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By George P. Brockway, originally published September/October 2000

2000-9-10 New Use for a Bad Idea - title.jpg

IN ECONOMICS no bad idea goes unused. This is perhaps to be expected in a discipline that prides itself on being the science of the efficient allocation of scarce resources. Ideas are hard to come by in the best of times. With many hundreds of doctoral candidates looking for original dissertation subjects, and many thousands of tenure-track assistant professors looking for profound article topics, nothing that looks like an idea can be allowed to waste its fragrance on the desert air. In addition, there are the diurnal needs of business-page journalists and bond salesmen. Not to mention the problems of NEW LEADER columnists.

A subject that has met all the above needs for at least the past quarter century is the productivity index. It is with mixed feelings that I report on a quite new use that has been thought up for this fallacious procedure. Since, as we shall see, the new use is in the very highest reaches of national policymaking, it is in an especially bad place for a bad idea.

The February 8, 1982, column in this space was titled “Productivity: The New Shell Game.” On May 28, 1984, “The Productivity Scam” appeared. The third antiproductivity- index piece had to wait until  May 19, 1993, and the fourth is here and now. Productivity being a protean idea, each column is concerned with a different use of the index.

True to its metaphor of a shell game, the earliest column said that in the new game each of the three shells had a “pea” under it. The first pea, “which always turns up on metropolitan bars and suburban bridge tables,” was that “it just seems people aren’t willing to work the way we did when we were young.”

Next was the “America has gone soft pea.” We let them beat us in Vietnam; investigative journalism got out of hand over Watergate; and now a court has said that creationism isn’t science. It’s hard to tell what the country stands for anymore. It’s no wonder that productivity is down and we have to have this recession to get us back on the track.

Under the third shell was the “archaic industry pea.” Our productivity is down because we don’t invest enough, because we don’t save enough, because we tax business-too much.

In other words, the productivity “peas” were Reaganomic explanations of the recession then stagnating. Regardless of the shell we chose, we got a pea; and regardless of the pea we got, we lost.

By May 1984, the productivity focus had narrowed, with this conclusion: “The uproar about labor productivity is a scam to distract attention from a massive shift in the distribution of the goods of the economy. The share of nonmanagerial labor is being reduced; the share of managerial labor is being increased; and the share of those who do no labor, who merely have money, is being increased most of all. This is what Reaganomics (or, if you will, Volckerism) is all about, and the Atari Democrats have been gulled into going along with it.”

(Those whom the late Robert Lekachman, a wise and witty contributor to this journal, dubbed Atari Democrats called themselves New Democrats. Atari was at one time the leading producer of electronic games, and was early seduced abroad by the promise of cheap labor. What became of it, deponent knoweth not.)

Nine years later (May 19, 1993), the focus had narrowed again. The talk was all about downsizing, a nasty and disgraceful business practice that continues to this day.

The productivity index is thus one of the most powerful ideas of our time. It has malignly affected the lives of millions of men and women, the fortunes of thousands of enterprises, and the economies of nations.  It is a tragedy of almost universal scope.

The basic idea of the index is sound enough. Output is divided by input to determine how many units of input achieve a unit of output. The result is an index number that can be compared with other numbers similarly derived. A single index number, of course, is almost useless; but much can be learned from comparisons, and they are of great and daily use in business management. The current performance of a company’s sales (or any other) department can be compared with. its performance in prior years, or with the performance of corresponding departments of the particular industry as a whole. Banks routinely analyze their customers’ profit and loss statements in this way, and trade associations frequently do the same for their members.

It must be confessed that executives sometimes make unreasonable use of the comparisons. A sales department may be faulted for a falling sales index, while the sales force argues that the quality of the product has declined, or that the advertising has been inadequate, or that the sales representative suffer from stress caused by driving poorly equipped automobiles.

Rumbles from the executive floor suggest that the sales reps are too well paid, or that there are too many of them, or that some territories are not worth covering.  This is the way that downsizing begins.  Every job in every department is ultimately at risk.

Years ago a chapter in a tome on book publishing started this way: “There are two simple principles by which the business thinking of a publishing house should be guided.  They are (1) Reducing costs by $1,000 has roughly the same effect on the profit and loss statement as increasing sales by $25,000.  (2) You have to spend a dollar to make a dollar.

