20 February, 2013

Raising Federal Minimum Wage May Hurt Growth

I was induced to write this article by several factors. In decreasing order of importance, they are my annoyance with the POTUS' State of the Union address (which fell prey to the usual bane of good rhetoric- politics), some macroeconomic studying that I have been doing, and the fact that I am myself a doubly-minimum-wage laborer (I am, at present, holding two minimum wage jobs while I am in school). Let me up-front and clear from the start:
I am opposed to a minimum wage on principle, yet my opposition to raising it does not in totality stem from this fundamental opposition to the existence of a minimum wage in the first place. 
I hope that, in this somewhat brief and informal format, I am able to at least arm you with another side to this issue you may not have considered, or to at best convince you that raising the federal minimum wage might be an economically poor decision, regardless of how politically savvy it may be.

Minimum Wage? You mean 'Price Floor'

As somebody who has studied economics to no small degree, I think of minimum wages differently than the way in which I imagine most people think of them. To me, wages represent a price for labor; more specifically, it is the price which I command for my labor, and the cost a business must pay to have my labor. When thought of this way, our thinking about wages becomes much easier to objectively analyze.
Just like any producer, I wish to sell my product (my labor) at the highest rate that I can. I cannot, however, force people to accept my price. I must sell my labor at a price with entices buyers. Conversely, firms who purchase labor cannot arbitrarily assign a price which I must accept, low though it may be. They must offer a price that I am willing to sell at, or I reserve the right to refuse to sell. These ideas, working in tandem, create both a supply for labor (on my side) and a demand for labor (on their side) at any give price (wage). Where these two factors intersect represents the equilibrium price for labor in a given market- they will go no higher, and I will go no lower. We meet in the middle.
If any of this sounds pedantic and familiar, it is because you've heard it before in any intro to economics course you've ever taken. The supply and demand of labor functions nearly identically to the supply and demand of price, because wages are simply a price for labor!
This means that, just as how price floors set above the equilibrium price cause a surplus of a good, or more prosaically a shortage of demand for a good, so does a price floor above the equilibrium wage. A minimum wage is just like a minimum price- it is a price floor. When set above the equilibrium, a price floor like minimum wages means that there will be, ceteris paribus, less demand for labor, which in turn means that there will be either fewer labor hours offered to existing employees, or fewer jobs available for new employees.
But who does this principally affect? It doesn't affect those who currently work above the minimum wage; in other words, it doesn't affect those whose careers or job markets have an equilibrium wage already above the minimum wage. Doctors, in short, are not effected by minimum wage. Nor are construction workers, fior that matter, who I know for a fact already receive compensation well above the minimum wage in most areas. Changing the minimum wage upwards principally affects those at the bottom of the pyramid, so to speak: unskilled or inexperienced workers in jobs where there is an almost perfect substitution for labor.
Raising the minimum wage causes increased costs for those businesses who employ unskilled or inexperienced workers, which means that in order to remain in business at all, they must either reduce their labor costs by giving each employee fewer hours or laying off some employees, or they must increase their income by raising prices. Either way, those at the bottom of the heap are the most impacted, since a 1% change in goods prices means more to you if you make $15,000/year than if you make $150,000/year, and since they are the ones who stand the greatest chance of losing hours or even their jobs.
There may also be another effect of minimum wages: preventing good wage negotiation. Think about jobs you commonly perceive as being 'minimum wage' jobs. Burger flipping comes to mind. Perhaps the minimum wage prevents those businesses from paying more than the minimum wage, simply because they perceive that job as being a 'minimum wage job!' If they had to negotiate wages with their employees more freely, the wage demanded by those skilled and/or experienced with burger flipping may well be above the minimum wage, but as it stands, there is little incentive to pay these employees more than the minimum wage, given that they're doing a 'minimum wage job.'

But What About Falling Real Wages?

We've all heard (okay, so maybe we haven't all heard) about the declining real wages in the United States recently. What is less often understood is just what real wages mean. Real wages are simply inflation-adjusted wages, which means that they are a more accurate measure of purchasing power than nominal (non-inflation-adjusted) wages. Why? Because if you make 5% more, but the price of goods has gone up 5%, you can't buy more. Your real wage has stayed the same. If, as has been the case lately, inflation is rising higher than nominal wages are, real wage will decline, and one can purchase fewer goods.
On the face of it, raising minimum wage might seem to address the problem. In fact, it makes it worse. By raising the minimum wage, one feeds into a cost-push inflation which drives consumer prices up (because the cost of labor, one of the factors of production in consumer goods, goes up), erasing any benefits to the real wage.
In fact, if one accepts anecdotal evidence (and I don't), minimum wage was last increased in 2009 (to the current value of $7.25/hr) and since then, median real wage has declined.
One might argue that increasing the minimum wage redistributes real wealth downward toward those making minimum wage and away from those at the very top. Even if this were desirable (something I'm not going to get into here), there seems to me to be little evidence that minimum wage does so.

