The truth about the minimum wage

4 Jan, 2018 at 16:43 | Posted in Economics | 2 Comments

low-wage-snapshot-updated-05-07-2015_1It has been more than eight years since many of the United States’ cashiers, dishwashers, janitors, lifeguards, baggage handlers, baristas, manicurists, retail employees, housekeepers, construction laborers, home health aides, security guards, and other minimum-wage workers last got a raise. The federal minimum wage now stands at just $7.25. In real terms, these workers’ earnings have declined by nearly 13 percent since the last hike, in 2009—and have fallen by over one-third since 1968, when the real federal minimum wage was at its peak of $11.38 in today’s money (although only $1.60 then) …

Opponents of the minimum wage have long invoked economic theory to claim that the measure destroys jobs. “Just as no physicist would claim that ‘water runs uphill,’ no self-respecting economist would claim that increases in the minimum wage increase employment,” the Nobel Prize–winning economist James Buchanan wrote in The Wall Street Journal in 1996. “Such a claim, if seriously advanced, becomes equivalent to a denial that there is even minimal scientific content in economics, and that, in consequence, economists can do nothing but write as advocates for ideological interests.”

Strong stuff, but wrong stuff. That view is rooted in either ignorance or dishonesty …

It is important not to mistake the labor market on planet Econ 101 for the labor market on planet Earth. The predictions of this model are not akin to the laws of physics, and alarm bells should go off anytime an economist, even a Nobel laureate, claims that they are.

The predictions of any economic model are only as good as the assumptions behind it. And the assumption of perfect competition is a bad approximation for real-world labor markets …

Alan Manning

There are, obviously, a lot of policymakers, presidents and economists still arguing in the Buchanan-Econ-101-style. Intimating that one could solve economic problems by low (minimum) wages, in these dire times, should really be taken more as a sign of how low the confidence in our economic system has sunk. Low wages don’t save neither competitiveness nor jobs.

What is needed more than anything else in these times is stimulus and economic policies that increase effective demand.

On a societal level, low minimum wages and general wage cuts only increase the risk of more people getting unemployed. To think that one can solve economic crises in this way is a turning back to those faulty economic theories and policies that John Maynard Keynes conclusively showed to be wrong already in the 1930s. It was theories and policies that made millions of people all over the world unemployed.

It’s an atomistic fallacy to think that a policy of keeping wages low would strengthen the economy. On the contrary. The aggregate effects would, as shown by Keynes, be catastrophic. They would start a cumulative spiral of lower prices that would make the real debts of individuals and firms increase since the nominal debts wouldn’t be affected by the general price and wage decrease. In an economy that more and more has come to rest on increased debt and borrowing this would be the entrance-gate to a debt deflation crises with decreasing investments and higher unemployment. In short, it would make depression knock on the door.

The impending danger for today’s economies is that they won’t get consumption and investments going. Confidence and effective demand have to be reestablished. The problem of our economies is not on the supply side. Overwhelming evidence shows that the problem today is on the demand side. Demand is – to put it bluntly – simply not sufficient to keep the wheels of the economies turning. To suggest that the solution is low (minimum) wages and unemployment compensations is just to write out a prescription for even worse catastrophes.

2 Comments

  1. “To suggest that the solution is low (minimum) wages and unemployment compensations is just to write out a prescription for even worse catastrophes.”

    I suggest no minimum wage and a $25k/year basic income, with all incomes indexed to price rises to eliminate unwanted, potential nominal inflation’s effects. Lower GDP is my goal because we should need less as we learn more.

    Comment by Robert Mitchell— 5 Jan, 2018 #

  2. Yes indeed,Buchanan-101- seem to live in the mindset of pundits ,politicans and economists still today,sadly. It remind me of old John Kenneth Galbraith,that called it the “Horse-and-sparrow approach”. This plan presumes that if you feed a horse enough oats, eventually the horse’s droppings will prove sufficient to feed the sparrows.