Downsizing tends to forget the second principle, and also the greater principle that the human beings who are so easily hired and fired are not a means to an end but are ends in themselves.  But the ethical objections to downsizing shouldn’t allow us to decide that there are not solid, hard-nosed, business-is-the-only-thing objections to the national productivity index.

THE INDEX numbers are simple fractions:  national output for a certain period in dollars (because we can’t add shoes and ships and sealing wax) divided by the hours worked by everyone engaged in production, whether paid or not.  Fractions, of course, are not unequivocal; you can increase their value either by increasing the nominator or by decreasing the denominator (2/3 and 1/2 are both greater than 1/3).  So you can increase a productivity index number either by increasing “dollars of output” or by decreasing “hours worked.”  As we shall see, the hours present a special problem.  Consider some examples of how the index works.

First, microeconomically:  Think of a journeyman plumber whose output is x, whose hours worked is y, and whose productivity is therefore x/y.  Suppose by taking on a plumber’s helper (a human being) he increases his output 20 per cent.  Being a rational person, you might conclude that such an increase in output would result in a substantial increase in productivity, but you would be sadly mistaken.  According to the formula, his productivity becomes 1.2x/2.0y, or .6x/y, and thus has fallen 40 percent.

We get similar results macroeconomically.  Take the 5.4 million or so people counted by the Bureau of Labor Statistics as unemployed. (There are about 10 million more who aren’t counted because they have a part-time job, or are too discouraged to continue looking for work, or are too turned off ever to have seriously entertained lawful employment).

Let’s accept (for argument only) that the conservative press is correct in saying the 4 percent of our civilian workforce officially designated unemployed are so careless, stupid, uneducated, arrogant, sickly or pregnant that they’re unlikely, if employed, to produce on the average more than a third as much as an equal number of those who are currently employed.  Even at that level, if we could find the wit and will to employ these people on this basis, we could increase our gross domestic product by 1.2 percent, or about $130 billion a year.

Being still a rational person, you might think such a tidy sum would increase our productivity, but again you would be sadly mistaken.  Productivity is still output divided by hours worked or x/y.  After finding jobs for the 4 percent of our civilian workforce that is now unemployed, our productivity becomes 1.012x/1.04y, a fall of 2.7 percent.

So if we really believe in the conventional theory of productivity, we must deny help to our plumber and jobs to the unemployed.  Unfortunately, a large majority of the members of the American Economic Association do believe in the theory.

A couple of other examples may clinch the case.

A young slugger lived up to his promise by hitting a grand slam home run his first time at bat in the majors.  His next time up, there were only two men on base.  His manager yanked him because (aside from drawing a walk or being hit by a pitch, neither of which would count as a time at bat) his productivity could only go down.

Then there was the unsung predecessor of Tiger Woods who hit a hole in one on the first hole of a club tournament, but retired when his drive on the second hole stopped rolling two feet short of the cup. “My productivity could only go down,” he lamented as he gave his clubs to his caddy and took up water polo to sublimate his aggressions[1].

THE THING about “hours worked” is that Gertrude Stein couldn’t have said “hour is an hour is an hour” because they aren’t. I was a lousy salesman, though I worked doggedly at it for almost five unproductive and depressing years. Many years later I became a moderately successful CEO of a small company and worked doggedly at that. I put in approximately the same number of hours a day as a salesman as I did as a CEO. After all, there are only so many hours in a day. But the value of my work as CEO really and truly was vastly greater than the value of my salesmanship, and you may believe I was paid more for it, too. Adding those different hours together in the denominator is less sensible than adding apples and oranges.

Karl Marx[2] faced a similar problem when he was wrestling with his theory of surplus value. He finally declared victory and wrote: “We therefore save ourselves a superfluous operation, and simplify our analysis, by the assumption, that the labor of the workman employed by the capitalist is unskilled average labor.” If this was a valid assumption in his day (and it probably wasn’t), it certainly is not in ours.

John Maynard Keynes also felt a need to devise a homogeneous unit of labor. He wrote: “Insofar as different grades and kinds of labor and salaried assistance enjoy a more or less fixed relative remuneration, the quantity of employment can be sufficiently defined for our purpose by taking an hour’s employment of ordinary labor as our unit and weighting an hour’s employment of special labor in proportion to its remuneration, i.e., an hour of special labor remunerated at double ordinary rates will count as two units.”

