friedrich hayek

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There is a better alternative to raising the minimum wage

The U.S. Secretary of Labor Thomas E. Perez wants to raise the minimum wage.

In fact, the vast majority of Americans — 91 percent of Democrats, but also 76 percent of Independents and even 58 percent of Republicans — are in favor of raising the minimum wage.

This is an understandable position. After all, the gap between richest and poorest has grown very wide in recent years. But in my view, minimum wage laws are not good laws at all. That’s not out of lack of compassion for low-wage earners, or because I like inequality. That is because I think that there is a better way to achieve a decent standard of living for the poorest in society.

The minimum wage is a factor in creating unemployment. Despite what’s often said to the contrary, it’s true: Countries with no minimum wage tend to have much lower unemployment. Right now, America is suffering a serious deficit of jobs, with over three jobseekers for every available job. We need all the jobs we can get.

Read More At TheWeek.com

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The Trouble With the Minimum Wage…

Opponents of the minimum wage tend to focus their attacks on the idea that it causes unemployment by forcing employers to discriminate against employees whose working abilities justify a wage less than the legal minimum:

Whether or not increases in the minimum wage (or minimum wage laws more generally) actually increase unemployment is a hotly-debated subject. Krueger and Card (1992) found that to not be the case; more recent meta-analyses of the academic literature such as Neumark and Wascher (2006) have found it to be true, but only to a small extent.

I want to come at this from a different angle. My intuition is that the minimum wage — even if it does not lead to decreased employment — is not an effective means to a fair wage level. This is because it is a price control set by the government, and as Hayek and Kirzner noted, the government has no scientific way to determine what an appropriate price level is for a good or service. Only a negotiation process between the employer and employees can organically determine such a thing. Moreover, as government is often bought out by large corporate interests, it is often in no position to fight for a fair share for workers. The notion that government dominated by corporate interests should set the minimum wage puts the fox in charge of the henhouse.

The empirical evidence seems to tally with my intuitions. Defenders of the minimum wage must confront the basic failure of minimum wage laws to secure the working class a fair share of the pie. Since the Federal minimum wage laws were introduced in the 1930s, wages and salaries as a percentage of GDP have gone on a general downward trend:

WASCUR:GDP

And the minimum wage has stagnated, even as productivity has risen:

min-wage1-fig2-2012-03

If the minimum wage is not meeting its aims, why do we continue to persist with it? There are other possible approaches.

Repealing minimum wage laws may be a better bet. Let the market negotiation process deal with wage levels. Accept that government has no scientific means to determine an appropriate wage level throughout the economy. Then treat any overhanging issues of poverty and living costs entirely separately, perhaps with a basic income guarantee as proposed by Milton Friedman and embraced by economists from across the political spectrum from Friedrich Hayek on the libertarian right to Lord Skidelsky on the Keynesian left. Such a scheme combined with a repeal of minimum wage laws would free labour markets from unnecessary price fixing, while still addressing the issues of poverty and unequal access to capital by providing citizens with a basic income to spend or invest.

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Still Not Spreading the Wealth Around

Obama has always claimed to want to spread the wealth around. Yet, as I stressed this June (and in my first ever blog post way back in July 2011!) that’s the exact opposite of what he has achieved.

And it’s getting worse, not better.

Wages-as-a-proportion-of-GDP just hit another all-time low:

WASCUR:GDP

And corporate-profits-as-a-proportion-of-GDP just hit another all-time high:

cp:gdp

Obama might throw a lot of rhetoric about fighting for the middle class.

But the reality has been the opposite. America today is all about the enrichment of big banks, financial corporations and the military-industrial complex, while the working class has rotted.

The truth of Obama’s policies (and successive administrations prior to Obama) is more concentrated wealth within the financial elites and Wall Street. Banks get bailed out. Campaign donors get stimulus money. And the middle class and future generations pay for it in taxation and the Cantillon Effect.

The Obama reinflation is a rotten bubble built on rotten foundations. Trying to reinflate the economy from a starting debt ratio of over 350% of GDP through crony corporatism and helicopter drops to the rich is an absurd notion that is doomed to abject failure.

And the growing gap between the rich and the poor is steadily beginning to resemble neofeudalism.

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The Mathematicization of Economics

If one thing has changed in the last one hundred years in economics it has been the huge outgrowth in the usage of mathematics:

This is largely a bad development, for a number of reasons.

First of all layers of mathematics acts as a barrier to public understanding. While mathematics is a useful language for communicating complex ideas, those without training in mathematics will struggle to grasp what an author is trying to communicate if a paper consists mostly of equations untranslated into English. This is bad practice; it is easier to baffle with bullshit in an unfamiliar language than it is in plain English.

Second, mathematical models are always simplifications. Human action and economic behaviour is complex and unpredictable. While mathematical models can sometimes approximate a pattern quite well and so have some limited uses as toys, the complexity of human behaviour means that there are always unmodelled variables that can throw off a model’s output. Over-reliance upon or excessive faith in mathematical models can lead to bad forecasting and bad policy decisions. The grand theoretical-mathematical approach to economics is fundamentally flawed.

