U.S. inequality is curable

Prudent Bear ^ | 6 January 2014 | Martin Hutchinson

[MegaSilver]

The Democrat playbook for 2014, we are told, intends to focus on U.S. inequality and to suggest that only redistributive taxation will solve or even alleviate it.

Certainly it's possible to reduce inequality through punitive levels of taxation—at the cost of making everybody poorer. I thus thought it worthwhile to disentangle the current causes of U.S. inequality to see how we might alleviate it by raising the incomes of the poor rather than simply depressing those of the rich. With good policies, this could even provide general economic uplift rather than depression, which would happen with redistributive tax.

The policy emphasis in the campaign against inequality looks likely to focus on a campaign to increase the minimum wage from the current $7.50 an hour, set in 2009. Traditionally, economists have been pretty well unanimous that increasing the minimum wage, as distinct from attacking poverty by direct transfers or the Earned Income Tax Credit, is damaging because it tends to increase unemployment among those receiving it. Employers forced to pay a wage higher than the market-clearing level will outsource activities or replace workers with robots. Hence a minimum-wage increase will do little for living standards but much to increase unemployment and reduce job opportunities.

However, of those paid at or below minimum wage in 2011, 51% worked in leisure and hospitality, according to the Bureau of Labor Statistics, while 17% worked in retail and 9% in education and health services. Only 2% worked in manufacturing and 1% in each of agriculture and construction. While one can suspect that agriculture and construction employed armies of low-paid people who weren't recorded on the BLS books because they were illegal immigrants, the fact remains that for legal U.S. residents, more than three quarters of minimum-wage jobs were in sectors that cannot effectively be outsourced overseas and for which automation is both complex and costly.

Thus, a moderate rise in the minimum wage, to no more than $10 an hour or so, would not cause massive job losses to emerging markets. Starbucks has customers in New York; it cannot serve them by relocating its stores to Shanghai. In the very long run, expensive low-skill workers are vulnerable to robotization. In practice, the costs and difficulties of replacing baristas with robots are such that it will only be tried in areas like Silicon Valley and suburban Washington, D.C., where the customers are robot-savvy and low-wage workers are scarce. Even McDonalds, the quintessential low-wage, high-volume food-service company, spends only 28% of its total cost budget on labor (including all its expensive top management) so a moderate rise in the minimum wage is unlikely to destroy its business model.

There are two caveats to this. First, a nationwide minimum wage is far too broad. It does not discriminate between places such as Silicon Valley, where demand for labor is robust and wages high, and modest-sized communities in the Rust Belt, where costs are low and $7.50 per hour is sufficiently high to deter marginal employers from operating. Minimum wages should be set at the state, not the national level. Even within states the differentials in Virginia between the affluent Washington, D.C., suburbs and the coal country, or in New York between Manhattan and Binghamton, are sufficiently large as to make local minimum wages the best way forward.

The second caveat is that ensuring that the demand for jobs cannot flit overseas after an increase in minimum wages is not enough; we also must be sure that the supply of limited-skill workers cannot be artificially increased. $10 an hour is a lot of money in Ecuador; hence the pressure on immigration would be increased by such a 33% rise in the U.S. minimum wage. It is thus essential that low-skill immigration be appropriately restricted (for example, by abolishing the visa lottery) and, more importantly, that the borders be controlled and immigration policy properly enforced to prevent the flood of illegal immigrants that blighted the lives of the domestic low-skilled from 2001-07. "Comprehensive immigration reform" along the lines of the current Senate bill, which would double legal immigration while doing very little to restrict the flow of illegal immigrants, must be resisted à l'outrance. When considering which politicians to support this should be non-negotiable.

Nevertheless, with these two provisos (a differential between high-wage and low-wage areas and provisions to prevent oversupply of cheap labor) a rise in the minimum wage should be seriously considered. It rectifies the very unequal balance in bargaining power between low-skill workers and their employers without driving significant numbers of jobs overseas or eliminating them altogether. Thereby it provides some income uplift to the low-skilled, lessening their claims on the welfare system and reducing inequality. Theoretical free-market economists may loathe the measure—and the cheap-labor lobby of the U.S. Chamber of Commerce certainly does—but in this case they're wrong.

Before readers think this column has gone soft, let me put in a good word for a measure that is hard-hearted but economically efficient: the lapsing of the 99-week limit for claiming unemployment benefits and its reversion to 26 weeks. While there needs to be a safety net to avoid absolute destitution, prolonged unemployment benefits tend to produce prolonged unemployment as workers fail to make the difficult decisions necessary to keep themselves actively engaged in the job market. It's also not an insignificant cost element. At $25 billion-a-year, the saving makes a significant dent in the deficit, which, as I shall explain below, is a crucial element in restoring the living standards of America's modestly qualified.

There are, however, two factors more important than minimum-wage legislation or the termination of unemployment compensation if you want to reduce U.S. inequality and get the low-skilled back to decently paid work: fiscal policy and monetary policy, both of which have been terribly distorted in recent years and need to be thoroughly reformed.

