professor lester and the neoclassicals

Professor Lester and the Neoclassicals: The 'Marginalist Controversy' and the PostwarAcademic Debate over Minimum Wage Legislation: 1945-1950Author(s): Robert E. PraschSource: Journal of Economic Issues, Vol. 41, No. 3 (Sep., 2007), pp. 809-825Published by: Association for Evolutionary EconomicsStable URL: http://www.jstor.org/stable/25511229 .Accessed: 28/06/2014 19:19

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IPJ JOURNAL OF ECONOMIC ISSUES Jul Vol.XLI No. 3 September 2007

Professor Lester and the Neoclassicals: The 'Marginalist Controversy' and the Postwar Academic Debate Over Minimum Wage Legislation: 1945-1950

Robert ? Prasch

Study of wage data and the actual processes of wage determination

indicates that psychological, social, and historical factors - such as the

social outlook and generosity of the management, community attitudes and

mores, tradition of the firm - are highly important influences in particular

cases. There appears to be a fairly high degree of irrationality in the wage structure and in company wage policies, judged either by the market

analysis of economists or job evaluation within and between plants.

Richard Lester (1946d, 158).

Soon after the end of the Second World War (WWII), the Truman Administration moved to raise the federal minimum wage and broaden the scope of its coverage.

Among other responses, this decision induced a critical debate in the professional economics literature, one that spilled over into the proper structure, substance, and

methods of economics. Professor Richard Lester, recently appointed to Princeton

University, initiated this debate in an article published in the American Economic

Review entitled "Shortcomings of Marginal Analysis for Wage-Employment Problems" (Lester 1946c), where he presented several pointed criticisms of the application of what he termed "marginalism" to the task of understanding modern American labor markets and their regulation. Specifically, he was interested in

reexamining and reassessing the applicability of the increasingly standard supply and demand model of wage determination under modern manufacturing conditions.

The author is an Associate Professor of Economics at Middlehury College in Middlebury, Vermont. He would like to thank Falguni A. Sheth, John Henry and David Andrews for their comments at various stages in the writing of this paper. He would also like to thank the audiences who heard earlier versions of this paper at the History of Economics Society, the Colgate/Hamilton Economics Seminar, the University of Utah Economics Department, and the Middle hury College Economics Seminar.

809

?2007, Journal of Economic Issues


810 Robert E. Prasch

Lester's core argument was that "marginalism" (broadly, what we would term

"Neoclassicism") was a theory that began with an inaccurate assessment of the

structure of costs in modern manufacturing firms.1 Neglected was the fact that

modern manufacturing firms usually experienced decreasing average costs as output

increased. This important error was compounded when Neoclassical theorists

insisted on a flawed conception of the structure and dynamics of labor markets -

including the assumptions of a high degree of factor mobility and a rough equality of

bargaining power. Arguing from such inauspicious foundations, Lester believed that

marginalists could not avoid deriving incorrect conclusions regarding labor market

regulation and policy. These incorrect conclusions included an unproven claim that

an increase in the federal minimum wage would induce greater disemployment among covered workers

- particularly low-wage workers in the south.

In a follow-up paper, "Marginalism, Minimum Wages, and Labor Markets,"

Lester neatly summarized the empirical basis of his case against marginalist economics. He concluded that "lr]easoning about labor markets as though they were

commodity markets seems to be an important explanation for erroneous conclusions

on such matters as minimum wages" (Lester 1947a, 146). He would reiterate this

theme in another paper published soon after the above debate, one that summarized

the arguments and conclusions of his voluminous research on labor economics and

the problems of marginalist theory.

Explanation of wages and wage changes have been highly mechanistic. Commodity market concepts are rigidly applied to

labor markets; wage theory is regarded merely as a part of price

theory. Allowance has not been made for the marked differences

between employers' wage and employment policies and their

policies regarding commodity prices and purchases. Lack of an

adequate theory of human behavior in the workshop and in the labor market has resulted in the neglect or insufficient recognition

of the importance of workers' reactions to wage payments, of

management's response to wage changes, and of company and

union wage policies (Lester 1948a, 197).

Building upon this list of failings and shortcomings within "highly mechanistic"

depictions of commodity and labor markets, and the marginalist schools' lack of

foundation in observed economic behavior, Lester repeatedly voiced his frustration

with "learned theorists spinning unrealistic abstractions and offering romantic

remedies" (Lester 1947c, 513). These tendencies were, to his mind, exemplified in

the course of a short article by George Stigler that, in a brief and almost entirely a

priori argument from the premises of marginalist theory, presented a sweeping

dismissal of minimum wage legislation (Stigler 1946).


