2014-02-06

Minimum Wage And The Gnome Hypothesis

Some months back, I introduced what I call "The Gnome Hypothesis," and added the term to my dubious little Lexicon, defining it as any chain of logic that is valid, but derived from imaginary assumptions.

Jonathan Finegold Catalan pushes the case for the monopsony theory of labor markets when discussing the minimum wage (bold added, italics in the original):
The case for a minimum wage. Many people believe that all people deserve a minimum standard of living, and that one method of pursuing this is by paying minimum wage workers an hourly income above the market value of their labor. The classic economic argument against the minimum wage is that it creates unemployment, by pricing many workers out of the market. However, much of the recent evidence fails to reveal disemployment costs, meaning that firms raise their minimum wage without having to let workers go. In fact, some studies show that the minimum wage increases employment, as the monopsony theory of markets predicts. The implication is that the most cited cost to minimum wage may actually not be a cost at all.
Instead of testing for monopsony, Jonathan imports it by conjecture. Whether the observed market is a monopsony is a determinable fact, but absent that determination, this is all merely a thought experiment.

A minimum wage increase that translates into an employment increase is consistent with a monopsony labor market theory, but it is also consistent with other stories. As I wrote recently, we might rather be looking at one contiguous county's gain at the expense of another. Or perhaps some other explanation is the right one.

But it's all just a Gnome Hypotheses until we investigate.

Unfortunately, a large body of economic research comes down to the following (highly flawed) analytical reasoning:

  • If X then Y.
  • If W then Z
  • Test for either Y or Z.
  • Therefore, conclude either X or W.

It feels scientific, because there are hypotheses, tests, and conclusions. But look what's missing: Every other conceivable explanation for Y and Z!  "If X then Y" is not even a hypothesis worth testing until we've ruled-out the alternative hypothesis, "If not-X then Y." We have to prove a causal link between X and Y before we can test for one.

We call this affirming the consequent, and minimum wage discussions are rife with this fallacy. If monoposony (P) then minimum wage increases will increase employment (Q); we test for Q, observe it, and conclude P. This is only a valid test if we first establish that Q is a necessary and sufficient condition for P, and not for any other theories, R, S, T, etc.

So, Jonathan Finegold Catalan is affirming the consequent when he says that observing Q is "reasonably" consistent with P. That's fallacious, but what makes it a Gnome Hypothesis is the fact that P is pure speculation. We can all imagine a monopsony scenario, but that doesn't mean that our imagination has established that the scenario applies to the real world.

In other words, we don't need a test for Q; we need a test for P.