Monthly Archives: September 2016

Kate, Allie, and the Fight for Fifteen

15

If only it was that simple

“I’ve been at Burger King since I was 14, now I’m 19 and still making $9.75,” said Alexis Collins at a protest outside the north Minneapolis fast-food restaurant where she works on Monday. This was another battle in the long running battle to have the minimum wage raised to $15 per hour.

The problem with this view is that a worker’s wage is not a simple function of how long they have worked at a company. Nor should it be. Neither is it a function, at all, of the cost of living or what other people are earning. Nor should it be.

To see the truth of this put yourself in the shoes of an employer named Kate for a second. Kate has the opportunity to hire Allie and thinks that Allie’s work will add $9.75 per hour to her company’s turnover (its income). Assuming for simplicity that Allie’s wage (the businesses’s expenditure) is the only cost that Kate faces, it will make sense for her to employ Allie at any wage up to $9.74 per hour. That is because at any wage up to that, hiring Allie adds more to Kate’s company’s income than it adds to its expenditures.

So what happens if the wage is suddenly raised by government edict to $15 per hour. That means that the cost of hiring Allie has risen by nearly 54%. So, if Kate still thinks that Allie’s work will add $9.75 per hour to her company’s turnover, she will be faced with a choice of adding $9.75 per hour to her income and $15 per hour to her expenditure.

What business would take a decision expecting it to add more to costs than to income? What would happen to a business that did so? Businesses that spend more money than they take in go bust. Knowing this, Kate just won’t hire Allie.

This is why the Fight for Fifteen’s argumentation is composed of irrelevancies and its demands actually counterproductive.

A protester in Minneapolis on Monday said “It’s hard for mothers, single mothers, two parent homes, single fathers, families period to live off the wages we’re making now”. Quite possibly, but, as we can see, Allie’s (the employee’s) cost of living is no part of Kate’s (the employer’s) calculation whatsoever.

Let’s say that initially Allie can get by on the $9.75 per hour Kate pays her. Now imagine that, for some reason – kids or a rent increase – Allie needs $10 per hour to get by and asks for a raise. If Kate still thinks that Allie’s work will add $9.75 per hour to her company’s turnover, she will be faced with a choice of adding $9.75 per hour to her income and $10 per hour to her expenditure. As before, Kate wouldn’t do it. She couldn’t.

What matters for Allie’s wage is Kate’s estimation of the amount of turnover she will generate. No government order will make Kate pay Allie a wage above what Kate thinks Allie will add to her turnover. That is the real iron law of wages. If government arbitrarily raises the minimum wage to $15 per hour, all that will do is exclude those workers whom employers deem to have low (sub $15 per hour) levels of productivity from the legal labour market.

If activists are really concerned about raising wages they need to raise the estimates that the Kates of this world make of the productivity of the Allies. This requires that Allie have better skills which needs better education and on the job training. It requires that she have more and better tools to work with which means more capital investment. And it means that Allie’s labour and Kate’s capital should be brought together as efficiently as possible, which demands better entrepreneurship.

This a longer shopping list of actions than simply jacking the minimum wage up by government diktat. It doesn’t fit into a tweet like #FightFor15. But it does take economic reality into account and it has more chance of helping Allie make $15 per hour.

Economic history in two (and a bit) charts

My MSc was in economic history. That probably sounds more straightforward than it actually is. Let me explain.

Adam Smith deployed episodes from history to illustrate the laws of economics he claimed to be outlining in The Wealth of Nations. These laws, like those Newton had just laid down for physics when Smith wrote, were held to be good at all times in all places. Just as Newton’s law of gravity dictated that the apple would always fall from the tree wherever it was in the universe, so did Smithian economists believe that the law of demand would hold anywhere at any time.

In the nineteenth century a group of economists in Germany challenged this. To them, economic theory was not something apart from the varied experiences of economic life. Instead, it grew from them. To these economists, it was ludicrous to argue that the lives of African tribesmen were dictated by the same economic laws as those of the industrial proletariat then emerging in European and North American cities. These economists thought, then, that economics should not be the study of a priori theories, but of the particular historical circumstances of economic life which varied from time to time and place to place. They set out to collect data on economic life, earning the nickname the Historicists and pretty much founding the field of economic history.

In recent decades theory has pushed back. The tools of econometrics were applied to historical data to create the field of cliometrics. Econometrics, essentially, is the application of statistical analysis to data to test economic theories. This appealed to economic historians as it gave their discipline the extra veneer of credibility that pages of impenetrable mathematical equations always bestows. But they needed theories to test. Thus were economics and economic history reunited. That is largely where the discipline stands today, at least at the LSE.

That is a brief history of economic history, what of economic history itself? The two big subjects can be laid out in the two and a bit graphs below.

First, the graph below shows GDP per capita from the year 0 to 2000. Two things are striking and worthy of study. First, why is the line so flat for so long? Second, why did the line take off like a rocket around 1800?

Image result for gdp per capita history

This chart doesn’t quite show everything though, so take a look at the ‘and a bit’ chart below.* This zeros in on the inflexion point of the line in the graph above. What we see is that the rocket didn’t take off for everyone around 1900. Some countries, with levels of GDP per capita previously comparable to the fast growers of the nineteenth century like Britain and France, stayed stuck on the launch pad, namely India and China.

This, then, gives rise to some further questions. Why did Britain’s economic growth take off? Why did China’s stagnate? Why did Japan’s catch up, both in the late nineteenth century and again after the Second World War? To carry on from above, the third question is in essence why did that GDP per capita line in the first chart diverge from country to country?