Professor Lester and the Neoclassicals 811

American Economics and Minimum Wage Legislation

Lester's criticism of a "highly mechanistic" economics would have garnered

considerable sympathy from American economists of the previous generation. This

period, remembered today as the Progressive Era, first introduced minimum wage

legislation to the United States. Prior to then the courts, committed to the doctrine of "Liberty of Contract," generally opposed legislative efforts to modify the labor contract. However, a crucial modification of that doctrine emerged from the case of

Muller v. Oregon (1908). In this case, the United States Supreme Court upheld a 1903 State of Oregon statute limiting the working day for women in factories and laundries

to ten hours, on the grounds that there was a need to "protect" women in the

workplace. Invoking the grounds articulated in that decision - the health, safety, and

welfare of covered workers - states were emboldened to pass a range of labor

legislation (Frankfurter 1916; Hepler 2000, chs. 1-3; Woloch 1996). Beginning in 1912, these laws included the minimum wage statutes passed

by fifteen states, Puerto Rico, and the District of Columbia. Consistent with the

precedent set in the Muller decision, these minimum wage statutes exclusively covered

women and children. Unfortunately, for proponents of this policy, the United States

Supreme Court ruled the District of Columbia minimum wage unconstitutional in 1923. Consequently, state minimum wage laws were largely abandoned and would

not be revived until the Supreme Court overruled itself in 1937, thereby clearing the

way for the Fair Labor Standards Act of 1938. The issue was finally resolved when the

government's prerogative to regulate the minimum wage was upheld by the Supreme

Court in 1941 (United States v. Darby Lumber Company 312 U.S. 100; Paulsen 1996; Chambers 1969).

Most striking from the perspective of the early twenty-first century is the fact that American economists of the Progressive Era were almost unanimous in their

support of the principle of minimum wage legislation (Prasch 1998; 1999; 2000a). Less consensus was evident on the questions of who should be covered, how high or

low these minimums should be, and how these issues should be decided and administered. Should coverage be extended to women and children only, or to all

low-wage workers? Should it be a single legislated rate for all industries in a state?

Alternatively, should a wage or industry board comprised of all interested parties hire experts to estimate, set, and supervise a minimum wage appropriate for each industry? These complicated discussions have been more closely examined elsewhere and will

not be reiterated here (Levin-Waldman 2001, ch. 3; Prasch 1998; 1999; 2005a; 2005b).2

With the demise of minimum wage legislation in the 1920s and early 1930s, economists' attention was drawn to issues of theory, depression, and war, so academic

discussion of the minimum wage virtually ceased. It was to be revived by the Fair Labor Standards Act of 1938 (FLSA), and especially by the important and substantial amendments to this act proposed by the Truman Administration after WWII. By this

time, something akin to a role reversal had taken place between the attitude of the



judiciary and the economics profession on the subject of minimum wages. By the late

1930s, the "Liberty of Contract" doctrine was losing its grip over the judiciary, and courts of appeal were increasingly open to arguments in favor of minimum wage

legislation. Now, however, the economics profession increasingly gave this legislation mixed reviews.

The Truman Administration's Amendments to the FLSA

With the end of WWII, the stage was set for an important debate among economists over the probable effects and wisdom of minimum wage legislation.- In light of

important trends occurring within the profession, it was not surprising that this

debate took the form of a controversy over economic theory and method, with the central issue being the correct formulation and use of assumptions by economists.

With hindsight, we know that the critical backdrop to this debate was the

rapid ascendance of the Neoclassical school within academic economics. Yet the Institutionalist school, while in retreat, could still be represented in the "top" economics journals

- a fact that, in a trivial sense, was essential for this debate to

occur at all. The ensuing controversy was, ostensibly, about the theory of the firm,

the structure of the firm's costs, the methods of economics, and the effects of a

minimum wage. What transpired was essentially a clash of methods (Kaufman 1993, chs. 3-5; McNulty 1980, chs. 6-7; Yonay 1998, pp. 188-189).

As indicated above, the immediate cause of what is today remembered as the

"Marginal Cost Controversy" was the Truman Administration's proposed

amendments to the FLSA. While increasing the scope of coverage, these amendments are most memorable for having enacted the largest single increase, in

percentage terms, that the minimum wage would receive before or since - from 40 to

75 cents per hour. Not surprisingly, economists were interested in the effect that such

a substantial adjustment would have on the cost structure of covered firms, and how

this increase would, in turn, impact employment decisions. Stated simply, would a

higher minimum wage result in less employment? This, of course, would depend upon the relationship between employment and wage levels.

The debate began with Richard Lester's critical assessment of the empirical foundations of several important claims of the Neoclassical school of economics. Did

the marginal product theory of distribution present a plausible explanation of

observed wage differentials? Would the minimum wage lead to wage compression and the substitution of capital for low-wage labor? Was the labor market "efficient"?

One way to consider these questions was to examine wage differentials within similar

firms, or between individual factories operating in the same industries in different

regions of the country -

say the northern and southern United States. Given the

conventional premises of what we now label Neoclassical economic theory, there

should be an association between lower wages, a lower capital-labor ratio, and less

efficient and productive labor. If such associations could be identified in the data,

they would lend a priori support to the idea that an increase in the federal minimum

wage could be detrimental to the prospects of low-wage workers.



