overall effect of minimum wage increases often lead people to overlook the fact that regional and sectoral wage differentials average together to produce the national result. A federal minimum wage of $5.15 an hour may substantially reduce employment in rural areas, where it exceeds the prevailing wage, but have little effect on employment in large cities, where almost everyone earns more. Regional studies leave little doubt that substantial increases in the minimum wage can shrink local industries and inhibit job creation in areas with market wages below the new minimum. The growth of the textile industry in the southern United States, for example, was propelled by low wages. Had the federal minimum wage been set at the wage earned by northern workers, the migration of textile workers to the South might never have occurred. It is also easy to overlook the fact that raising the minimum wage applicable to a relatively small proportion of occupations will not necessarily increase measured unemployment. Some people will lose their jobs in covered occupations and withdraw from the labor market entirely. They will not be included in the unemployment statistics. Others will seek jobs at lower pay in uncovered occupations. Though the labor influx reduces wages in the uncovered sector, people do have jobs, and unemployment may not change. As minimum wage laws cover more occupations, however, the shrinking uncovered sector may not be able to absorb all of the people thrown out of work. The 1989 U.S. minimum wage legislation brought us one step closer to this possibility by extending coverage to all workers engaged in interstate commerce, regardless of employer size. The fact that gross unemployment statistics do not necessarily reflect the harm done by minimum wage laws with limited coverage probably explains the popularity of the living-wage ordinances now in vogue in American cities with strong union ties. Living-wage ordinances set minimum wages for businesses and nonprofits that receive contracts or subsidies from local government. To arrive at the appropriate minimum living wage, advocates calculate the amount required to pay for a basket of goods containing “decent” housing, child care, food, transportation, health insurance, clothing, and taxes for various family sizes. The minimum is then set at the rate that produces enough money to buy the basket when someone works forty hours a week for a year. Initial empirical studies by Neumark suggest that the trade-off between wages and employment is the same for living wages as for minimum wages.16 In San Francisco in 2001, passage of a living-wage law raised the compensation of airport skycaps from $4.75 an hour to $10.00 an hour plus health insurance.17 By the end of 2002, the Economic Policy Institute, an advocacy group supported by labor unions and liberal foundations, reported that living-wage ordinances had set minimum wages ranging from $6.25 an hour in Milwaukee to $12.00 an hour in Santa Cruz, California.18 In September 2003, the California Assembly passed a $10 minimum-wage requirement for contractors doing business with the state. By one reckoning, the total cost of the typical basket of worker necessities used to arrive at living-wage minimums exceeds the incomes of almost a third of all families in the United States.19 It will not be surprising, therefore, as the number of cities with “living-wage” laws expands, to see unskilled workers harmed by falling employment, fewer entry-level jobs, and a reduction in job-related training and educational opportunities. About the Author Linda Gorman is a senior fellow with the Independence Institute in Golden, Colorado. She was previously an economics professor at the Naval Postgraduate School in Monterey, California. Further Reading   Brown, Charles. “Minimum Wage Laws: Are They Overrated?” Journal of Economic Perspectives 2, no. 3 (1988): 133–145. Burkhauser, Richard V., Kenneth Couch, and David C. Wittenburg. “A Reassessment of the New Economics of the Minimum Wage Literature with Monthly Data from the Current Population Survey.” Journal of Labor Economics 18, no. 4 (2000): 653–680. Employment Standards Administration. U.S. Department of Labor. “History of Changes to the Minimum Wage Law.” Online at: http://www.dol.gov/esa/minwage/coverage.htm. Eccles, Mary, and Richard B. Freeman. “What! Another Minimum Wage Study?” American Economic Review 94 (May 1982): 226–232. Forster, Colin. “Unemployment and Minimum Wages in Australia, 1900–1930.” Journal of Economic History 45, no. 2 (June 1985): 383–391. Hashimoto, Masanori. “Minimum Wage Effects on Training on the Job.” American Economic Review 72, no. 5 (1982): 1070–1087. Neumark, David, Mark Schweitzer, and William Wascher. “Will Increasing the Minimum Wage Help the Poor?” Federal Reserve Bank of Cleveland Economic Commentary, February 1, 1999. Online at: http://www.clevelandfed.org/Research/com99/0201.pdf. Neumark, David, and William Wascher. “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Comment.” American Economic Review 90, no. 5 (2000): 1362–1396. Neumark, David, and William Wascher. “Minimum Wages and Training Revisited.” Journal of Labor Economics 19, no. 3 (2001): 563–595. Rottenberg, Simon, ed. The Economics of Legal Minimum Wages. Washington, D.C.: American Enterprise Institute for Public Policy Research, 1981. Welch, Finis. Minimum Wages: Issues and Evidence. Santa Monica, Calif.: RAND Corp., 1978. Wilson, D. Mark. Increasing the Mandated Minimum Wage: Who Pays the Price? Backgrounder no. 1162. Washington, D.C.: Heritage Foundation, 1998.   