Thursday, January 16, 2014

Dumb idea #6,258: Create jobs by paying poor people less

… [The] alternative to unbridled capitalism is not socialism but Catholicism.
Michael Coren, “Blessed are the poor

The main problem with most non-economists’ economic analyses is that they take one aspect of economic relations and then ride it into the ground. Case in point: “How Democrats Kill Jobs”, a piece in Defining Ideas by Richard A. Epstein.

Epstein is a libertarian looking to make a case against government intervention in the market via an increase in minimum wages. He begins by looking at the most recent jobs report:

The latest government labor report indicates that job growth has slowed once again. It is now at a three-year low, with only an estimated 74,000 new jobs added this past month. To be sure, the nominal unemployment rate dropped to 6.7 percent, but as experts on both the left and the right have noted, the only reason for this “improvement” is the decline of labor force participation, which is at the lowest level since 1978, with little prospect of any short-term improvement.

So far, so good. But it’s his second paragraph in which he sets out his theme:

One might think that these figures would be taken as evidence that a radical change in course is needed to boost labor market participation. The grounds for that revision rest on a straightforward application of the fundamental economic law of demand: As the cost of labor increases, the demand for labor will decrease [bold type mine.—ASL]. There are, of course, empirical disputes as to just how rapidly wage increases will reduce that demand for labor.

From this point on Epstein’s line of argument wanders off course. How will getting rid of the minimum wage and extended unemployment benefits boost labor force participation? Will businesses and buildings stop needing janitorial services if their contractors have to pay $11.10/hour rather than $7.25? Epstein is more concerned with slamming Democrats than with explaining himself.

Even if we grant Epstein’s apparent premiss (jobs aren’t being created because labor costs are too high), allowing employers to cut the wages of the segment of the labor force that costs the least isn’t just counterintuitive — it’s what-color-is-the-sky-in-your-world insane. More to the point, the relationship between labor cost and labor demand isn’t as simple or direct as Epstein thinks (or, at least, as Epstein wants us to think).

Acme Corporation employs workers to produce widgets[*] at $7.50/hour. Each employee produces approximately 6 widgets an hour, so the labor cost of each widget is $1.25 per widget. Increasing the minimum wage to $11.10 would raise the labor cost of each widget to $1.85. But whether that $0.60 increase in cost actually translates into jobs lost depends on other factors, such as the price-elasticity of demand for widgets and the effect the minimum wage increase would have on Acme’s clients; for instance, sometimes in some markets, you can actually increase demand by increasing prices. Furthermore, if Acme found ways to improve efficiency so that each employee could produce 7.5 widgets an hour, the actual marginal increase would be about $0.22 per widget rather than $0.60.

My point here isn’t that a minimum wage hike would have no negative individual consequences; rather, it’s to point out that the effect labor cost has on labor demand depends very much on how sensitive a particular market is to marginal changes in price. For instance, office buildings will continue to require janitors and hotels maids no matter what the minimum wage is; the restaurant industry could survive a modest increase, and the resulting short-term depression of business, so long as all restaurants were equally burdened.

No, the futility of raising the minimum wage lies in the fact that eventually the rest of the economy catches up, and the minimum-wage worker ends up no better off than he was before the hike. Increasing minimum wage won’t fully address our current economic stagnation, and would only help for a little while … but it’s by no means the job-killer Epstein claims it to be.

In fact, Epstein is arguing from a false premiss: Increased labor costs are not what’s dragging down our recovery.

Since 1980, the consumer price index has increased 195.6%; in that same time, however, labor costs in the business sector increased only 96.6%, while real output per hour increased 99.7%. In that period, real compensation only increased 39.5%. Since the increase in production more than covers the increase in labor costs, we must look at an increase in non-compensation costs — training, travel expenses, safety equipment, etc. — to explain the difference. More to the point, though, it shows that employers got more for the more they paid … even slightly more than the more they paid.

The real problem becomes apparent when we compare the increase of prices and consumer debt to the increase in real wages: both of the former are rising faster than the latter, putting a squeeze on consumers’ disposable incomes and diminishing their capacity to purchase goods and services. From 1984 to 2012, the CPI for all urban consumers rose 120.9% and consumer debt rose 75.3%. However, median real wages peaked in 1999 and have been dropping ever since, so that in 2012 they were a mere 8.1% higher than in 1984.

It doesn’t matter if prices increase by 4% a year or 50% a month, the standard benchmark for hyperinflation, so long as disposable wages fail to keep pace: the endgame is simply protracted, not avoided. Because the purchase price for widgets is increasing faster than wages, and because consumers are spending more of their disposable incomes on the widgets they already bought, their ability to buy more widgets now is degrading. The problem is aggravated as the average wage of the jobs created since June 2009 is significantly lower than those that were lost, a higher (albeit declining) percentage of the workforce is underemployed[†] and millions of unemployed workers have simply dropped off the rolls.

Raising the minimum wage may or may not be a good temporary solution. On the other hand, Congress may just as well cut their throats as cut the minimum wage for all the good it would do. Epstein isn’t consulting the available data but rather communing with his political dogmata, cherry-picking individual stories which seemingly support his conclusion while ignoring the facts that don’t. If cutting wages makes any sense at all, it makes sense only if we cut the wages of those who are paid the most, rather than those who are paid the least.

I agree with Epstein that government redistribution of wealth is generally clumsy, at best inefficient and at worst counterproductive, and ought to be avoided whenever possible. However, we have way too much paper in our monetary system, and the vast majority of it is ending up in the hands of the class least willing and able to spend it, while others don’t get enough of it to save or invest for themselves. If these two dysfunctions aren’t put on the path to some better balance, eventually our economy will collapse, and wealth will be “redistributed” by dissolution.

And liberals won’t be to blame for that.


[*] Here, widget is used in its classic sense; i.e., a placeholder word for a notional product.
[†] Employed part-time for economic reasons, slack work or business conditions.