But even for those countries whose GDP per capita line did take off it did not proceed smoothly. At times the line has gone upwards very fast, at other times not so fast, and at still others it has even gone down. This is known, erroneously I think, as the business cycle and is illustrated by the chart below.

We see a steadily rising trend for GDP per capita but we also see fluctuations around that trend. We see, for example, the Roaring Twenties and the Great Depression which followed them. We see the sharp contractions in the US and UK in the late 1970s and early 1980s and the prolonged expansions which came afterwards.

If the first set of questions relates to why economies grow – or don’t, as it was for most of human history – the second set relate to why that growth fluctuates. Why do economies sometimes stop growing? What, if anything, can be done to get them growing again? These questions are the stuff of macroeconomics.

But that is another topic, macroeconomics, funnily enough. The rest, in a nutshell, is economic history as it is practiced today.

* These graphs are sometimes merged and that would have helped here. However, I couldn’t find such a graph at present and my graph drawing skills are such that I thought it best not to try.

Trump, the United States, and the bogeymen

biltmore

Still there

“I know from a common sense financial standpoint that something has to burst. When a country is losing billions and billions and billions of dollars a year and when other countries are making hundreds of billions of dollars, something is going to burst” That was businessman Donald J. Trump on America’s trade deficit 27 years ago. It could be candidate Donald J. Trump on the trade deficit today.* The worry then, widely shared, was Japan. Now it is China. Now, as then, the worries are on the wrong side.

In the first half of the 1980s the dollar surged as a result of the Federal Reserve’s tight money to fight inflation. Partly as a consequence, Japanese imports poured into America and US companies lost market share. So pressured was America’s car industry that the Reagan administration forced Japan to agree to Voluntary Export Restraints. As the ill-fated Mr Takagi explained to John McClane in 1988’s Die Hard, “Pearl Harbor didn’t work so we got you with tape decks”

The Louvre Accord of 1985 ended this. Central banks worldwide agreed to boost their currencies against the dollar. Now, as the dollar/yen rate shifted the other way, Japanese capital poured into America buying iconic assets such as the Biltmore Hotel and the Mobil Building. There were worries about a “corporate Japanese takeover” of America.

And, in 1989, something burst but not, perhaps, what businessman Trump expected. To meet its Louvre Accord commitments the Bank of Japan brought its policy rate down from 7.44 per cent in November 1985 to 3.37 per cent in August 1987 and kept it there. This fuelled an asset price boom: in 1988 the land surrounding Japan’s Imperial Palace was said to be worth more than the whole of California. The Nikkei Stock Index rose from 22,621 in November 1987 to 38,130 in December 1989 when it accounted for more than one third of the world’s stock market capitalization.

But inflation eventually ticked up and the Bank of Japan acted. The policy rate was increased from four per cent to six per cent between March and August 1990, climbing to 8.15 per cent in February 1991. This popped the asset price bubble. By December 1990 the Nikkei was down to 23,470, reaching 17,390 in December 1992. House prices fell by two thirds and remain at that level today.

Today the worry is China. Candidate Trump frequently lambasts the Chinese for devaluing their currency. In 2014 he told the CPAC that “China, which I’ve been talking about for the last five years, yesterday, right in our face, they just devalued their currency…what they’re basically doing is saying ‘We’re really ripping you big league, nobody’s ever done it better than us, but now we’re going to really do it again’”, adding “they’re taking our jobs”

Indeed, it is true that policymakers in Beijing have tried to keep the yuan weaker against the dollar that market forces might allow. This has helped Chinese exporters. By extension it has also, some say, enabled China to buy ‘everything between Portland, Maine, and Portland, Oregon’, including Starwood Hotels and $1.2 trillion of US government debt.

But, as for the Japanese before them, this has not been a costless exercise for the Chinese.

By holding down the value of the yuan the Chinese government has held down the purchasing power of Chinese producers. This has effectively worked as a subsidy from Chinese producers, with an average GDP per capita of $14,100, to US consumers, with an average GDP per head of $56,000. If anyone should be angry about this arrangement, it should be Chinese producers.

What of concerns about China’s purchase of American assets? While some say that America is ‘hostage’ to China because of the vast debt it owes the People’s Republic, it is just as true to say that China is hostage to America for the same reason. In the event of a flashpoint between the two countries, the Chinese could dump their dollar assets, forcing US interest rates up. But the prices of China’s US bond holdings would tumble representing a capital loss for Beijing. As John Paul Getty put it, “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem”

There is even less to worry about with tangible assets. If tension flares between America and China the Chinese owned AMC movie theatre in Inver Grove Heights, Minnesota, will still be in Inver Grove Heights, Minnesota, just as the once Japanese owned Biltmore Hotel is still there on LA’s South Grand Avenue and the Mobil Building is still at 150 East 42nd Street in Midtown Manhattan. When someone says that the Chinese have bought ‘everything between Portland, Maine, and Portland, Oregon’, remember that those things are still somewhere between Portland, Maine, and Portland, Oregon. They have not been shipped to China, only the paper claims on them have.

Finally, by pegging the yuan to the dollar Beijing has essentially been importing US monetary policy. As the US has expanded its money supply so has China. Debt, much of it bad, has increased in China to levels some analysts believe to be higher than in America on the eve of the subprime crisis. China’s empty cities, like the abandoned properties of Michigan a decade ago, are monuments to malinvestment. 

Free trade benefits both parties, they wouldn’t trade if it didn’t. But trade that is distorted by tariffs, quotas, and currency manipulation, can blow up horribly. “Something has to burst”, as a man once said but, as with Japan a quarter of a century ago, it might not be the Americans who should be most worried.

* As a sign of the topsy-turvy times, it could also be candidate Bernie Sanders