Richard Lester set out to investigate these relationships. He was uniquely well positioned to consider them, as he had previously chaired the Southern Textile Commission of the National War Labor Board, and had then supplemented his own

knowledge of this industry with several additional, and for that time extensive,

empirical investigations. Prominent among these was a detailed questionnaire sent to

the senior managers of 430 industrial firms and factories operating in and across

several jurisdictions. These resulted in 68 responses, of which 58 had answered

enough of the questions to be informative. Based on these and other investigations,

such as those conducted by the Bureau of Labor Statistics, Lester published a series of

papers summarizing his findings on the costs and wage structures of contemporary

manufacturing firms. He also drew several policy conclusions and presented

arguments for their plausibility. Among the latter was his contention that an increase

in the national minimum wage would have a minimal, if any, effect on the

employment prospects of covered workers (Lester 1944; 1946a; 1946b; 1946c; 1947a; 1947b; 1947c; 1948a; 1948b).

Lester's results, and the implications he drew from them, represented a

direct challenge to the emerging Neoclassical school of economists. Not surprisingly, given its conclusions and the prominence of the journal in which it appeared, Lester's American Economic Review paper drew an immediate response. This came in the form

of a lengthy and detailed paper by Fritz Machlup - then at the University of Buffalo

-

who challenged Lester's methods, results, and conclusions (Machlup 1946). Lester's

reply to this counter-critique was presented in "Marginalism, Minimum Wages, and

Labor Markets" (Lester 1947a). Machlup was allowed a final rejoinder (Machlup 1947). George Stigler was also allowed a rejoinder as Lester had criticized his paper on the minimum wage in the course of his response to Machlup (Stigler 1946; 1947).

This debate is remembered today, when it is remembered at all, for its

insights on economic method. While this perspective is appropriate, it has the

unfortunate effect of eclipsing its implications for its immediate subject. As indicated,

this was the relationship between wages and the cost structure of firms, and the

implication of these findings for the effects on employment that could be anticipated from a reduction in the north-south wage differential following an increase in the

federal minimum wage.

Prior to this debate and its symbolic heralding of a new era in the profession, economic research was conducted largely along the lines of the Institutionalist school.

Methodologically, this approach was different in a number of observable ways. The issue, as Malcolm Rutherford has so carefully demonstrated, was never one of "theory versus no theory" as George Stigler and other partisans of the Neoclassical school have characterized it so frequently and inaccurately. Rather the difference rested on

the method and purpose of economics, considered as a social science. Of most

importance was the Institutionalists' position on the role that empirical studies

should play in constructing or supporting the assumptions upon which economic

theories, models, and -

eventually -

policy prescriptions would be grounded. Institutionalists such as Walton Hamilton, Wesley Clair Mitchell, John Commons, or

John Maurice Clark thought that economics should begin with empirically grounded



"stylized facts" from which generalizations and then an economic theory could be derived. Moreover, a sound theory had to have a firm foundation in, and relationship to, known economic phenomena and human psychology. With such foundations in place, economists could develop their theories with confidence

- even

if this implied that any given theory might be restricted in its scope and range of applicability (Asso and Fiorito 2004; Hamilton 1919; Mitchell 1919; Rutherford 2000).

While Richard Lester eschewed labels, it is evident from his methods that his research was firmly grounded in the Institutionalist approach to labor economics (Kaufman 1993, 226 n. 18). For example, he was of the view that "[a]t the heart of economic theory should be an adequate analysis and understanding of the psychology, policies, and practices of business management in modern industry" (Lester 1947a, 146). According to the Institutionalists and Lester, when the essential qualities of a

theory's analytical concepts, including the competitiveness of the market, the nature

of economic rationality, or the structure of a firm's costs, are assumed or asserted

without reference to widely understood and accepted facts, then that theory lacked a

genuinely scientific foundation.

By contrast, with what was to come Institutionalists believed that the premises of a scientific theory of economics should be inferred from generalizations that could be verified empirically. Only after this preliminary work was done, and done well, should the researcher posit his or her concepts, make generalizations and

deductions, and draw implications for economic theory and policy. This method was

exemplified in the sometimes plodding approach favored by the new research

institutes that emerged during the late nineteenth and early twentieth centuries;

including the National Bureau of Economic Research, the Russell Sage Foundation, the Bureau of Labor Statistics, and several other organizations devoted to the study of

social and economic policy (Goldberg and Moye 1985; Grossman 1982; Stone 1945). The substantial gulf between the methodological and theoretical approaches

of the Institutionalist and Neoclassical schools was at the center of this debate over

firms' costs and the effects of an increase in the federal minimum wage. It was

perhaps inevitable that the methodological distance between the rivals implied that this vigorous debate, while pointed, could not be resolved to the satisfaction of the immediate participants. As so often occurs in important debates over fundamentals, its lasting value was that it allowed others to garner substantial insights into the structure of the ideas under discussion as each side presented and defended its core

beliefs, conceptions, and even preconceptions.

Economics in the Late 1940s: Empiricists Versus Marginalists

It is widely accepted that the Great Depression facilitated the rise of Keynesian economics in America. However, a concurrent trend of at least equal importance, one that was to absorb, supplant and eventually overturn the Keynesian school, was

the planning and policy agendas of WWII. Among others, Michael Bernstein has

persuasively argued that this experience and the ensuing Cold War were crucial



factors in the rise and growing prestige of the Neoclassical school of economics,

especially in its contemporary mathematical form (Bernstein 2001). Whatever its ultimate cause, the rapid advance in the fortunes of marginalist

economics was evident in the style and substance of postwar economic thought in the

United States. As a result, when professional economists debated the proposed increase in the federal minimum wage soon after the end of the war, all disputants understood that the controversy was as much about the role and meaning of marginal

analysis in economic thought as it was about the narrower subject of the economics of

minimum wage legislation. For these reasons, I would argue that this episode, now

remembered as the "Marginal Cost Controversy," presents us with something of an

American Methodenstreit.