    Stephanie Kelton,at University of Missouri-Kansas City, reminds me of an old favourite read, John Kenneth Galbraith’s book, “The Good Society: The Humane Agenda”
    in an article, she writes :That it “creates a blueprint for a more just, prosperous and stable world. I’m re-reading it for the ninth time because I continue to believe we might just get there one day. Indeed, I’m convinced we must.

    Here are some excerpts:

    “While the economy must accord everyone a chance both to participate and to advance according to ability and ambition, there are two further requirements. There must be a reasonable stability in economic performance; the economic system cannot recurrently deny employment and aspiration because of recession and depression. And it may not frustrate the efforts of those who plan diligently and intelligently for old age and retirement or for illness or unanticipated need. The threat in this case is, of course, inflation — the diminished purchasing power of money — and with it the loss of provision for the future.

    The flow of aggregate demand for goods and services must keep the economy at or near [full employment]. The failure to do so — resulting in cyclical or enduring unemployment — is inconsistent with the goals of the good society…

    The stabilization of the flow of aggregate demand is the vital factor…There are three substantive lines of corrective action that will accomplish this, will increase the flow of aggregate demand as required…..

    1. taxes can be lowered
    2. interest rates can be reduced
    3. the government can contribute directly to the flow of demand by new expenditure in excess of tax receipts

    Action on interest rates, commonly referred to as monetary policy, has the highest establishment approval as an effective measure against stagnation and unemployment…

    The serious flaw in monetary policy is that it may have little or no effect on the flow of aggregate demand. As noted, the lowered interest rates are assumed to work against depressive conditions by encouraging consumer borrowing and expenditure and business investment. The latter responds to the lower cost of borrowing and therewith the improved possibility for profit. But when times are poor and unemployment is high, lower interest rates do not reliably inspire consumer expenditure; depressive attitudes, including those which are the product of unemployment or uncertain employment, are in control. And at such times, excess business capacity being evident, business firms, old and new, may not be encouraged by low interest rates to borrow and invest and so contribute to the income flow; the larger prospect is too uncertain. There is also the adverse effect of low rates on those whose income comes from interest — a reduction in their contribution to aggregate demand. None of this, however, discourages faith in monetary action as a decisive economic instrument. Quasi-religious conviction here triumphs over conflicting experience.

    Tax reduction is also celebrated as a way to sustain aggregate demand during recession…Here again the hope is at odds with reality; there is no certainty that the funds released by tax reduction will be invested or spent.

    As a way to stimulate demand in times of negative growth or stagnation, there remains only one direct and active intervention by the state to create employment… the only true substantive action is for the government to move to provide jobs for those for whom unemployment is otherwise inevitable…

    The deficit… must not be seen as a barrier to effective public action….When the economy recovers and public revenues rise, there must then be the discipline that brings stimulative expenditure to an end. Taxes must be kept at previous levels or increased as a counter to speculative excess and, at the extreme, the inflationary pressure of demand on markets.

    There is nothing easy about this broad course of action. An influential body of opinion now dismisses it as beyond the collective intelligence of the modern polity. Once again the unfortunate fact asserts itself: there is no effective alternative. What is dismissed as functionally difficult, ideologically passé, is the only way to prevent recurrent periods of stagnation and unemployment.”

    The “influential body of opinion” remains too enthralled with monetary policy, too wedded to supply-side “solutions” and too focused on deficit reduction to allow us to build The Good Society. The rich and powerful, working through our elected officials, insist that There is No Alternative: we must spread sacrifice instead of prosperity, make tough choices rather than wise investments, focus on budget outcomes instead of human achievements. Theirs is a bleak world – at least for the masses – arrived at through the cultivation of fear and mysticism. The Good Society is out there, and while it may seem unachievable in this Plutocratic world, Galbraith offers this:

    “To identify and urge the good and achievable society may well be a minority effort, but better that effort than none at all.”

    http://neweconomicperspectives.org/2013/08/the-good-society-lessons-not-yet-learned.html

    Comment by Jan Milch— 5 Jan, 2018 #


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