In the March 23rd edition of the NY Times Mankiw proposes a `do no harm’ test for policy makers:
…when people have voluntarily agreed upon an economic arrangement to their mutual benefit, that arrangement should be respected.
There is a qualifier for negative externalities, and he goes on to say:
As a result, when a policy is complex , hard to evaluate and disruptive of private transactions, there is good reason to be skeptical of it.
Minimum wage legislation is offered as an example of a policy that fails the do no harm test.
The association with the Hippocratic oath gives it an immediate appeal. I think the test to be more Panglossian (or should I say Leibnizian) than Hippocratic.
There is an immediate `heart strings’ argument against the test, because indentured servitude passes the `do no harm’ test. However, indentured servitude contracts are illegal in many jurisdictions ( repugnant contracts?). This argument raises only more questions, like why would we rule out such contracts? I want to focus instead on two other aspects of the `do no harm’ principle contained in the words `voluntarily’ and `benefit’. What is voluntary and benefit compared to what?
To fix ideas imagine two parties, who if they work together and expend equal effort can jointly produce a good worth $1. How should they split the surplus produced? How will they split the surplus produced? An immediate answer to the `should’ question is 50-50. A deeper answer would suggest that they each receive their marginal product (or added value) of $1, but this impossible without an injection of money from the outside. There is no immediate answer to the `will’ question as it will depend on the outside options of each of the agents and their relative patience. Suppose for example, the outside option of each party is $0, one agent is infinitely patient and the other has a high discount rate. It isn’t hard to construct a model of bargaining where the lions share of the gains from trade go to the patient agent. Thus, what `will’ happen will be very different from what `should’ happen. What `will’ happen depends on the relative patience and outside options of the agents at the time of bargaining. In my extreme example of a very impatient agent, one might ask why is it that one agent is so impatient? Is the patient agent exploiting the impatience of the other agent coercion?
When parties negotiate to their mutual benefit, it is to their benefit relative to the status quo. When the status quo presents one agent an outside option that is untenable, say starvation, is bargaining voluntary, even if the other agent is not directly threatening starvation? The difficulty with the `do no harm’ principle in policy matters is the assumption that the status quo does less harm than a change in it would. This is not clear to me at all. Let me illustrate this with two examples to be found in any standard microeconomic text book.
Assuming a perfectly competitive market, imposing a minimum wage constraint above the equilibrium wage would reduce total welfare. What if the labor market were not perfectly competitive? In particular, suppose it was a monopsony employer constrained to offer the same wage to everyone employed. Then, imposing a minimum wage above the monopsonist’s optimal wage would increase total welfare.