Thursday, April 21, 2016

The Economic Argument For Raising The Minimum Wage.

With the US presidential elections in full swing this year and with the candidacy of Bernie Sanders for the Democratic nomination, the argument over the federal minimum wage issue is now penetrating the public sphere like never before.  Yes, we did have the fast-food workers stage protests in the past, demanding that they be paid a living wage.  Now however, with Bernie Sanders taking the issue on the campaign trail, it has become hard to ignore.  Unfortunately, the argument has become largely about ethics versus economics, with the ethical argument in favor of a higher minimum wage, while the economic argument is largely used to oppose the idea, arguing that it would lead to massive job loss, inflation, loss of economic competitiveness as well as other typical arguments which were typically used over the past decades.

While many of the economic arguments against raising the minimum wage may have made perfect sense a few decades ago, in case many of us have not noticed, we no longer live in the same economic environment we did for the past few decades.  Changes in the structure of the economy, in large part brought about by globalization made most of those arguments largely irrelevant.  One of the changes that took place has to do with inflation.  Inflation stopped being a major problem in the past decade and a half or so, because the influx of much cheaper goods coming from places like China, where labor and environmental protection costs are much lower.  Since the 2008 crisis, deflation has become the bigger concern, not just in the United States, but in the entire developed world, with even developing nations such as in Eastern Europe and China experiencing a dramatic shift towards a lower inflation environment.  While the US Federal Reserve target rate is an average of 2%, since 2014, inflation has been hovering consistently under 1%.  2011 was the last year that inflation was above 2%.  Needless to say therefore that inflation is not really a huge problem right now, therefore a hike in the minimum wage would not only be safe, but in fact beneficial, because it would be just the thing to help the economy get back to the 2% inflation goal.

As far as job loss issue goes, it is certainly true that higher wages would have an initial effect of causing some job destruction.  At the same time however, we should keep in mind that there would also be the secondary effect which I believe in this case would be more powerful than the primary effect and the secondary effect would involve job creation through an increase in consumer demand.  In fact, our current dilemma stems from a lack of consumer demand, which was also caused by the effects of globalization.  Wages have risen dramatically in China for instance, taking hundreds of millions of people out of poverty.  In the US however the effect of globalization is opposite.  Aside from the top 5% of households by income, pretty much all income groups have experienced stagnation or a steep decline in real household income.

Upper Limit of each fifth.
% change
Lowest 20%
Second lowest 20%
Third Lowest 20%
Fourth Lowest 20%
Lower Threshold of top 5%
+ 3.5%

Data source:  United States Census Bureau.

As we can see, aside from the top five percent of households by income, most households have either stagnated or are experiencing a decline in real income, which means that the US consumer’s ability to increase consumption is in decline for over a decade and a half already.  The consumer debt bubble carried the consumer after 2000, until that bubble burst, and since then the consumer is being carried by the low interest rate environment, which is in effect reducing the consumer’s interest burden, freeing up income to increase consumption.  The effects of the low interest rates are also starting to wear off, because it is a one-time boost, which cannot be replicated given that interest rates cannot go further down from here.  An increase in the minimum wage is therefore the only viable solution going forward, because there is no other viable way of boosting the consumer’s ability to continue increasing spending.  In fact, if nothing is done, consumer spending which makes up about 70% of the economy may end up contracting back to 2000 levels, causing a very nasty period of sustained economic contraction in the process.  For this reason, the economic argument which currently mainly supports the idea that raising the minimum wage is a bad thing, which will cause unwanted inflation and job loss is flawed.  The current path may in fact lead to a much greater loss of jobs and the economy could get permanently stuck in a deflationary cycle, as seems to be the case with Japan for decades now, and Europe as well for the past few years, unless we start seeing some income growth for the other 95% of households, not just the top 5%.  A sure way to accomplish this would be to introduce a multi-year plan to get us to a much higher minimum wage compared with today.