The minimum wage (currently $5.15 an hour) may be taken as a homogeneous unit of labor. But why bother? It is merely a multiple of a homogeneous unit we already had ($1.00) and tells us nothing new.

Unless you naturally think like an economist, you may wonder why the denominator of the productivity fraction is “hours worked” rather than “dollars paid for labor.” The deep secret is that economists, like well-bred  characters in an early 19th-century English novel, are with a few exceptions embarrassed by talk about money. General equilibrium analysis, the most fashionable economic theory at the bulk of elite American universities, can find no place for money in its doctrine. Even monetarism, despite its name, is scornful of the stuff we pay our bills with, which it speaks of as “nominal” money, and insists that what it calls “real” money is what matters, although no such thing exists. (If you’ve read much medieval philosophy, you may find such talk familiar.)

There is another problem with the denominator. We learned in school that the factors of production are land, labor and capital. Some add technology, and Adam Smith wrote of a propensity to barter. In any case, labor is merely one of the factors of production; yet the productivity index treats it as the only one.

To be sure, labor may be the largest factor. A quasi-constant of the economy is that the cost of labor currently runs about 60 per cent of GDP. But the cost of capital-the money spent for interest by nonfinancial, nonagricultural businesses -has increased roughly five and a half times in the past 40 years, partly because the Federal Reserve has increased interest rates, and partly because today American business relies much more on borrowed money than it used to. Common laborers, not Protestant financiers, are now the austere actors on our economic stage[3].

This shift in roles may be good or bad or indifferent, but the productivity index, no matter how constructed, will at best only call our attention to the fact that a shift has occurred. It will neither judge the desirability of the shift nor tell us what to do about it. Econometrics-c-playing with statistics-is the beginning, not the end, of economics.

ALL THAT said, we come to the new use of the productivity index mentioned at the start. I’m sorry, but I can’t say who invented the new use. It was a stroke of genius, even though the Federal Reserve Board had already pioneered the implausible idea of using high productivity (according to the index) as an excuse for trying to reduce production. I’m sorry again, but I can’t say, at least with a straight face, why we should reduce production.

The new scheme goes like this: (1) Production is produced by workers exercising their productivity. (2) The population of workers increases about 1 per cent a year. (3) The productivity index, fallacies and errors and all, increases about 1.5 per cent a year. (4) Put them together, and you get 2.5 per cent a year as the rate at which a well-mannered economy should expand. (5) The economy has been expanding at better than that rate in every year except one in the last eight. (The low one was 2.4 per cent in 1993.) Conclusion: Look out! It must be overheating!

Well, I ask you!

I regret to have to add that the Democratic Party Platform Committee listened solemnly to this kind of stuff. I doubt that the Republicans bothered their heads about it. All they need to know on earth is that a tax cut is beauty, and beauty is a tax cut, especially a tax cut for millionaires. I regret further to have to admit that the economics profession is careless about such nonsense. The other day I read a paper by a friend of mine that was decorated by several equations in which a symbol for productivity occurred. I objected that the symbol stood for a fallacy, and that his equations were therefore fallacious.

He laughed. “Everybody does it,” he said. “You’re expected to do it. It doesn’t matter.”

Well, I’ve already asked you.

The New Leader

[1] Ed:  As a similar tale goes, a golfer played at Pine Valley, arguably the best golf course on earth, and in the first four holes had two birdies and two eagles. One eagle was a hole-in-one.  He was 6 under par.  The fourth green is back at the club house.  The golfer walked off the course and into the bar and would not come out as he’d only screw up the round.

[2] Ed:  Though likely not as a salesman….

[3] Ed: emphasis mine

By George P. Brockway, originally published August 10, 1992

1992-8-10 Are You Naturally Unemployed title

AT THE END Of my piece on “The Last Chapter in Keynes” (NL, June 29), I referred to the currently received doctrine of the natural rate of unemployment. The implications of the doctrine are such that they don’t, as the saying goes, bear thinking about. Nevertheless, I propose to try to think about them here and now.

The expression “the natural rate of unemployment” was apparently coined by Milton Friedman in his presidential address to the American Economic Association on December 29, 1967. Friedman was clear that what he called the natural rate was not a natural law (like, say, S= 1/2[gt^2]). “On the contrary,” he said, “many of the market characteristics that determine its level [such as minimum wage laws] are man-made and policy-made.” Yet he saw and, I believe, still sees something inexorable in the idea.

