The President’s Minimum Wage Proposal

Commentary by Bob McTeer

Source: Forbes

This morning I heard President Obama bragging on the June jobs report. Moving on to what further could be done to improve the jobs situation, he mentioned his proposal to increase the minimum wage. I’m sorry I have to paraphrase here, but I couldn’t pull over and write down his exact words; so I ask you to trust me that I’m not exaggerating.

First, he said that a higher minimum wage would put more money in the pockets those most likely to spend it, implying a high multiplier effect. Then he went on to say that a higher minimum wage would expand employment because those receiving the higher wage would be able to afford more purchases. What gets me is that he sounded like he knew what he was talking about, and I’m sure most listeners agreed. Where to start?

Let’s start with his second point first and use the great economist Frederic Bastiat’s technique of “reductio ad absurdum,” that is showing the flaws in an argument by taking it to its logical absurd conclusion. If legislating a higher minimum wage, or dictating one by administrative fiat, could create prosperity, why stop with two or three dollars? Just go ahead and raise it to $50 an hour and get a really good bang for your bucks. (Actually, there was no logical reason to stop at $50.)

One problem with that is that the businesses forced to pay the higher wages are more concentrated than those presumably benefiting from more consumer spending. Their costs will go up a larger percentage than their share of their benefit from generalized spending increases. To stay in business, they will need to raise prices and let the consuming public share in the higher costs, or, more likely, they will higher fewer workers in proportion to the size of the mandated wage increases.

Trying to achieve prosperity through fiat denies the link between wages and productivity. Without wage increases being grounded in productivity increases, we are just trying to levitate. Think of trying to pick yourself or each other up by your bootstraps.

On the President’s first point, of putting more money in the pockets of those most likely to spend it, you still have the problem of concentrated costs and generalized benefits. Some workers would get higher wages, and some of them may manage to keep their jobs, but many would not be employed. Their negative multiplier ripples would work against the President’s positive ripples. Raising the minimum wage by a very large amount brings the shortcomings of the plan into greater relief.

Finally, let me object to the simple-minded multiplier analysis that implicitly assumes that consumption spending is the only useful spending. The marginal propensity to consume may well be a tad higher for minimum wage workers than for higher income workers, but not much. Moreover, the higher saving rate among the latter means that financial intermediation will shift their savings into investment spending, or one of the other categories of non-consumption spending. This business of the poor having a higher propensity to consume is a phony reason for transferring income from one group of spenders and savers to another.

If a higher minimum wage is to be part of a government effort to reduce income inequality without doing great harm, the proponents should stop pretending there are no negative consequences and deal with those in a broader proposal. Denying negative consequences altogether, as the President did this morning, leaves proponents of a higher minimum wage vulnerable to reductio ad absurdum.