Since the turn of the century, the United States has run a balance of payments deficit of $500 billion or more every single year. This is far more than an accounting problem. On the financial side, it de-capitalizes the U.S. economy by this amount every year, building up liabilities to foreigners who may not be willing to roll them over forever. The cartoon image of Americans working for cruel Chinese bosses by 2030 is not entirely fictional; it needs only a few more years of bad management to come true.

More important even than the drain of capital, as far as American workers are concerned, is the persistent shortage of manufacturing jobs, which normally pay much better than low-skill service jobs. If imports persistently exceed exports by $500 billion annually, that's $500 billion of products that would in equilibrium be manufactured in the U. S. but in current conditions are being manufactured overseas. In rough terms, that's around 3-4 million jobs that should exist but don't, keeping the unemployment rate about 2% higher than it should be. This is accomplished mostly by suppressing the labor-participation rate rather than raising reported unemployment, which is kept artificially low by the Bureau of Labor Statistics’ definition of "participation" so that the long-term unemployed are not counted in the official 7% unemployment rate but are assumed to have left the workforce altogether.

However, since the overall books must balance, the $500 billion annual-payments deficit is a creature of two factors: the current $560 billion (projected for the year to September 2014) budget deficit and the excessively low U.S. savings ratio, which forces U.S. investments to be financed from abroad. Hence, arithmetically, to eliminate the payments deficit and restore U.S. jobs, we must eliminate the budget deficit and increase the savings ratio. That, in turn, requires deep reforms in both fiscal and monetary policy.

Budget deficits have been more than $1 trillion annually since 2009, with the exception of the year immediately past. Some progress has been made on reducing them, but the Ryan-Murray agreement just before Christmas, which increased spending in the short term, shows that even the modest spending cuts in the sequester were too much for many politicians. Studies have shown that budget-balancing attempts that get more than 25% of the money from tax increases are highly damaging to economic growth. Hence, in rough terms, the legislators need to find $420 billion in annual spending cuts, which they can then balance with $140 billion in tax increases.

Finding that level of spending cuts is not economically difficult – it is only about 2.6% of GDP -- but it requires political courage. The most egregious spending, on agriculture and "green energy" subsidies, should be eliminated altogether. Further cuts can be made in the defense budget by assuming a foreign policy posture that intervenes much less than in the past decade. "Waste and fraud" is huge and can be cut back (for example, in the food stamps program, the number of recipients has expanded more than the number of unemployed, but also in fraudulent Medicare/Medicaid reimbursements.) Only then should modest cuts be made in entitlement programs, ideally by delaying the eligibility age to reflect higher life expectancies.

Just as the U.S. fiscal position needs to be restored to its historical balance, so does its monetary policy. Interest rates have been negative in real terms (below the inflation rate) since 2008, and for much of the period before then. Thus U.S. savers have been consistently penalized for thrift; every dollar they save is eaten away by even modest inflation and they are compelled to speculate in stocks, gold or Bitcoin in order to break-even in real terms. Conversely, the very rich, who have access to cheap leverage, are artificially subsidized by being able to borrow for free. This has caused a savings deficit that is preventing the baby boomers from properly preparing for retirement and, in many cases, is keeping them artificially in the workforce. Participation rates for the over-55’s have increased substantially since 2007, the only age group for which this is true. However, except for the few who make exceptional economic contributions, every geezer clinging desperately to his job prevents a young person from getting one.

Whatever the Keynesian ill-effects of balancing the budget and raising interest rates, they are short-term. It is now more than five years since the crash, well past time for policy to be normalized. By doing so, and at the margin raising the minimum wage, curbing immigration and cutting the length of unemployment benefits, the policy mix will once again be restored to one that provides decent jobs for all except the disabled. And, to agree with the left for one rare moment, this will produce a much healthier society.

[RipSawyer]

Totally correct, some people, especially leftists, do not comprehend that there are some who would like to have a small income with a small effort expended but are either unable or unwilling to put forth the effort to earn a better income. Some retired people are happy to take a job at $7.25 an hour to earn a little mad money so long as no great effort is required. A higher minimum wage would eliminate the opportunity to do something of that sort. Some people just want a way to get out of the house while earning a few dollars rather than spending money. For those who crave being around people it is far better to be a greeter, even at $5.00 an hour, than to sit home and watch TV. Minimum wage laws simply destroy such opportunities without doing anything really positive for anyone.

As always, for those who think the minimum really helps people, why don’t we raise it to at least $500. an hour?

[4Liberty]

Why would we want to “cure” it?

These differences are called: price signals.

We can all be “rich.” People should select useful careers. Electrical engineering instead of women’s studies.

And if you do see income “differences” — it’s not ‘the economy’ that’s the problem. It’s your MAJOR:

If you selected a GOOD (high-yield, useful) Major, it would be a “good” economy. wouldn’t it?

;-)

But no, you selected Feminist Haiku Studies. Now you live in your dad’s basement and are still unemployed at age 40.

[CorporateStepsister]

“We save and defer to accumulate.”

This is my philosophy; I’m not a university graduate because I’m not going to take out a loan for school. Hence, I don’t have a degree, but I am debt free.

Frankly I think it’s the biggest blessing in the world to be able to say that at my age (I’m 30).