Third, attempting to smudge the human reality of economics into cold mathematical shackles is degenerative. Economics is a human subject. Human behaviour is not mechanical, it is not mechanistic. Physicists can very accurately model the trajectories of rocks in space. But economists cannot accurately model the trajectories of prices, employment and interest rates down on the rocky ground.

Economics would benefit from self-restraint in regard to the usage of mathematics. Alfred Marshall made some useful suggestions:

  1.  Use mathematics as shorthand language, rather than as an engine of inquiry.
  2.  Keep to them till you have done.
  3. Translate into English.
  4. Then illustrate by examples that are important in real life
  5. Burn the mathematics.
  6. If you can’t succeed in 4, burn 3. This I do often.

I hope the blowout growth in mathematics in economics is a bubble that soon bursts.

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The Origin of Money

Markets are true democracies. The allocation of resources, capital and labour is achieved through the mechanism of spending, and so based on spending preferences. As money flows through the economy the popular grows and the unpopular shrinks.  Producers receive a signal to produce more or less based on spending preferences. Markets distribute power according to demand and productivity; the more you earn, the more power you accumulate to allocate resources, capital and labour. As the power to allocate resources (i.e. money) is widely desired, markets encourage the development of skills, talents and ideas.

Planned economies have a track record of failure, in my view because they do not have this democratic dimension. The state may claim to be “scientific”, but as Hayek conclusively illustrated, the lack of any real feedback mechanism has always led planned economies into hideous misallocations of resources, the most egregious example being the collectivisation of agriculture in both Maoist China and Soviet Russia that led to mass starvation and millions of deaths. The market’s resource allocation system is a complex, multi-dimensional process that blends together the skills, knowledge, and ideas of society, and for which there is no substitute. Socialism might claim to represent the wider interests of society, but in adopting a system based on economic planning, the wider interests and desires of society and the democratic market process are ignored.

This complex process begins with the designation of money, which is why the choice of the monetary medium is critical.

Like all democracies, markets can be corrupted.

Whoever creates the money holds a position of great power — the choice of how to allocate resources is in their hands. They choose who gets the money, and for what, and when. And they do this again and again and again.

Who should create the monetary medium? Today, money is designated by a central bank and allocated through the financial system via credit creation. Historically, in the days of commodity-money, money was initially allocated by digging it up out of the ground. Anyone with a shovel or a gold pan could create money. In the days of barter, a monetary medium was created even more simply, through producing things others were happy to swap or credit.

While central banks might claim that they have the nation’s best democratic interests at heart, evidence shows that since the world exited the gold exchange standard in 1971 (thus giving banks a monopoly over the allocation of money and credit), bank assets as a percentage of GDP have exploded (this data is from the United Kingdom, but there is a similar pattern around the world).

Clearly, some pigs are more equal than others:

Giving banks a monopoly over the allocation of capital has dramatically enriched banking interests. It is also correlated with a dramatic fall in total factor productivity, and a dramatic increase in income inequality.

Very simply, I believe that the present system is inherently undemocratic. Giving banks a monopoly over the initial allocation of credit and money enriches the banks at the expense of society. Banks and bankers — who produce nothing — allocate resources to their interests. The rest of society — including all the productive sectors — get crumbs from the table. The market mechanism is perverted, and bent in favour of the financial system. The financial system can subsidise incompetence and ineptitude through bailouts and helicopter drops.

Such a system is unsustainable. The subsidisation of incompetence breeds more incompetence, and weakens the system, whether it is government handing off corporate welfare to inept corporations, or whether it is the central bank bailing out inept financial institutions. The financial system never learned the lessons of 2008; MF Global and the London Whale illustrate that. Printing money to save broken systems just makes these systems more fragile and prone to collapse. Ignoring the market mechanism, and the interests of the wider society to subsidise the financial sector and well-connected corporations just makes society angry and disaffected.

Our monopoly will eventually discredit itself through the subsidisation of graft and incompetence. It is just a matter of time.

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The Road to Serfdom: Keynes & Hayek

Are we walking the road to serfdom? In his treatise The Road to Serfdom, Friedrich Hayek argued that Western democracies, including England and America, have:

Progressively abandoned that freedom in economic affairs without which personal and political freedom has never existed in the past. We have in effect undertaken to dispense with the forces which produced unforeseen results and to replace the impersonal and anonymous mechanism of the market by collective and ‘conscious’ direction of all social forces to deliberately chosen goals. Planning, because coercive, is an inferior method of regulation, while the cooperation of a free market is superior because it is the only method by which our activities can be adjusted to each other without coercive or arbitrary intervention of authority.

Centralized planning is inherently undemocratic, because it requires that the will of a small minority be imposed upon the people. The power of these minorities to act by taking money or property in pursuit of centralized goals, destroys the Rule of Law and individual freedoms. Where there is centralized planning, “the individual would more than ever become a mere means, to be used by the authority in the service of such abstractions as the ‘social welfare’ or the ‘good of the community.

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