Minimum Wage and Growth

In order to discuss, very briefly, the effects I believe an increase in the minimum wage would have on growth, we must first, even more briefly, discuss what economic growth actually is, and what causes it to occur.
Economic growth is not caused by increased consumer spending, or my increased government spending. While each of these may increase GDP in the short run (they can hardly avoid doing so, as GDP counts them as inputs), in the long run neither of them tends to represent meaningful growth.
What matters in economic growth is the improvement of productivity (being able to make more stuff). This can only occur in two ways:
1. we get better at making stuff more efficiently out of the resources we have, and/or
2. we find more resources to use in making stuff
What matters, then, in generating economic growth is investment spending, not consumption spending. Investment, of course, being spending on more or better factors of production (including improving the quality of our labor through education/training), spending on finding new sources of a resource, or spending money on research and development to invent new ways to put resources together.
So, to return to minimum wages: even if an increase in minimum wage represents an increase in the real wage, that means that (all else held equal) there will be less investment spending, simply because there is less to be spent! Slowing our investment spending at a time when our economy is in critical need of greater capital accumulation seems, to me, to be absurd.
Besides, even if wages stay the same, the rising tide lifts all boats: a more efficient, growing economy means that all things will be relatively cheaper. For proof, look at how improvements in manufacturing and technology have made computers vastly less expensive and vastly more available than they once were. The standard of living enjoyed by those on the brink of poverty today is much higher than it was only 50 years ago. The access to luxuries is higher now that it has ever been. Improving the economy as a whole does more for the poor than a minimum wage ever could.

Alternative to a Minimum Wage

Some might argue, and I might be in some cases inclined to agree, that something still needs to be done to address income disparity between the very poor and the middle or upper classes. As I have argued above, minimum wage doesn't help; at least, not enough. So, then, what should we do?
I personally support the idea of setting the Earned Income Tax Credit at the poverty level. If we deduct from taxable income all income up to what is considered the poverty line, then there will be more income available for essential purchases for those at or near that line. This would help to ensure that every family received a minimum level of income to purchase their basic needs (food, housing, etc) without needless interference in the job market.
I also support tax reductions aimed at invigorating economic investment, such as eliminating taxes on the purchases of capital stock, education or training expenses, and providing greater incentive for innovation into more efficient production methods by eliminating any taxes associated with expenditures on legitimate research and development. By growing the economy and making it more efficient, we can provide more goods and services at a lower cost, meaning those on the brink of poverty, or in it, can purchase more and enjoy a higher standard of living than they do today (even if they are still, relatively, poorer than their contemporaries).

In conclusion,

I do not support an increase in the federal minimum wage because it further distorts the labor market unnecessarily, fails to help those who need it most, and may stifle economic growth.

