Minimum Wage Fallacies

During the State of the Union last week, Obama issued a call to raise the minimum wage once again. He cried forth, “Tonight, let’s declare that in the wealthiest nation on Earth, no one who works full-time should have to live in poverty, and raise the federal minimum wage to $9.00 an hour”. What he fails to comprehend or deliberately ignores is that the impact of such a policy on small businesses — the backbone of our economy — would be devastating. Higher wages inhibits a business’s ability to grow and invest.

An incorrect understanding regarding the relationship between wages and the economy is often espoused by pundits and politicians alike. It is generally believed by the Left that lower wages are bad for the economy because it gives workers less money to spend. But focusing only on the spending side is the problem.

The Fed Chairman has argued that the problem with our economy is wages, and our recession has not turned around as quickly because of “sticky wages”, which are less flexible. The term “sticky wages” was created by Keynes, who observed that wages fall less sharply during a recession/depression than other factors of production. If wages were more flexible, he surmised, it would help with unemployment. But in reality, wages are really only “sticky” due to artificially induced impediments such as minimum wage legislation or labor unions – hence the problem with this line of thinking.

Wages are not an artificial, isolated factor in the economy. In a recession, employers simply cannot afford to pay high labor costs. It took a real recession like this one – unheard of since the Great Depression – to cut labor pay. But the cutting of the pay is actually a good thing because hiring at lower wages will help turn around the economy.

Here’s how: Having the labor at the lower price allows prices in general to come down. Selling at lower prices in turn allows the poorer to buy which then helps to boost the economy. Consumptive spending is one factor in a recovery. Investment is another. Prices must be permitted to fall to reintroduce good market competition and a return on investments. This is fundamental economics. Without the strength of businesses and longevity, our recovery will continue to be anemic.

There are many arguments against the raising minimum wage, chief among them the staggering costs, hardships on struggling businesses, and loss of jobs. The failure to understand the true effect of wages on the economy is frustrating. Such faulty logic is representative of the current trend, especially in politics, to focus on short-term gain rather than long-term economic recovery.

Crossposted at alanjoelny.com