It may be surprising, in light of the close association that the Neoclassical school of our era claims to have with hypothesis testing and the employment of

empirical methods, that it was the Institutionalist Richard Lester who presented all of the empirical arguments and data, much of which he collected or compiled himself. To make his rebuttal, Fritz Machlup had to argue that a clear understanding of the

subjective aspects of a firm's costs warranted a skeptical interpretation of Lester's data -

including the responses provided by the executives themselves. Neither Machlup nor Stigler chose to contest Lester's data by contrasting it with opposing facts or other varieties of empirically grounded knowledge. In neither effort at rebuttal were new facts brought to bear on the issue at hand.

This omission was not lost on observers, including supporters of the

Neoclassical approach. In the course of a recent article, "The Early Patinkin

Friedman Correspondence," Robert Leeson quotes extensively from several letters by Don Patinkin to Milton Friedman that illustrate the degree of dismay experienced by Chicago insiders over the arguments presented by Machlup and Stigler. Leeson

quotes Patinkin as saying in a letter of February 4, 1950, "Machlup and Stigler dispense with [Lester's] findings much too glibly ... I would like to ask Machlup your question: under what circumstances would you reject the marginal productivity

theory. I don't know if he can produce any (can you?)." In another letter of March 5, 1950, Leeson quotes Patinkin as stating, "[I]t does seem to me that Stigler must

present some empirical evidence before sounding off like that. Isn't it a sad reflection

on the sad state of economics that Stigler can write a straight textbook analysis of

minimum wage legislation without even feeling himself obliged to make any empirical surveys. Stigler is just an example of what everybody does

- including yours truly. I

am merely bemoaning the type of training we receive that doesn't make us horrified at

'casual empiricism'" (Leeson 1998, 443). For his part, Lester vigorously challenged the marginalist positions along

with some important implications that should readily follow from that theory. He

argued for the stylized fact of firms' monopsonistic power on the grounds that it was

amply affirmed on empirical and institutional grounds. Among other advantages, firms are setting wage policies for tens, hundreds, or even a few thousand people at a

time, whereas most individuals have to present themselves to one employer at a time

to apply for a job or renegotiate their contract. Ultimately, firms were price-makers in



modern labor markets because "[i]n the absence of collective bargaining, the buyers quote the wage" (Lester 1947c, 517; see also 1947d, ch. 5). This tendency was bolstered by the fact that firms, who were continually operating in the same factor markets, would have a more substantial knowledge of local and regional labor market conditions than the typically isolated individuals with whom they negotiate (Lester 1947d, ch. 5).

To Lester the facts simply and readily affirmed that the demand-side of the modern labor market was not made up of many small firms observing and passively paying the going wage for homogeneous labor. Rather, the labor market was made up of relatively large firms actively developing and implementing a wage policy that they could adjust from time to time. Of some interest to economic theory was the fact that firms maintained their wage policies even when they were operating in highly competitive labor markets. The simple reason was that "[pjerfect fluidity or flexibility in individual wage rates - with frequent upward and downward movements and numerous changes in occupational differentials within a plant

- would have adverse effects upon labor efficiency." For this reason, "the policies of employers toward labor are more often in marked contrast to their policies in commodity markets" (Lester

1947c, 515). Lester argued further that profound differences distinguished the supply of low-wage labor from the supply of commodities. For one thing, "[cjompetition also

tends to establish real wage differentials because the supply of labor, especially unskilled labor, does not adjust to relative price changes as the supply of individual commodities tends to do. Lower real wages (at least above relief standards) tend to increase the supply of labor offered for sale by a family" (Lester 1947c, 515; see also 1947d, 105-8). It was observations such as these that lay behind Lester's conclusion that "[a] more realistic theory of the economic behavior of management in American

business is badly needed" (Lester 1947b, 392).3 In light of such considerations, Lester repeatedly maintained that what is

known today as "The Law of One Price" did not hold in low-wage labor markets, including those characterized by substantial competition. He was also adamant that

the observed variance could not be explained away by differential risk, effort, or other factors associated with either the employee or the job. By pointed contrast to what he thought of as false or mechanistic analogies to commodity markets, Lester believed that the observation of a single price in the labor market was proof that some

intervention had taken place, rather than evidence for the presence of a mythological perfect competition:

[I]nterplant uniformity of hourly rates for the same grade of labor in an industrial community is not normal and has been relatively rare. It is likely to occur under only four conditions: (1) common or combined action by employers, (2) collective action by employees, (3) joint action by labor and employer groups, or (4) compulsory action by government. In other words, uniformity in

wage rates is evidence of concerted action and restraint of



competition . . . Competitive forces in the labor market apparently

do not tend to enforce a single rate but result in a variety of rates

for industrial work (Lester 1948a, 211; see also Lester 1946d, 157

8).