Friedman said he used the word “natural” because the idea was comparable to “the natural rate of interest,” a notion advanced by the Swedish economist Knut Wicksell in 1898. Wicksell is worth reading (though perhaps not on this issue), but for the moment we need note only that he is thought by many to have anticipated Keynes in some ways. And as to Keynes, we need remember particularly that his initial quarrel with the classic economists was that they believed involuntary unemployment was impossible. Since whatever is “natural” is ipso facto involuntary, Friedman, too, broke with the classics on this point. I hasten to insist that Friedman is not now and never has been a Keynesian or a neo-Keynesian, and certainly not a Post Keynesian (which, if you must know, is more or less what I am).

The natural rate of unemployment is thus an idea that resonated unexpectedly in many corners of modern economic thought. In its pure form it goes like this: Given the civil laws, customs and institutions of the economy (though Friedman is not now and never has been an institutionalist follower of Thorstein Veblen or John R. Commons), beyond a certain point any increase in the rate of unemployment will result in deflation and a recession that will continue until wages fall to a level to encourage entrepreneurs to start hiring again; on the other hand, any decrease in unemployment will result in inflation and a recession that will continue until employment returns to its natural rate.

The idea was not immediately embraced by the profession. Very likely thin-skinned economists were timid about saying that joblessness could be your patriotic duty. This difficulty was overcome when somebody (I’m sorry I don’t know who[1]) came up with a name that obscures the implications of the idea and has, moreover, an acronym that soothingly sounds like the name of a languorous South Sea isle. The new name is Non Accelerating Inflationary Rate of Unemployment, or NAIRU. The modifier “nonaccelerating” is a modifier of Friedman’s original notion and recognizes the fact that, as we know from our experience of the past half century, it is not too difficult to live with inflation if the rate is fairly low and steady.

The NAIRU was 3 or 4 per cent at the end of World War II. It reached 5 or 6 per cent in 1975, after the Federal Reserve Board raised interest rates in its quixotic response to the first OPEC embargo. And it appears to be around 5 or 6 per cent today (the current 7.7 per cent rate of unemployment is dismal from any point of view).

Let us be sure we understand what a NAIRU of 5 or 6 per cent means. It means that, given our present labor force of some 127 million men and women, about 7 million of them must be unemployed through no fault of their own. Forgive me for raising my voice, but we must see clearly that NAIRU won’t work if unemployment is the result of stupidity, poor training, laziness, lawlessness, or unreasonably high wage demands – if unemployment is, as the classical economists said, voluntary. The NAIRU people are not the people of Reaganesque anecdotes (if such people there ever were) who flit from job to unemployment insurance to job as spirit moves them. Stupid, incompetent, lazy, lawless, or grasping people do not compete for existing jobs; it is the function of NAIRU people to make holders of existing jobs fear for their positions and so acquiesce in low pay, unsafe or Quayle-approved working conditions, frayed fringe benefits, and nonunion shops.

Perhaps you will now sense another resonance of the natural rate of unemployment. It is the stern, impassioned tread of Karl Marx’ industrial reserve army. “The industrial reserve army,” Marx wrote, “during periods of stagnation and average prosperity, weighs down the active labor-army; during periods of overproduction and paroxysm, it holds its pretensions in check.” Friedman might have put it somewhat more gracefully, but he couldn’t agree with it more.

How did the soldiers of the industrial reserve army get recruited? They weren’t rounded up by press gangs like those that helped Britannia rule the waves, but their fate has not been dissimilar. They did not volunteer, and they were not drafted; they were in the wrong place at the wrong time, and many of them were simply born wrong, just as Rockefellers and such happened to be born right. They are victims of crashingly bad luck.

From time to time, demographers publish studies averring that only a percentage (say 10 per cent or 5 per cent or perhaps 1 per cent) are what we used to call lifers and spend their entire lives in the industrial reserve army, or that only some other percentage (say 12 per cent) serves more than 27 weeks at a time, while Horatio Alger and his like are discharged in a matter of days. We may accept these studies, or most of them, at their face value and still observe that those in the industrial reserve army serve as a consequence of crashingly bad luck, and that they serve in our interest and indeed in our stead. This being the case, it cannot be denied that our economic system – a system said to depend on the natural rate of unemployment – would self-destruct if it were not fundamentally unjust. It is clever to say that life is unfair; it is corrupt to raise unfairness to a principle of control.

