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Minimum wages, the Labor Government and Keynesian myths
Gerard Jackson
Now that Australia has the good fortune to have wall-to-wall labor governments thanks to the incompetence of the likes of Michael Kroger, the cry for higher minimum wages is now being raised. It is a fundamental economic law that pricing the services of any product above its market clearing level will generate a surplus for that product. Painful as this must be for many people, this economic law applies to labour with equal force.
Regardless of what a great many people think, labour services are not special nor are they bought or sold. What employers actually do is pay rent to labour for the use of its services. What determines how much is paid for those services depends on the supply of labour and the value of its marginal product.
The lower the supply (given an unchanged demand for labour services) the higher will be the wage, and vice versa. The demand curve consists of a descending array of marginal productivities. What ultimately determines labour's productivity is the size of the capital structure relative to the size of the population. Now the point at which the wage rate is determined is where we find marginal workers, those it only just pays to hire. It is at this point that minimum wage laws do their damage. These workers are the first to go when the effective minimum is raised.
(It is rarely made clear, though it should be, that only effective minimum wages cause unemployment, i.e., wage rates that are fixed above the market rate. If the minimum is fixed at or below the market rate no economic damage will be done. However, because the existence of minimum wages will convince many that they are beneficial, especially if there is no unemployment, there invariably arises a demand for job-destroying increases in the minimum.)
Despite what economics has discovered and taught its basic lessons are still ignored if not actually denied. That ideologically motivated 'journalists', politicians, union activists, etc., should engage in this dishonourable activity does not surprise informed opinion. But staggering as it may seem to some we even have economic commentators with degrees in the subject seriously claiming that minimum wage rates promote economic growth.
I recently received an email from a reader who wanted to draw my attention to an article by Peter Switzer that was published by The Australian in May 1998. As providence would have it, I did deal at the time with Switzer's fallacious thinking. Now that Labor is in power and the very same economic fallacies are being resurrected — again — I think it prudent to once more restate the facts.
Switzer asserted that economics showed that people on low incomes save proportionally less than those on high incomes. Economics has done nothing of the kind. All that competent economists have said is that it is reasonable to assume that people on low incomes will tend to save proportionally less than those on higher incomes. No more than that. Even though statistics have tended to confirm this reasonable assumption, no economic law is at work here.
Applying vulgar Keynesian thinking, Switzer also asserted that the minimum wage rise would raise total spending by about $1.5 billion dollars, plus raising government revenue by a further $400 million dollars. This increase in spending will "make more jobs than it kills off." This is what I call incredible stupidity. There are so many fallacies here that they will have to be dealt with by the numbers.
If Switzer was right, why stop at $14 per week? Why not make it $140 instead? According to his logic this would have boosted consumer spending by $15 billion dollars and increased government revenue by more than $4 billion. Wow! With one stroke of the pen, so to speak, our economic problems would have been over. Of course he knows a $140 wage hike would be catastrophic for employment, even though it is the logical outcome of his own argument. One mark of a bad economist is to fail to take his own economic prescriptions to their logical conclusion. Something Switzer clearly failed to do.
In any case, the idea that transferring income from one group to another boosts aggregate spending should be self-evidently absurd. Taking money from A and giving it to B cannot raise total spending; it merely reduces A's income by the same amount that it raise B's income. Yet Switzer claims total income would rise creating a net increase in jobs. John Stuart Mill demolished this fallacy more than a 170 years ago when he wrote:
It is no longer supposed that you can benefit the producer by taking his money, provided you give it to him again in exchange for his goods. (John Stuart Mill, Essays on Economics and Society, University of Toronto Press, 1967, p. 262).
Mill then ridiculed this absurd fallacy even further.
Of course, Switzer could have argued that if A saves proportionally more than B, then confiscating part of A's income to boost B's income would raise spending. No it wouldn't. This fallacy contains even more fallacies. To begin with it assumes that to save is not to spend. But saving is spending by another name and is a means by which a person temporarily transfers his spending power to another person. Like most Keynesians, the likes of Switzer cannot distinguish between savings and cash balances.
This view about savings assumes consumption drives the economy. No it doesn't. Entrepreneurship drives economies and savings fuel them. Without savings there can be no investment and that means no growth. Even competent Keynesians admit that growth is forgone consumption. But to save is to forgo consumption. Therefore consumption comes out of production. It follows that reducing savings reduces economic growth and thus real incomes.
Another (fallacy) is that consumer spending is the main component of total spending. It isn't. Aggregate business spending is several times greater than consumer spending. National accounting techniques understate total spending by excluding a huge amount of business outlays on the basis that including them would be double counting.
Another dangerous Keynesian fallacy is the belief that total spending determines the level of employment. Wrong again. So long as the means to employ labour is available widespread persistent unemployment will not be a problem, whatever the volume of spending, so long as wages and costs are allowed to adjust to market conditions.
Unfortunately, Switzer's brand of vulgar Keynesian thinking has apparently gained a following in the Australian Labor Party.
Gerard Jackson is Brookesnews' economics editor
BrookesNews.Com
Monday 31 December 2007