August is normally a time for vacation and reinvigoration, for this author who is now in attendance at the Mont Pelerin Society meeting in Sweden. But while he is speaking of the virtues of free markets and the rule of law, the home front reveals a summer of intense confrontation and disillusionment as two nonmarket issues, health care and taxes, confront a restless and bellicose public. And herein lies a political tale about the importance of principle in politics.
Barack Obama was a great, if empty, orator when running for office. He projected an elusive utopian vision of hope and change that won over the hearts of those who postponed thinking about how the brutal fact of scarce resources can stymie even his grandiose plans for social reform. Unfortunately, his campaign skills have not easily transferred to the humdrum business of governance. So much so, that his best chance for reelection requires the remainder of his legislative program to fail.
Why? For decidedly academic reasons: His campaign rhetoric rests on implicit ceteris paribus assumptions that can't hold good. Ceteris paribus is a bit of fancy Latin that means, "all other things being equal." It is an intuitive way to hedge one's bets about the future, by saying that some specified change in a complex system will have its desired effect, assuming that everything else remains unchanged.
This approach is a mixed blessing. On the high side, the ceteris paribus assumption allows for a convenient simplification of what otherwise would be an intractable problem. Thus if one wants to figure out the overall social effects of a rent control statute, it is useful to ignore the possibility that tenants will use their rent savings to bid up the price of tangerines. The prudent analyst is better advised to concentrate on the (dramatic) effects that the regulation has on the supply and quality of housing.
The downside is that in some settings a more capacious view of ceteris paribus lulls people into ignoring issues that are at the core of a problem. Thus it would be foolish to evaluate the impact of a minimum-wage law by assuming that its increase will leave unchanged either the overall levels of employment or the additional terms of employment contracts.
Both these assumptions conceal the serious defects in these laws. As a first approximation, any minimum-wage law will block at least some transactions, so we can expect overall levels of employment to drop. But how much is uncertain. For small increments, the impact is less than you might expect because shrewd employers and employees alike will look for ways to finesse the grim legislative reaper. They may temporize the adverse effects by reducing employer training, and cutting out company-furnished meals and clothing allowances. These won't work for large shifts, and even when they help, they still leave both sides worse off than before.
In the end, it is no longer possible to hope that minimum wages transfer wealth from employers to employees. Rather they hurt both sides. Remove ceteris paribus, and the empirical explanation for these laws has to come from somewhere else, usually misguided politicians and from protectionist labor unions intent on blocking cheaper competition.
Ceteris paribus assumptions are even more dangerous with respect to major interventions in the economy. One of Obama's favorite campaign promises was that he would not raise taxes on the middle class "one dime" to finance the rich package of benefits he hopes to supply them. Once more ceteris paribus won't work.
Let's suppose by some miracle he could pile enough taxes on the rich to achieve his desired revenue target. Middle-class taxes won't rise, but middle- class incomes will surely fall. The high tax on capital gains and upper-class income will lead to reduced investments. Foreign capital can easily flow elsewhere, and high-income taxpayers will cut their tax-generating activities. States will suffer a revenue bite that will in turn lead them to raise their taxes, which won't be enough to keep their levels of service constant. Worse still, even if taxes won't rise, wages will fall, leaving less disposable income. No great achievement here. In the end, it is a replay of the minimum wage: the tax increases on the rich make the middle class unambiguously worse off.
The Obama starry-eyed health care plans will generate the same bad consequences. Obama can say that if you like your current employer health care plan, keep it. That startling claim falls flat on the face of its implicit ceteris paribus assumptions. Higher taxes will shut down some employers and induce other hard-pressed employers either to ditch or trim their current coverages.
Ours is, or at least was, a dynamic economy, and pious political promises of noninterference in one protected enclave are palpably naïve when the rest of the business environment is turned upside down. Dynamic analysis trumps the dangerous status-quo bias of government forecasters. Until the president and Congress learn this one lesson, hold on to your wallet--assuming that the greenbacks in it are still worth tomorrow what they were worth today.
Richard A. Epstein is the James Parker Hall Distinguished Service Professor of Law, The University of Chicago; the Peter and Kirsten Senior Fellow the Hoover Institution and a visiting professor at New York Law School. He writes a weekly column for Forbes.