As mentioned, Lester's objections were compelling because they were based on several wide-ranging empirical investigations into the cost structures and

management decisions of medium-to-large manufacturing concerns operating in both

southern and northern states (Lester 1946a; 1946b; 1947b). From these inter- and

intra-regional studies Lester drew several conclusions, each of which undermined the

lessons that followed from the then-emerging neoclassical models of the firm and the market for labor. First, he concluded that it was not a shortage of capital in the

south, and thereby a lower capital-labor ratio that was responsible for firms paying

lower wages in that region. Second, he concluded that the experience of multi-plant

firms lent support to the proposition that southern labor was not inherently less

efficient or productive than northern labor. As he summarized from his own

research, "[t]wo detailed studies of three textile firms with plants in both regions indicated that southern labor in those cases was fully as efficient as northern labor.

Twenty-three out of 41 replying interregional concerns reported the efficiency of

factory labor in their southern plants equal to or (in four instances) above that of labor in their northern plants, yet a majority of these 23 concerns were paying wage

scales in the South averaging from 10 to 25 percent lower than in the North" (Lester

1947b, 390). From such results, several more in-depth interviews, and similar

evidence drawn from other sources, Lester inferred that "[interregional differences in

wage scales and in labor effectiveness or output are not closely correlated; differences

in labor productivity apparently are not a fundamental factor in South-North wage

differentials" (Lester 1947b, 392). Third, based on his own experience and that of

others, he speculated that southern employers were beginning to appreciate that the

south-north wage differential was no longer necessary. Fourth and finally, he noted

that differential living costs across the two regions were not large enough to explain the observed wage differential. In light of the above points, Lester did not believe that the marginalist account of wage determination held true. He felt confident stating that:

Predictions of widespread unemployment in the South as a

consequence of wage minima and a narrowing of South-North

differentials brought about by the NRA, the Fair Labor Standards Act, or unionization have not come true. They have proved unfounded partly perhaps because of extenuating circumstances but

partly also because they have been based on marginalist theory and mistaken notions concerning the labor market (Lester 1947b, 391).

This condemnation of marginalist theory followed from an observation of a

year earlier:



If company output and employment policies are based on the

assumption of decreasing marginal variable cost up to full capacity operations, much of the economic reasoning on company

employment adjustments to increases or decreases in wage rates is

invalid, and a new theory of wage-employment relationships for the

individual firms must be developed (Lester 1946c, 71).

Fritz Machlup and George Stigler Respond

As is evident from the above, Lester's challenge was neither subtle nor coded. On the

contrary, he presented a direct refutation of "conventional marginalist theory." Fritz

Machlup took up Lester's challenge and defended the marginalist approach in an article entitled "Marginal Analysis and Empirical Research" (Machlup 1946).

Machlup argued against Lester on the grounds that "the alleged 'inapplicability' of

marginal analysis is often due to a failure to understand it, to faulty research

techniques, or to mistaken interpretations of'findings'" (Machlup 1946, 519-520). To this end, Machlup pursued three lines of thought. First, Machlup made

the argument that the Neoclassical theory was a dynamic rather than a static theory. In his words:

Instead of giving a complete explanation of the "determination" of

output, prices and employment by the firm, marginal analysis really intends to explain the effects which certain changes in conditions

may have upon the actions of the firm . . . Economic theory, static

as well as dynamic, is essentially a theory of adjustment to change. The concept of equilibrium is a tool in this theory of change; the

marginal calculus is its dominating principle (Machlup 1946, 521).

Second, Machlup argued with a crucial premise of Lester's research: namely

the idea that cost curves were, in some sense, objective and for that reason their shape,

and specifically their slope, could be plausibly described by an outside researcher or

observer. Essentially, Machlup presented an "Austrian" interpretation of marginal

cost, and on such grounds argued that a firm's costs were, to a significant degree,

subjective. It followed that their shape and slope would be difficult to ascertain by means of empirical research:

An outside observer, if he had expert knowledge of the production techniques and full insight into the cost situation of the producing firm, might arrive at a different "objective" figure of the firm's

marginal cost; but what the observer thinks is not necessarily the

same as what the producer thinks. The producer's actual decision

is based on what he himself thinks; it is based on "subjective" cost

expectations (Machlup 1946, 521).



In this discussion oi the subjective nature of costs, Machlup also raised the interrelated objections that there are temporal dimensions to the estimation of costs

and that cost calculations are not conducted by businessmen and economic

researchers in the same manner. In addition, he noted that non-pecuniary

considerations necessarily play a role in the understanding and estimation of "costs"

considered from a subjective perspective (Machlup 1946, 523-528). Third, Machlup was critical

- dismissive to be exact - of Lester's effort to account for these subjective factors through the method of employer surveys.

