Deconstructing the Minimum Wage Debate (version 2)

Minimum wage debates are back in vogue. Unfortunately, these discussions instead of reflecting a possible fix for America's economic woes are indicative of the key theoretical failure which permeates nearly all schools of economics. On one hand we find the modern Quantity Theory of Money (QTM) theorists equipped with their models of barter (general equilibrium theory) built on instantly and infinitely flexible wage and price price assumptions. In short, their "money-as-a-veil" mindset requires not only the abolition of minimum wage laws which they believe interfere with the critical market mechanics of supply and demand, but also require the fantasy of an invisible auctioneer to coordinate the entire America economy via an auction house in the blink of an eye (simultaneous equations that instantly converge) . In short, it is concluded that allowing the minimum wage to fall to that of a subsistence farmer overnight will restore economic bliss to America. This key idea also underpins their models of free trade. Big mistake.

At the other end of the ideological spectrum we find the simple gut instincts of the advocates of universal economic equality. Raise the minimum wage and the income gap between the rich and poor vanishes, though no theoretical models are generally found behind such propositions. While both suggestions appear to cover all possible solutions, both are defective because neither position has a sound theoretical understanding of economics. Economics in turn has never had a sound theory of money. Money's critical function, over looked for 200 years, is tracking industrial productivity gains to ensure worker mobility between dynamic industrial sectors in a closed economy. Because the economy must be closed, money is ultimately a domestic phenomenon as we will see shortly.

To help make sense of the minimum wage's place in a new model of economics and the proper fix of America's economic decline ,let's begin with a very simple scenario. Imagine a war devastated country whose currency has become worthless. In order to rise from the ashes, the government has chosen to give every citizen 1000 units of the new currency with no strings attached. Each citizen is free to choose to spend the money as he or she sees fit. One individual may spend it all in a week, and the other hopes to spend it over six months. Notice the subtle problem. No one actually has a reference point to determine what these 1000 units are worth. In other words, the worthless paper money has no established value. Economic confusion ensues.

Now lets, reconsider the same situation, but from a different starting point. Again imagine the war torn nation, but with a wiser government. This time, the government says it will issue the 1000 units as a minimum wage (1000 units for a week's work). Immediately, the average citizen can grasp the value of the 1000 units. Bank credit will be issued against this baseline of value. Competitive wage structures will rise up from this baseline. Cost of productions can be established. Economic harmony is established.

In contrast, the modern QTM theorist would argue (in the first scenario) that issuing 1000 units to each citizen would define a money total supply (i.e. 1000 times the population). This money supply in turn would be sprinkled on top of their barter models, which would establish a nations price level. But this is wishful thinking in the form of a so called exogenous model of money. Ask the average American what the money supply is and you'll probably get a blank look. Ask him what the min wage is, and he'll probably know within $1.

The point is the key observation that James Steuart made in the 1700s (writing before the "father" of economics Adam Smith): money is simply an "arbitrary scale." Scales of course make no sense if they are wildly flexible as modern theory would like us to introduce into our thinking. More importantly, it is a DOMESTIC arbitrary scale, another aspect rejected by the modern schools of economics. Most relevant to our discussion is the realization that the scale in a paper based economy can ONLY be established by government decree (i.e. a minimum wage). More importantly with regard to America's economic future, this scale can only function properly in a closed economy for a number of reasons (e.g. wage negotiations are domestic comparative process as Keynes argued).

The critical domestic aspect lies in the simple idea that a productivity gain in an industrial sector usually results in unemployed workers (less labor per good). But it also means a cost saving to the domestic consumer who spends the savings in a new sector, thus resulting in new employment opportunities in the long run. The economic circle is closed. But note the overlooked assumption in modern theory of a common language as a requirement for worker mobility. I suspect no modern economist armed with QTM would ever consider the core problem the Euro introduces (a very subtle form of free trade) when an Italian worker loses his job to a superior French competitor. He can no longer migrate easily to where the consumer savings will be spent (perhaps in France).

