Stark Wars Episode III

by Benjamin Studebaker

It’s time for another (and perhaps the final?) round of the Stark/Studebaker Minimum Wage Debate. For those new to this back and forth, Stark, a broadly Keynesian blogger who has my respect, came out against Obama’s proposal to raise the minimum wage to $9 an hour. I responded to his argument, and since then we have had a back and forth. Stark has done us the service of compiling the relevant posts in order here. Stark took issue with some of the casual terminology I employed in my last post, and in the interval between that one and this one we have messaged back and forth via Facebook to sort out for our mutual benefit precisely what one another means. In some cases, I thought Stark’s terminological criticisms pedantic, but in other cases he was right to press for clarification. Fundamentally, if I write a post and an intelligent person (which Stark is) has trouble sorting out what is meant, that’s on me. Now that we have sorted out our positions, Stark has posted his latest attack on the minimum wage hike, and I think myself ready to take it on. So here goes.

The first thing Stark points out is this:

At the extreme end, a billionaire consuming 15% of her net worth in a year could outspend 10,000 minimum wage employees. Even the upper middle class, consuming most of low 6-figure wage is going to have an economic weight in excess of several minimum wage employees. The point being, if the minimum wage increase crimps compensation higher in the hierarchy, it can definitely drown out any increase.

This is totally true. It is completely feasible to have an economy that is extremely unequal yet nonetheless is high growth if one can rely on the small pool of high earners to consume the entirety out output. If we look back to the 19th century, we see an economy designed in that way. In the Victorian period, the Gilded Age, the Roaring Twenties, the economy, relative to the modern one, was much more luxury-reliant. Instead of producing goods primarily for mass consumption by a strong middle class, the economy of a hundred years ago produced comparatively more extremely ornate, high value goods. This is why the aesthetic of the 19th and early 20th centuries still has so much appeal for so many people–the beautiful old things we associate with those times were made not for everyone, but for a very small group of very rich people. They could pay more for those little details. The modern economy is not, at present, designed in that way. It could become that way again in theory, given significant adjustment in the kinds of products we produce and who we expect to buy them, but it hasn’t happened naturally. Instead of rich people consuming larger chunks of their own incomes, the tendency is for rich people to invest their incomes in providing credit to the working classes. The working classes, victims of depressed wages, are eventually overcome with debt; mass defaults and economic instability become the inevitable result. This is why I emphasise the change in household debt:

The rate of increase in household debt begins to accelerate in the eighties, slows in the late nineties, and then zips ahead in the naughties in the run up to the financial crisis. This corresponds roughly to the rate of change in the wage share:

As we can see, the wage share begins to fall in the eighties, briefly reverses its gradual fall in the late nineties, and then collapses in the naughties. Stark prefers to look at the link between wages and productivity, but the story that tells is broadly similar. Either statistic suffices to show a connection.

In order to have an economy that’s driven by the consumption of the rich, the rich must consume their earnings instead of using them to subsidise consumption by the lower and middle classes. And if credit was suddenly much less available to the lower and middle classes? I expect that would not make for a very happy society, particularly if you agree to the assumption of marginal utility of resources–if I give or take away a dollar’s worth of consumption to or from a poor person, it has a larger effect on that person’s welfare than it would if that person were wealthy. Give a homeless man a dollar and he’s quite pleased, give Bill Gates a dollar and he doesn’t care. Take a dollar from a homeless man and he’s more miserable, take a dollar from Bill Gates and he’s not bothered. This is to some degree tangential for Stark, however, because his concern in this context is promoting high growth rates, not the maximisation of welfare. It is relevant however in so far as turning our economy into a luxury economy is not desirable policy and is not the correct answer to the problem posed by the working classes’ waning consumption power.

If we reject the creation of a luxury economy, then we actually have to deal with the problem of weak consumption by the working class. Stark is right when he points out that raising the minimum wage can reduce corporate profits and result in less hiring or less investment, but what he misses here is that, unless we are going to adopt this luxury economy model, growth without a correction in the distribution will only lead to new future credit bubbles. It won’t be sustainable–some time later, we’ll end up with the same kind of economic malaise we see now. I argue from the liquidity trap that corporations are sitting on money they don’t need to sit on, and that the minimum wage increase would force companies to irrationally invest their profits in producing a larger sustainable consumer base so as to break a paradox of rationality, but that argument need not be true for my position to hold. It need only be true that a luxury economy is not desirable and that a change in the wage distribution is consequently required for sustainable growth, regardless of whether or not in the short run it reduces hiring or investment.