Machlup bluntly stated that the answers that businessmen provide on surveys such as

Lester's are "almost certainly worthless" (Machlup 1946, 544). Despite these critical comments and his emphasis on the subjective aspect of

a firm's costs, Machlup was also emphatic in stating that he was not categorically

opposed to empirical research. Indeed, he closed his paper with an endorsement of

empirical methods (Machlup 1946, 554). In light of his strong commitment to

subjectivist economics, Machlup's endorsement of empirical methods was less than

fully convincing to Milton Friedman, who observed that "in Machlup's emphasis on the logical structure, he comes perilously close to presenting the theory as a pure

tautology, though it is evident at a number of points that he is aware of this danger and anxious to avoid it" (Friedman 1953, 15-16 n. 13).

Lester's reply to Machlup (Lester 1947a) included extensive comments on

George Stigler's critical evaluation of minimum wage legislation (Stigler 1946). Summarizing his empirical findings and defending his conclusions, Lester continued

to insist upon an empirically based and inductive approach to economic theory and

policy. He claimed that before we could understand the dynamics of the wage employment relationship we had to develop a detailed, nuanced and

- most

importantly - an empirically grounded theory o( the cost structures and decision

making processes of modern large-scale manufacturing firms. In his words, "[n]ew and

broader approaches are needed to develop adequate explanations of wage rates

actually being paid - to explain differentials between firms in the same labor market,

differentials between occupations, and geographic differentials" (Lester 1946d, 159). Stigler's initial contribution to this debate was noteworthy for being a purely

theoretical exposition of the economics of minimum wage legislation (Stigler 1946). Besides Don Patinkin, Fred Blum and Richard Lester also observed that Stigler's arguments were almost exclusively based upon deductions from the first principles of

marginalist economics (Lester 1947a, 142-146; Blum 1947, 648-651). Moreover, in his reply to Lester, Stigler made no effort to defend the empirical content of the theoretical categories deployed in his earlier criticism of the minimum wage (Stigler 1947). Rather than argue the merits oi his own favored theory and method of analysis, Stigler presented a largely rhetorical defense of it

- albeit one that was to

become increasingly popular over the decades to come. This was to conflate criticisms

of the Neoclassical school, such as those advanced by Lester, with "an attack on economic theory." After ascribing such a peculiar position to Lester, Stigler then

presented himself as an "economic theorist" upholding the position that economics

should have a theory. Stigler's reframing of the debate asked his readers to believe



that Richard Lester was neither "a theorist" nor even wished for economics to have a

theory. Clearly, for such rhetoric to be effective, readers must not be allowed to think or even imagine that more than one economic theory could exist, much less be

present in this particular debate. To bolster his position, Stigler spent a substantial portion of his short response presenting a criticism of some unrelated arguments made by Lester in an earlier book, the Economics of Labor (Lester 1947d; Stigler 1947). According to Stigler, Lester had spent much of that book criticizing theories that "I have never before encountered in economic literature" including the proposition that

"the total demand curve for all labor is the sum of all employers' individual marginal productivity curves" (Stigler 1947, 155). It is difficult to imagine that Stigler did not know that many "marginalist" economists were making just such claims

- one that was indeed erroneous for ignoring the critical issue of interdependence among and between the marginal productivity curves of different firms.

Machlup's rejoinder took a very different tone and style from Stigler's. He defended Neoclassical economics by stressing what he perceived to be its strengths: its formal, universal, and subjectivist aspects. By way of illustration, he argued that most of the substantive points raised by Lester could be incorporated into a marginalist presentation.4 While Machlup made several insightful points concerning the level of abstraction and subjectivity inherent in Neoclassical analysis, for the most part these

were not adopted by his colleagues. Later participants in the debate, and the

Neoclassical school more broadly, would largely ignore Machlup's subjectivist interpretation of costs and emphasis on dynamics. However, with the exception of

Fred Blum, few of the later participants in the extended debate wished to jettison

completely the marginalist project. Concerning the formulation of assumptions, and

more broadly the issue of policy, Lester's arguments generally carried the day - at least

at first. The bulk of the academic scholarship of the late 1940s either accepted or elaborated upon Lester's presentation of the typical manufacturing firm's cost curves.

As a consequence, contemporary writers either rejected, or failed to support, George

Stigler's conclusion that a broadly applied minimum wage would necessarily lower the

level of employment.5

Milton Friedman Redirects the Debate

As the controversy described above was concerned with the foundations of economics

and the policy implications that flowed from different conceptions and methods, it was no coincidence that Friedman's "Essay on Positive Economics" began by referring to it (Friedman 1953). In the course of his widely cited essay, Friedman famously rejected all of the positions taken in the course of the controversy by maintaining that the several core assumptions of Neoclassical economics should be upheld, not on the

basis of their "realism," whether subjectively or objectively conceived, but on the basis of their "usefulness" for constructing testable hypotheses. In other words, Friedman

wished to transcend the differences between Lester and Machlup by reconceiving the function and place of empirical data in economic research. To this end, he argued that economics should abandon any effort to establish empirically-grounded premises



and concepts. Assumptions, he proposed, should not be judged along a continuum

from "accurate" to "inaccurate." Rather, they should be assessed according to

whether they are more or less useful in the formulation of hypotheses that can withstand statistical tests. Hypotheses that survived repeated statistical tests should

then be adopted and accepted by the community of researchers. In short, Friedman did not answer or resolve the methodological debate between the Neoclassical