Footnotes 1. Employment Standards Administration, U.S. Department of Labor, History of Changes to the Minimum Wage Law, 2003, online at: http://www.dol.gov/esa/minwage/coverage.htm.   2. “Minimum Wage vs. Supply and Demand,” Wall Street Journal, April 24, 1996.   3. Paul Samuelson, Economics, 9th ed. (New York: McGraw-Hill, 1973), pp. 393–394.   4. Organization for Economic Cooperation and Development, OECD Submission to the Irish National Minimum Wage Commission, Labour Market and Social Policy Occasional Papers no. 28, 1997, p. 15.   5. Kearl, J. R., et al., “A Confusion of Economists?” American Economic Review 69 (1979): 28–37.   6. David Neumark and William Wascher, “Minimum Wages and Training Revisited,” NBER Working Paper no. 6651, National Bureau of Economic Research, Cambridge, Mass., 1998.   7. James Bovard, “How Fair Are the Fair Labor Standards,” Regulation 18, no. 1 (1985), online at: http://www.cato.org/pubs/regulation/reg18n1d.html.   8. Section 64c06: Salvation Army says: “The Salvation Army’s position is that individuals in its rehabilitation program (called ‘beneficiaries’) are not employees under the FLSA. Although WH may not agree with this position, do not initiate C/As until receiving clearance from both the RA and the Child Labor and Special Employment Team, NO/OEP. Advise beneficiaries who complain that this WH policy has no effect on their private-action rights under section 16(b) of the FLSA” (http://www.dol.gov/esa/whd/FOH/ch64/64c06.htm).   9. D. Mark Wilson, Increasing the Mandated Minimum Wage: Who Pays the Price? Backgrounder no. 1162 (Washington, D.C.: Heritage Foundation, 1998).   10. Richard V. Burkhauser, Written testimony before the Committee on Education and the Workforce, U.S. House of Representatives, 106th Congress, April 27, 1999. See also Richard V. Burkhauser, Kenneth A. Couch, and Andrew J. Glenn, “Public Policies for the Working Poor: The Earned Income Tax Credit Versus Minimum Wage Legislation,” Research in Labor Economics 15 (1996): 65–109; Richard V. Burkhauser, Kenneth A. Couch, and David C. Wittenburg, “Who Gets What from Minimum Wage Hikes: A Re-estimation of Card and Kreuger’s Distributional Analysis in Myth and Measurement: The New Economics of the Minimum Wage,” Industrial and Labor Relations Review 49, no. 3 (1996): 547–552.   11. David Neumark, Mark Schweitzer, and William Wascher, “Will Increasing the Minimum Wage Help the Poor?” Federal Reserve Bank of Cleveland Economic Commentary, February 1, 1999, online version at: http://www.clevelandfed.org/Research/Workpaper/2004/WP04-12.pdf.   12. David Card and Alan B. Krueger, “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania,” American Economic Review 84, no. 4 (1994): 792. A later book expanded on these results, see David Card and Alan B. Krueger, Myth and Measurement: The New Economics of the Minimum Wage (Princeton: Princeton University Press, 1995).   13. David Neumark and William Wascher, “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Comment,” American Economic Review 90, no. 5 (2000): 1390. Researchers from the Employment Policies Institute also reported finding data errors in the Card and Krueger sample. In one Wendy’s in New Jersey, for example, there were no full-time workers and thirty part-time workers in February 1992. By November 1992, the restaurant had added thirty-five full-time workers with no change in part-timers. See David R. Henderson, “The Squabble over the Minimum Wage,” Fortune, July 8, 1996, pp. 28ff.   14. David Card and Alan B. Krueger, “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Reply.” American Economic Review 90, no. 5 (2000): 1419.   15. American Enterprise Institute, “The Minimum Wage and Employment: What Research Shows,” conference summaries, Washington, D.C., August 1995, online at: http://www.aei.org/cs/cs5365.htm.   16. David Neumark and Scott Adams, “Do Living Wage Ordinances Reduce Urban Poverty?” NBER Working Paper no. 7606, National Bureau of Economic Research, Cambridge, Mass., 2000; David Neumark, How Living Wages Affect Low-Wage Workers and Low Income Families (San Francisco: Public Policy Institute of California, 2002).   17. Adam Geller, “‘Living-Wage’ Laws Raise Pay for Poor but May Cost Jobs,” Associated Press, September 1, 2001, online at: http://projects.is.asu.edu/pipermail/hpn/2001-September/004534.html.   18. The Economic Policy Institute received $90,000 from the NEA in 2000–2001 (Education Policy Institute, http://216.239.33.100/search?q=cache:fYjj4PUYjiYC:www.educationpolicy.org/NEAreport2000.htm+%22Economic+Policy+Institute%22+%22Form+990%22&hl=en&ie=UTF-8), and $200,000 from the Joyce Foundation (2001 Annual Report, http://www.joycefdn.org/pdf/01_AnnualReport.pdf). For a complete list of supporters in 2000, see the institute’s annual report at: http://www.epinet.org/ar2000/AR00_RS3.htm. The rate is $11.00 if health benefits are included in the wage package.   19. Economic Policy Institute, Basic Family Budget Calculator, online at: http://epinet.org/, under Poverty and Family Budgets section. Fraction below living wage minimums from Heather Boushey, Chauna Brocht, Bethney Gunderson, and Jared Bernstein, Hardships in America: The Real Story of Working Families (Washington, D.C.: Economic Policy Institute, 2001), table 5.   (0 COMMENTS)

“Law and economics,” also known as the economic analysis of law, differs from other forms of legal analysis in two main ways. First, the theoretical analysis focuses on efficiency. In simple terms, a legal situation is said to be efficient if a right is given to the party who would be willing to pay the most for it. There are two distinct theories of legal efficiency, and law and economics scholars support