As we noted here a short while ago (“Where Schumpeter Went [Astray],” NL, April 6[2]), Joseph Schumpeter celebrated capitalism as “the civilization of inequality and the family fortune.” I cannot do that. I cannot understand doing that. I cannot settle for NAIRU in any of its forms. I can accept the military draft and have in fact been drafted. It is possible in time of war to show citizens, chosen by lot, their duty to risk their lives in defense of the nation that nurtured them. It is not possible to show anyone a duty to lead a life of squalor in order that others may be free to choose among moderately priced commodities.

If there really is a natural rate of unemployment for our system, the system is immoral. If it is immoral, we should change it. Some will say that even with NAIRU, ours is the best system seen so far, and others will say that NAIRU applies to all systems. Despite these answers, improvements are possible.

To share the burden of NAIRU fairly, we might take Marx’ metaphor literally and institute a draft for the industrial reserve army[3]. It is unlikely that there would be volunteers, and there should be no exemptions of any kind (except for the unemployable). Membership in the army probably would be by nuclear families, unless children were put out for adoption while their parents served. There would no doubt be problems with the definition of a family, but I’m sure that, given good will, solutions could be found.

Every able-bodied family in the nation would pull at least one hitch in the army. Service would consist of living without personal assets or income (including imputed income, as for example, decent food, clothing, and shelter) for a period. I imagine two or three years would suffice at the present natural rate of unemployment. For ease of administration, it might be convenient in some cases for families to exchange homes. Certainly the houses of wealthy draftees could not be left vacant without inflating the general cost of housing.

Private charity also would have to be rigorously controlled to prevent favoritism and corruption. Food Stamps, Aid to Families with Dependent Children, Medicaid, and the like (including Workfare if finally enacted) would be available. Of course, for the army to serve its purpose, recruits must be able to work, but their availability would have to be in accordance with length of service. It wouldn’t be fair for me to be enlisted one day and hired by a friend the next.

Perhaps all that strikes you as preposterous. I hope so. It certainly seems preposterous to me. But the whole idea of placidly accepting a natural rate of unemployment strikes me as far more preposterous.

Now, looking back at the theory of NAIRU, we note that the general price level is to be controlled by holding down only one of the factors of production (labor). Why shouldn’t we also hold down the rate of interest? Since inflation of the costs of production is the issue, why shouldn’t we have NAIRI as well as NAIRU?

“But,” cry the governors of the Federal Reserve Board, “we already control inflation by raising the interest rate.” They know not what they do. In the 40 years since 1951, when the Reserve freed itself from its wartime agreement with the Treasury to hold rates down, the percentage of GNP that goes to pay interest on debt of the nonfinancial sector has gone from 4.59 per cent to 20.51 per cent. Let me put it another way: In 1951 the interest bill of American corporations was about one-twelfth of their wage bill, whereas today it is more than a third. If the 1951 ratio still applied, today’s costs would be roughly $845 billion less than they actually are, and the price level would be lower by a considerably greater amount.

By raising the interest rate (even now it is more than double what it was in 1951), the Federal Reserve Board has contributed to (if not mainly caused) inflation. It has then restrained the inflation it caused by bringing on recession, which keeps the industrial reserve army in being.

So NAIRU not only serves reactionary interests in keeping wages in check; it is a convenient reactionary ploy in other situations. Public works cannot be used to reinvigorate the economy because the increase in employment would violate NAIRU. Likewise, although doctrinaire free traders may admit that selective protection might protect or restore as many as 2 million jobs, NAIRU forbids it. And so on.

In short, the nasty theory of a natural rate of unemployment is counterproductive as well as immoral.

The New Leader

[1] Ed:  According to Wikipedia It was first introduced as NIRU (non-inflationary rate of unemployment) in Modigliani – Papademos (1975) – Wikipedia offers three references:  [3][4][5]

[2] Ed:  The actual title is “Where Schumpeter Went Astray” but when this article was written it was cited, with a lack of the author’s normal poetry, as “Where Schumpeter Went Wrong.”

[3] Ed:  In case you’re not paying attention, the next 3 paragraphs are at once both analytically correct but intended to demonstrate to the reader how insufferably wrong-headed NAIRU is… These paragraphs are, in current parlance, “snarky”

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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