Machlup and the Institutionalist Lester; so much as he redirected the project of economics considered as a theoretical and applied social science. This change of focus is evident in the following quotation, one that specifically addresses the

marginal cost controversy. "The articles on both sides of the controversy largely

neglect what seems to me clearly the main issue - the conformity to experience of the

implications of the marginal analysis - and concentrate on the largely irrelevant

question whether businessmen do or do not in fact reach their decisions by consulting schedules, or curves, or multivariable functions showing marginal cost and

marginal revenue" (Friedman 1953, 15). Notice, again, that Friedman's stresses

neither the accuracy nor the inaccuracy of assumptions - rather he wishes to stress

their implications. In reading over Friedman's statement, one may reasonably ask

- implications

for what? The answer is implications for the clear statement and testing of

hypotheses. Lester, it will be recalled, criticized the core Neoclassical assumptions for their lack of conformity to experience. In doing so, he clearly cast doubt on their

predictive power. For Friedman, on the other hand, the Neoclassical assumptions that Lester so thoroughly criticized nevertheless retained a powerful predictive capacity despite their self-evident flaws as empirical generalizations.

This redirection of the terms of the debate turned out to be successful and

Friedman's view of what constituted the correct method of economic research came

to be widely accepted - even mandated. Almost all issues concerning the "realism" of

assumptions were considered, to the satisfaction of the Neoclassical school, to have

been most capably resolved and thereby closed to further discussion. This

methodological hegemony was to last for almost forty years. Only in the last fifteen years has it become even moderately respectable for an economist to use survey data

or check assumptions for their accuracy. Unsurprisingly this recent methodological

openness, or peristroyka, has been accompanied by a reassessment, albeit a

controversial one, of the economics of the minimum wage (Card and Krueger 1995).

Conclusions

For a brief period during the late 1940s, Richard Lester was triumphant in convincing labor economists of the importance of his empirically based insights concerning wage dispersion between and across regions, the shape of a representative manufacturing firm's cost curves, and the importance of these several stylized facts for policy formulation and assessment - specifically minimum wage legislation. Hindsight also

reveals that he was much less successful in heading off the profession's coming embrace of "marginalism," the supply-and-demand theory of wage determination, the



use of increasing marginal costs to production as a standard assumption, and related

arguments and conclusions over matters of economic theory and policy. In this sense,

Machlup's and Stigler's articles, with their emphasis on the now-conventional

depiction of the representative firm as a rational maximizer facing increasing marginal costs to additional units of output, represented the future of economic theory and policy analysis. By the 1970s and 1980s, this perspective came to be the virtually unchallenged starting point of almost all respected and respectable academic discussions of labor market policy

- including minimum wage legislation. While the

past decade and a half has featured some tentative reassessments, the "marginalist"

approach retains pride of place in "middlebrow" literatures such as college textbooks and the "research" conducted and promulgated by Washington think tanks.

Ironically, Machlup's vision of economic method fared little better than Lester's. His commitment to methodological subjectivism was almost immediately

eclipsed by Milton Friedman's idiosyncratic brand of positivism (Friedman 1953). In

hindsight, it is now evident that the profession was on the cusp of abandoning both

Machlup's "subjectivism" and Lester's "inductive" method of empirical research.

Taking their place was the emerging "Chicago" method of "positive economics" that

emphasized strictly Neoclassical or marginalist assumptions operating in conjunction with a professed, if not as frequently practiced, commitment to hypothesis testing.

Most remarkable in light of his strong a priorism and the lack of direct support that he received from his intellectual allies, the immediate disputants, or

ensuing contributions to the literature, was the dramatic transformation in the

economics profession's evaluation of the merits of Stigler's brief article on the

economics of the minimum wage. By the 1980s, it had emerged as a minor classic of

Neoclassical analysis. This article, acknowledged by both friend and critic to be

alarmingly weak - an assessment implicitly affirmed by Stigler's decision to defend it

by advancing criticisms of Lester's earlier work - is now considered an exemplary

illustration of the "insights" to be derived from Neoclassical labor market analysis. The reasons behind this sea change in the collective assessment of Stigler's contribution cannot be taken up here, but it is evident that such an examination

would require a close study of both the sociology and rhetoric of economics. With hindsight it is now also evident that the minimum wage did not fall

out of favor among professional economists as a consequence of some critical

experiment or other compelling proof. On the contrary, what changed between the

Progressive Era and the 1980s was the profession's understanding of the nature,

scope, and method of economics. With this change came a parallel change in the set of arguments, types of evidence, and forms of reasoning that economists came to

consider a priori plausible. In short, the negative assessment of the minimum wage, one that still retains a prominent place in so many of our elementary textbooks and

policy discussions, is an artifact or by-product of a changing set of methodological and

theoretical commitments within academic economics.