06 February, 2013

Musings On Growth

Lately, I've been doing quite a lot of economic data analysis; in particular, I have sifted through figures gathered from around the word for real GDP over the last three decades, and capital accumulation, production efficiency changes, and regional factors over the same period. Much of this data suggests a convergence of economies toward the most-developed economies. In other words, smaller, less developed economies grow (often exponentially) faster than more developed, larger economies. This produces a trend over time that would seem to indicate two factors which I would like to casually explore with this post:
a) economic growth over the long run seems to behave quasi-asymptotically 
b) convergence of economies implies that rapid growth might be inherently unsustainable
Before I begin discussing these ideas, I would like to point out that these thought are, unlike many of my other posts, not yet tested empirically, at least not so far as I was able to dig up with a cursory search. I am likewise not in the possession of enough relevant data to make such an empirical analysis myself. This is just, as the title suggests, a simple musing, rather than a rigorous analysis.
That having been said, there are some data which support these arguments. Growth rates, as measured in real GDP and real GDP per capita, over the past several decades, while showing great variability, seem to bear out the general conclusion that if a country started big, it grew more slowly in terms of percent change per annum; if it started smaller, it grew more rapidly in terms of percent change per annum. This means that large economies may have grown more in terms of absolute addition to real GDP, but their rate of growth was, on the whole, smaller than those of developing economies (especially the 'Tiger' economies of Asia and OPEC nations).
Given this, and given other observable indicators of economic growth (industrial development, capital accumulation, etc), it seems that there is some sort of marginal cost to continued growth. Economists and economically minded people are used to thinking in terms of margins, but for the relatively uninitiated reader, I will now go on a slight digression of margins (that those familiar therewith can skip by moving forward to the paragraph after next).
'Marginal' analysis is simply the analysis of the change that occurs in a given dependent variable when the independent variable is changed by 1 unit. For instance, Suppose that you are purchasing cans of soda. Each can costs $0.75. This means that the marginal cost of purchasing each additional can of soda is $0.75 - in other words, the additional cost you bear for each additional soda is $0.75. This is an example of a constant marginal cost. Now, suppose you are purchasing labor from a friend (you're paying him or her for their work). They might be willing to work 8 hours at a rate of $10/hour, but if you want them to work a 9th hour, they wish to be paid overtime ($15/hour). This means that the marginal cost of that 9th hour is not $10, but is $15- an example of increasing marginal costs.
It is commonly noted in microeconomics that marginal costs increase over time and marginal benefits decrease over time. Given the fundamental economic assumption of scarcity, this is inevitable- the more of a good is consumed, the more precious the remaining quantity of that good will necessarily become. Conversely, the marginal utility or marginal benefit goes down over time- a convenient way of imagining why is to think about how much pleasure you get from drinking a 6 pack versus drinking a case of beer. Once you drink too much, you puke; a clear example of a decreased marginal benefit from one additional can of beer.
This sort of thinking is what I wish to apply to economic growth. I am coming to the conclusion that increased economic growth in real terms has an increasing marginal cost and a decreasing marginal benefit over the long run. This implies that there is perhaps a steady state at which it would be most rational NOT to grow the economy, and perhaps it is this steady state toward which most economies seem to be converging.
There seems to be some logical basis for these thoughts. In the broad scope, it is commonly recognized that the pace of technological innovation and development is increasing at a rapid rate. One common measurement of the efficiency of technology, the doubling time for computer memory that can be produced at a given cost, has been increasing for the past 40 years. New innovations are being produced at a breakneck rate. Given most macroeconomic growth formulas (in which output is generally a function of capital, labor, investment, and technology), this would seem to imply that, ceteris paribus (all else being held equal), we should see increasing growth rates.
We do not.
Growth rates for most developed economies- the places where most of this innovation happens and where the benefits of those innovations are most strongly and immediately felt- have remained the same or even slowed, and they are certainly growing more slowly than less developed economies. It is my argument here that perhaps there is a decreasing marginal return for each unit of technological innovation; inversely, there is an increasing marginal cost for each little bit of growth that technological change adds to output. Cursorily, this seems to hold up to scrutiny. The jump in production efficiency gained from having no computers to having basic computers was large; the jump in production efficiency from the earliest computers to the ubiquitous desktop was large but smaller; the jump from desktops to faster and more powerful desktops modest, and smaller still. Yet the amount of resources spent on development of computers, and the rate at which new computing technology increases, has grown all the while. In real terms, the cost in resources (time, energy, etc) which must be spent for each additional 'unit' of technological innovation is rising over time!
The other factors of production are similarly limited. There is only so much capital to go around- it cannot increase forever. There are only so many natural resources to go around- they cannot increase forever. Historically, and in some cases currently, if there is a shortage of resources, more can be found somewhere at some cost. Think of today's situation with oil and fracking as representative. This process cannot go on forever- even if we eventually reach such a peak of efficiency that we are able to run an entire economy using only renewable resources like solar and wind power, there is only so much sun and so much wind! No matter how you think about it, the inputs which go into output are inherently limited and finite in nature, whether we have reach those limits or not.
All of this taken together supports the idea that economic growth over the long-run (and in this particular case, I'm talking about perhaps a century or more into the future) is going to slow asymptotically as it reaches this limit, whatever it is. This will be true for the world economy collectively, but it will be noticed most drastically by highly developed economies who will find that their present rates of growth are increasingly difficult to maintain, until they can't maintain them at all.
Eventually, this seems to imply that economics will become something that it has not been at any other time in human history: a zero-sum game. At this end-state when we have reached or are approaching the limits of resources and when further technological gains become massively costly, economic gains by smaller economies may begin to come at the cost of growth or even absolute size, in larger economies. This would promote a cutthroat growth expansion by all economies who seek to increase their share of the pie before the pie stops growing (or begins growing so slowly that the growth is negligible) which will only hasten the coming of a 0-development steady-state world economy.
This end-state need not be bleak; presumably, since all economies would have grown from today's size, quality of life and material wealth would have increased as well. No further growth does not mean  that there will be negative growth, nor does it mean that economies will collapse. There need not be a dystopia; this argument, if true, simply means that we may have to abandon our hopes of an ever-increasing utopia.
In conclusion, I reiterate that these are musings and speculations based upon no thorough or rigorous empirical or statistical analysis. These arguments are, however, interesting and have weighed on my mind for several weeks now. It will be interesting to see if any research is done into this area; perhaps even a model built for long-run growth which includes some of these conjectures.