Minimum Wage VS. Maximum Confusion

By George P. Brockway, originally published April 3, 1989

1989-4-3 Minimum Wage vs. Maximum Confusion Title

THE FIGHT in Congress over a minimum-wage bill was recognized by both sides to be largely symbolic. It was nevertheless worth making. The press and TV characteristically presented what little they reported of the debate as a clash of personalities. But fundamental issues were at stake, and one must hope the debate has gone at least a little way toward educating the public (and the Congress) on the way the economy actually works.

First, a bit of background: The minimum wage is now $3.35 an hour. It has not been changed for eight years, even though the Consumer Price Index has gone up 32.3 per cent in that time. If you work full time, $3.35 an hour comes to $134 a week or $6,968 a year, which is well below the poverty level. But of course the assumption of full-time work is what economists call a heroic assumption (meaning that it doesn’t hurt the economists who make it any more than heroic medical procedures hurt doctors).  In fact, 25.3 per cent of the people employed in America work part time roughly half of them because they can’t get better jobs and half because they prefer it that way. It’s a fair guess that almost all of the minimum-wage workers are in the part-time group.

At present about 4 million workers earn the minimum wage or less. (Economics is full of miracles: In mathematics there’s nothing less than the minimum, but in economics there’s a great nether region below the minimum because commerce that doesn’t cross state lines is not covered by Federal law.) There are in addition just over 6.5 million people officially classified unemployed, and just under 1 million more who do not count because they are too discouraged to look for work. That adds up to 11.5 million Americans who work or are willing to work yet still are a long way below the poverty level.

The bills recently passed by both the House of Representatives and the Senate provide for the minimum to go to $3.85 in October of this year, then to $4.25 in 1990, and to $4.55 in 1991 (by which time inflation will have wiped out most, if not all, of the increase). In an attempt to attract Republican votes, the bills include a subminimum training wage: 85 per cent of the minimum for a first-time employee’s initial 60 days.  This provision would phase out in 1992. Though the bills have substantial support in both houses, particularly among Democrats, President George Bush has threatened to veto anything that goes beyond $4.25 an hour. Thirty-five Republican Senators have promised to sustain a veto. That should pretty much do it.

The threatened veto is, naturally, presented as a kinder, gentler act. The conservative argument is that companies pay the minimum wage (or less) because they cannot afford to pay more. Since they are at the limit of their resources, a pay increase would force them to fire those paid the present minimum and to turn away inexperienced teenagers, blacks and women looking for entry level jobs. The net result, conservatives say, would be an increase in unemployment.

Anyone who bothers to look at the record, however, will find that employment has risen in seven of the eight years when the minimum wage has been raised; and the one year employment fell (1975) was a time of severe recession when the drop was expected for other reasons. Moreover, the 11 states that now have a statewide minimum wage higher than the Federal standard also have the lowest unemployment.

You will have noticed that the argument shifts back and forth between the fate of the economy as a whole and that of individual workers and individual businesses – in other words, between macroeconomics and microeconomics. Several times over the years I have called attention to the fallacy of composition, which often pops up when such shifts are made, and I’ve suggested that economists must love it because they do so much dancing. In brief, the fallacy assumes that what is true of members of a logical class is thereby true of the class itself. Sometimes this leads to the laughable, as when Engine Charlie Wilson averred, “What’s good for General Motors is good for the country.”

In the present instance, conservatives argue that what may be bad for some workers must be bad for all. Liberals, on the other hand, argue that the possible microeconomic effect of some job loss will be more than offset by the macroeconomic effect of better jobs in the economy as a whole, resulting in increased spending that will stimulate business into hiring more workers.

Over a quarter of the low-income workers would have to be fired for the total wages to fall. It’s a judgment call, and the call pretty much separates the optimists from the pessimists, and the liberals from the conservatives. I’m such a liberal optimist, I doubt that as many as 10 per cent would be fired. In that case the macroeconomic stimulus would be considerable, making it likely the 10 per cent would be rehired almost at once, thus intensifying the stimulus and making inroads on those millions of unemployed.

