Small change and big delusions

Some economics is intuitive; most isn’t.

Here is some intuitive stuff. Major supermarket chains charge lower prices because they operate in a contestable market, buy in bulk and squeeze the bejesus out of their suppliers. Suppliers don’t like this. They would prefer to be paid higher prices and let the consumer go hang. Thus we have the special pleading of dairy farmers over the price of milk.

The above is as predictable as it is intuitive. Maybe next week the bakers will complain or the fruit canneries or whoever would like supermarkets to pay them more. All of this should be ignored by us and the ACCC. Imagine the prices at supermarkets if the interests of suppliers had held sway over the years.

The market is a hard taskmaster. Think you are underpaid, well do something else; don’t whine about it. Mind you, if you like the lifestyle, whatever it is, then stick at it, but don’t expect consumers to pay for it.

Those on the minimum wage might prefer, I would guess, a rather more lavish lifestyle than they have. Unfortunately, the effects of increasing the minimum wage (an invention of New Zealand, apparently) are not intuitive. Or at least economists could easily be found who would argue among themselves as to its effects.

President Obama wants to increase the federal minimum wage in the United States from its current level of US$7.25 per hour to $9 (for those 21 years’ of age and older). The minimum wage is higher at £ 6.19 in the UK and still higher here, at $15.96. There is never a shortage of advocates among unions and compassion spruikers wanting to see increases in minimum wages.

At one level, the effect of increasing minimum wages is straightforward. People lose their jobs. However this is not clear cut if employees face self-imposed or external obstacles to moving employment. They may be earning less than their worth. In these cases obtaining an increased wage (up to a point) should not threaten their employment.

Also economics uses the margin as the theoretical base case. Employers hire workers until they add less to profit than they do to costs. This is a useful theoretical device to understand the world, but the world does not actually work with such precision. It is therefore unlikely that a dollar added to minimum wage costs will have much effect on employment.

This is not to say that the economy would not work better and create more jobs without minimum wages at all. It most certainly would. It simply says that once you have them, and most countries do, tinkering around the edges is likely to have little measurable effect. Fortunately capitalism is robust enough to accommodate and adjust for all kinds of misguided government interference.

Conservatives among us should not get too wound up (as the Republicans are in the US) with the economic effects of marginal increases in the minimum wage, provided such increases are quarantined and do not produce a ripple effect on broader employment costs as a result of efforts among unions to maintain relativities. Instead, of rejecting Obama’s proposal outright maybe they should split the difference and agree to $8.13 to win a brownie point.

On the other hand, conservatives, worth their salt, should get wound up with one particular argument in favour of increasing minimum wages, steeped, as it is, in Keynesian folklore.

This argument runs as follows. Workers who are paid more will spend more and therefore benefit business. You can hear this everywhere. The last time I heard it was the other day on Fox News; so imagine what you would get on CNN or MSNBC or the BBC or, given half a chance, on our own ABC.

I could say that spending money for the economy as a whole follows after – i.e., does not go before — earning money. If you have difficulty with that, as Keynesian junkies do, try eating a coconut on a desert island before you’ve picked it or a fish before you’ve caught it.

But why stay in hard reality when you can wallow in imaginary lotus land. We should all be given massive pay increases, week after week, which we can then spend madly and lift the economy out of its doldrums into a whirlwind of conspicuous consumption and growth. Hooray for Mr Keynes!

Peter Smith, a frequent Quadrant Online contributor, is the author of Bad Economics