Professor Lester and the neoclassicals: the 'marginalist controversy' and the postwar academic debate over minimum wage legislation: 1945-1950.

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.

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 "[r]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).

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 …