Notes

1. We should note that Richard Lester typically used the compound term "conventional marginalist theory" in his papers. By this, he meant the "conventional" depiction of the firm that featured

marginal and average costs increasing as the level of output increased (Lester 1946c, 75, 80, 81; 1949). He was also critical of the method that begins with a presumption that firms are in a state of

competitive equilibrium with factor prices set equal to marginal products (Lester 1947a, 146-148). Fred Blum and Henry Oliver are helpful in their clarification of what each of the sides meant by the term "marginalism" (Blum 1947; Oliver 1947). In this paper, I will accept the taxonomic conventions

of the 1940s and use the terms "Neoclassical" and "Marginalist" interchangeably. 2. In addition to those economists that we would today label "Institutionalists," important early

Neoclassical writers such as John Bates Clark and Frank Taussig also expressed support, albeit

circumscribed and sometimes conditional, for some form of minimum wage legislation (Clark 1913;

Taussig 1916; Prasch 2000a). In one of the more important papers of the debate covered in this

paper, Richard Lester mistakenly identifies, by name, Clark and Taussig as opponents of minimum

wage legislation (Lester 1947a, 143). To be fair, he has not been alone in this error. While Taussig and Clark each objected to a single inflexible federal or state minimum wage, a careful reading reveals that each of them supported a minimum wage set by a wage board for individual industries if it could be demonstrated that the market mechanism was inefficient, as they each thought that it was for local

markets in low-wage labor. Along these lines, it should also be noted that Frank Taussig was affiliated with the Consumers League of Massachusetts

- one of the most important pressure groups behind the 1912 passage of the first statewide minimum wage law in United States history.

3. For a recent restatement of the argument that the market for labor is theoretically distinct from

output markets see Prasch (2004). As to the supply of labor, the mainstream of economics has long allowed that for relatively high-income workers the supply of labor schedule may slope downwards to

the right. However, a long-standing, if minority view, has maintained that because lower income families are often at risk of failing to meet their subsistence needs, it is likely that the supply of labor function for the lowest-income families also slopes downward to the right. Lester thought that this latter argument had merit, and identified some precedent for it in the history of economic thought (Lester 1947d, 105-108; see also Prasch 2000b; 2000c; 2001; Perlman 1969, ch. 1; Rothschild 1954, ch. 3; Sharif 2003).

4. This perspective on the methodological issues at stake in this debate was shared by Joseph Schumpeter who took the view that the marginal productivity theory of wages was only true at a high level of abstraction, one that could then be modified by various restrictions and modifications as the situation demanded. Schumpeter believed that a failure to realize this induced some economists to defend the marginalist theory as operating without modification, even as others criticized it for being erroneous. He felt that each of these views was naive as both positions confused an abstract truth with an empirical statement about the actual situation at any given moment (Schumpeter 1986, 1038).

5. This literature was both rich and diverse. Important contributions included papers by Fred Blum

(1947); John Dunlop (1948); Wilford Eiteman (1947); Robert A. Gordon (1948); Henry M. Oliver

(1947); and Lloyd G. Reynolds (1946; 1948). An important but somewhat neglected article that

anticipated several aspects of the debate was that of Wilford Eiteman (1945).

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Article Contentsp. 809p. 810p. 811p. 812p. 813p. 814p. 815p. 816p. 817p. 818p. 819p. 820p. 821p. 822p. 823p. 824p. 825

Issue Table of ContentsJournal of Economic Issues, Vol. 41, No. 3 (Sep., 2007), pp. 625-902Front MatterThe Impact of Foreign Direct Investment, Financial Crises and Organizational Culture on Managers' Views as to the Finance-Growth Nexus [pp. 625-660]Effective Central Bank Communication under Uncertainty [pp. 661-680]The Impact of Workers' Compensation Experience-Rating on Discriminatory Hiring Practices [pp. 681-699]Competition, Selection and Rock and Roll: The Economics of Payola and Authenticity [pp. 701-714]U.S. Decline in the Context of Formal Education and "In Situ" Learning [pp. 715-728]Charter Schools in Arizona: Does Being a For-Profit Institution Make a Difference? [pp. 729-746]The Role of "Instincts" in the Development of Corporate Cultures [pp. 747-764]Policymaking and Learning Actors, or Is a 'Double Movement' in Cognition Possible? [pp. 765-781]Karl Polanyi and Return of the "Primitive" in Institutional Economics [pp. 783-808]Professor Lester and the Neoclassicals: The 'Marginalist Controversy' and the Postwar Academic Debate over Minimum Wage Legislation: 1945-1950 [pp. 809-825]Toward an Evolutionary Economics: The 'Theory of the Individual' in Thorstein Veblen and Joseph Schumpeter [pp. 827-839]Veblen and the Problem of Rationality [pp. 841-862]Notes and CommunicationsDo Conservative Governments Make a Difference in Fiscal Policy? Evidence from the U.S. and the U.K. [pp. 863-872]

Book ReviewsReview: untitled [pp. 873-875]Review: untitled [pp. 875-877]Review: untitled [pp. 877-879]Review: untitled [pp. 879-881]Review: untitled [pp. 881-883]Review: untitled [pp. 883-885]Review: untitled [pp. 886-887]Review: untitled [pp. 888-889]Review: untitled [pp. 890-892]Review: untitled [pp. 892-894]Review: untitled [pp. 894-895]Review: untitled [pp. 896-898]Review: untitled [pp. 898-899]Review: untitled [pp. 900-901]

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