It is better to have an economy that adds jobs at a lower rate and grows at a lower rate but is safe from a future credit crunch than it is to have an economy that adds lots of jobs now and grows faster now but will, eventually, lose those jobs and lose that growth through another lost decade. Keep in mind also that the growth in the naughties prior to the economic crisis was very weak relative to previous historical conditions in which wages were higher. Stark inadvertently obfuscates this fact by using a graph showing total GDP. This makes it appear that GDP has more or less been increasing continuously. The figure is misleading. A much better figure looks at the change in the rate of growth, not in the total. If you look at those figures, here’s what you get:

As we can see, the moving average rate of GDP growth drops by an average of one entire percentage point between the 53-73 period and the 73-07 period. The 07-present period is substantially worse, though I’d argue that much of that is due to austerity. The point is that returning our growth rate to what we saw before the recession is not particularly impressive–the goal should be a return to the rates of growth seen in the 50’s and 60’s. If you look at the average for each decade, the difference comes very clearly into focus:

In short, the rate at which we are growing is not at all similar to what it used to be. I am not the only one to point it out–Robert Gordon has a fascinating paper on the subject, which came to my attention some months ago. In his paper, Gordon notes two “head-winds” against 60’s and 70’s era growth, both of which I have mentioned in the debate:

The most important quantitatively in holding down the growth of our future income is rising inequality. The growth in median real income has been substantially slower than all of these growth rates of average per-capita income discussed thus far. The Berkeley web site of Emmanuel Saez provides the startling figures. From 1993 to 2008, the average growth in real household income was 1.3 percent per year. But for the bottom 99% growth was only 0.75, a  gap of 0.55 percent per year. The top one percent of the income distribution captured fully 52% of the income gains during that 15-year period. If what we care about when we talk about “consumer well being” is the bottom 99 percent, then we must deduct 0.55 percent from the average growth rates of real GDP per capita presented here and elsewhere…

The twin household and government deficits represent the final headwind. Already in 2007 U.S. households suffered from an unprecedented overhang of debt equal to 133 percent of disposable income. The government debt was then manageable but has since begun to explode. Consumers have gradually been paying off debt, and this is one reason why the economic recovery has been so tepid.

Gordon doesn’t mention it, but the increase in state debt is the result of lower revenues due to lower growth, higher spending on welfare due to lower growth, and having bailed out and taken on the debts of various private sector entities during the financial crisis–ultimately, it all comes back to the exploding household debt, and the exploding household debt comes down to the replacement of wages with credit.

Now, Stark has a further defence against all this–he appeals to the current account. His argument here, as I understand it, goes something like this: when states are net importers of goods, they must simultaneously be net exporters of cash. When the imports tend to come from labour-intensive industries, domestic labourers are put at a disadvantage; their wage growth is undermined. Stark’s answer to this is debt and deficit reduction to bring down the current account deficit. The trouble is that whether Stark is right or not (and there’s good reason to suppose he’s not quite right, as we’ll soon see), we still do not have a superior alternative policy to the wage hike.

If we say Stark is right, it’s still the case that if we bring down debt and deficits before we bring about the sustainable economic recovery (which, if you recall, requires that labour consumption be driven more by wages and less by credit), our austerity will result in contraction, which will reduce revenues, increase state welfare spending, and worsen the deficit and the current account.  While Stark would be right to say that the current account deficit would still undermine our wages eventually, it is not necessarily the case that the current account deficit would undermine that increase fast enough to be important–once the economy recovers in a sustainable way, the current account deficit can be reduced. What alternative is there?

  1. If we create a luxury economy, we’ve provided for future growth but done so by screwing over most of our people.
  2. If we try to reduce debt and deficits to reduce the current account deficit and raise wages, we create contraction, undercut revenue, raise welfare spending, and thwart ourselves

The only move seems to be temporary stimulus combined with a direct wage hike through state wage-fixing–the minimum wage.

But wait a second, the current account deficit has already been reduced significantly, as illustrated by Paul Krugman:

Yet during the same period, the debt and deficit have both increased. This is because selling bonds to foreigners is only one input on the current account. It is possible to improve the current account balance not by reducing federal spending or raising taxes, but by reducing the gap between our imports and exports in the first place by closing the trade gap and having one’s newly issued bonds purchased by domestic investors or the central bank. Sure enough, the balance of trade improved at right around the same time the current account improved, implying that the trade balance is a much larger and more powerful force than borrowing from foreigners is:

Unfortunately, it appears as though we’re once again moving away from the kind of trade balance that is conducive to a healthier current account, but the answer is not growth-crushing austerity, it’s improving our import/export position. This can be done in several ways:

  1. Devaluing the dollar through expansionary monetary and fiscal policy.
  2. State investment in domestic business and state undermining of foreign competitors.

Stopping China from manipulating its currency to keep its wages down would be a good start (“pegging” is manipulation, “printing” is fair policy). Tariffs, too, could be helpful, if deployed against countries in which our balance of trade is particularly unfavourable such that any counter-tariffs would not pose a large threat to our exports.

Of course, if we import less from countries that pay cheap wages in favour of higher priced domestic goods, the price of consumer goods is likely to rise (while the cost increase from higher wages is likely to be offset by reduced transportation and energy costs, the net effect is still likely to be more expensive goods). How will our consumers pay for more expensive products?

A wage hike.