Such implications are significant for the minimum wage debate. The fix for the income gap is therefore not a change to the minimum wage. The fix is to stop free trade. To help grasp this, lets return to our simple model again. As the worn torn nation rises from the ashes, ask your self this: If the government had instead chosen to use a different "arbitrary scale" of 10 units per week would it have changed the standard of living? Price of goods would have declined by a factor of hundred due to cost of production reflected in labor costs, but the standard of living remains the same. In other words, the real measure of income is the national output of a nation's factories and the ability to consume them (not export them). If this is difficult for the reader to grasp this, assume that at the start of this model all workers are making a mininum wage. The cost of output is reflected in this wage. There is no reason the worker will not be able to consume what he produces.

Supporters of raising the minimum wage face the same problem. In short, how many zeroes would you like to add to the minimum wage? Say two more. Let's go from $7 / hr to $700 / hr. Now you'll simply pay $700 for your next hamburger. So what have you achieved? The problem that is overlooked here is that free trade creates an over abundance of workers, which breaks the normally healthy wage negotiation process. Much like a few foreclosures lead to the entire collapse of house prices.

To emphasize the notion of Steuart's arbitrary scale, let's take the idea a step further. Say CountryA and CountryB have the same minimum wage of 1000 units per week. CountryA is able to produce an entire car with a week's worth of labor, while B can only make a box of toothpicks. Changing the scale from 1000 to 10,000 (raising the min wage) has no impact at all on either worker's standard of living. Since the scales in each nation are arbitrary, free trade by introducing products whose labor content cannot be translated to domestic labor content breaks the critical mechanics of a domestic minimum wage. Economic chaos ensues again..

Nor is often touted gold any type of panacea. Gold ultimately is just another domestic "arbitrary scale." One nation may require 100 hours of labor to dig an ounce out of the ground, the other nation 10 hours. Trading between such two nations again amounts to economic chaos. For example, gold did not prevent economic chaos from being unleashed in the States under the Articles of Confederation when they failed to compete with low cost manufacture Great Britian. The US Constitution according to Daniel Webster was the economic answer to reign in the free trade madness. The modern Austrian school of economics, home to many libertarians, with its emphasis on gold seems to have missed this point. Keep also in mind, infinite credit can be expanded against a gold base, because it is ultimately extinguished by the associated debt. It is this same reason that paper money is not highly inflationary. The arbitrary scale keeps the credit mechanism under control via the industrialist who asks for loans against a national wage structure, not vice versa as the QTM theorist would have us believe.

In conclusion, the minimum wage is not an argument about rich and poor. The rich industrialist in a healthy closed capitalist economy would have earned his fortune by being a superior competitor with significant production cost reductions to gain such an advantage. In other words, the capitalist may have made his first 1 million of profit by saving the consumer 10 million in price reductions. In order for domestic industrialist to compete fairly against each other at the domestic level, a nation needs an arbitrary "rigid" scale for wages. A wildly flexible wage scale would make measuring productivity gains meaningless. It is precisely this oversight that forced the modern schools to only partially admit to some wage stickiness and the Post Keynesian to fail to grasp the money in a closed economy is the key to capitalism's stability.

Thus the minimum wage ultimately amounts to a debate about free trade and national survival in the form of the industrial base. Because money's proper role in economic theory has never been fully understood, in spite of two hundreds years of debates, the confusion persists in the minimum wage debate.

Van Geldstone

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Comments

international miniimum wage along with PPP scale

Ok, what I got out of this is we need a minimum wage international law, dealing somehow with different PPP. This would stop offshore outsourcing in a heartbeat and the great race to the bottom.

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international minimum wage

Robert

You raise a good point: I failed to mention what I consider is the fix. My conclusions lead me to sky high tariffs as the fix (as America has historically done until the 1960s).. I'm of the opinion that fair trade is impossible, because of what Ricardo observed as the wealth measuring problem. With that said, I'd be glad to hear how you visual an international wage working. The problem I think lies in the complexity that results from a PPP approach. For example, how would address the numerous factors such as differentials in blue collar worker, engineer, doctor, lawyer, cost of real estate, abundance of nature, productivity, etc to come up with PPP. Just my two cents. Open to suggestions. Thanks for the feedback.

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