If you too are an optimist, I ask you to consider a special implication of what we have been saying. The happier world we have projected depends on an act of Congress combined with a President’s willingness to sign his name. There is no economic law that will achieve our goal. Rather the contrary. Standard economics pits businesses in such implacable competition with each other that even good-hearted employers are unable to pay more than the minimum, while workers compete so fiercely for jobs that even the stout-hearted can’t hold out for more. (That, by the way, is the Iron Law of Wages, which prompted Thomas Carlyle to coin the name for this column.) Thus wages tend inexorably to zero, and profits do as well. So, to be sure, do prices; but since no one will have any money, I’ve never understood what difference that makes. Individual companies can’t stop this fall; it takes governmental action. Hence the minimum wage.

Shifting back to microeconomics, we are likely to find in boardrooms across the land another objection to raising the minimum wage. It cuts into profits, the gut feelings is, and cripples enterprise. This feeling is known as the wage-fund theory: it argues that the gross receipts of any enterprise form a fund from which wages, other costs and profits are paid. Therefore, as David Ricardo insisted, “There can be no rise in the value of labor without a fall of profits.” Karl Marx, an admirer of Ricardo, found the wage-fund theory handy in explaining the implacable opposition of labor and capital. Here, as in so many cases, we find the far Right in bed with the far Left.

But taking a peek at the real world, Joseph Schumpeter remarked the empirical fact that wages and profits tend to go up together. Really good times are at least pretty good times for everybody. Profits are high, wages are high, unemployment is low, and so, for that matter, is inflation. None of this could happen if the wage-fund theory were valid. It is not valid because wages are a cost of doing business, while profits are not.

Profit (or loss) is what is left over after all receivables have been collected and all bills paid. The costs of wages, interest, rent, and supplies can all be contracted for in advance; but profit is systematically residual. What’s to come is still unsure.

1989-4-3 Minimum Wage vs. Maximum Confusion boots

I’m talking about actual profit-the kind you pay taxes on. Business people talk also about “normal” profit – what they think an enterprise ought to earn to be worth the bother. There is obviously no such thing as normal loss. Normal profit is a planning concept. It is an estimate, even an expectation, but not an actuality. It is on the basis of this estimate that go/ no-go decisions are made, prices are set, and production runs are scheduled. Although in the real world some businesses are vastly more profitable than others, and more or less profitable from year to year, normal profits, making allowance for risk, are uniform, as are short-term interest rates. High-risk enterprises must promise high normal profits, yet in the real world the low-risk enterprises generally show the highest profits.

THERE IS clearly not much point in running an enterprise if it can’t earn the going interest rate and a bit more. You could lend your money to someone else and earn bank interest or better with no trouble at all. So the interest rate is what economists call an opportunity cost of normal profit: they are roughly equal. Consequently we have three related concepts: normal or hoped- for profit, the interest rate, and actual profit or loss. Since only the first two come out of the wage fund, only they are in conflict with wages.

A common error, from David Ricardo to Alan Greenspan, is to confuse interest and actual profits. Mathematical economists, too, have trouble with this phenomenon, because they are prone to work with normal profits rather than actual profits. Actual profits are earned in historical time, but mathematics knows only the present tense.

What Ricardo should have said was, “There can be no rise in the value of labor without a fall in the interest rate.” Wages and actual profits can and do go up and down together. They go up together when the interest rate is low, and they go down together when the interest rate is high.

As Henry Ford understood, it is in the rnicroeconornic interest of each business that all businesses pay good wages. For this macroeconomic phenomenon to happen reliably, it takes a law. It takes more than a minimum-wage law, but it takes at least that. It is not unlikely that pushing up the minimum wage would eventually push up the wages and salaries above it. That is why we have said (see “Reality and Welfare Reform,” NL, November 28, 1988) that doing something about the poor is inflationary unless a major effort is made to correct the massive maldistribution of income and wealth in this country.

That will not be easy, especially since we seem bemused by personalities, and since a previously wimpy personality will veto any attempt of personable Congressional leaders to move in the right direction. There is something more to the problem than David Rockefeller‘s objections to Michael Milken’s junky performance.

The New Leader

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