Monday, February 8

Path to More Jobs: Cut Minimum Wage

Of course cutting the minimum wage might not be popular, but it is very likely good economic policy especially in a recession. Labor like any freely traded commodity is subject to the laws of supply and demand. Right now there is a significantly weak demand for work and a large supply of people wanting it. What should happen? The price of labor (wages) should decrease. At one level we understand this: those multi-millionaire CEO should get a cut we all agree. But what about the rest of the workers? If a company had a choice between cutting a third of its workforce or cutting the wages by a third, would you rather be working for a third as much or not working at all?

Interestingly, during one of the hardest depressions the United States ever faced during the 1920-1921 wages were allowed to fluctuate with the state of the economy. Although wages fell substantially along with the stock market and the rest of the economy, unemployment was quickly (in around a  year!) brought under control, and wages too quickly recovered.

Indeed, probably the best synopsis of this success was written by none other than Ben Bernanke
On how bad it was:

"In one crucial respect, the depression of 1920-21 was actually more severe than the Great Depression itself: there was a rapid decline in the price level of between forty and fifty percent within the course of a single year."

On how employment reacted:

"Employment and output were however not as severely affected as in the Great Depression. Of course precise unemployment data are not available for this period, but one representative estimate (Lebergott, 1957) puts civilian unemployment at 2.3% in 1919, 11.9% in 1921, and back to 3.2% in 1923."

The reason? Wage flexibility:

"As these stylized facts indicate, the second unusual feature of the depression of 1920-21 was the rapid recovery in employment and output, in sync with a swift adjustment of the real wage to its new equilibrium position."

One of the unique differences between the depression of 1920 and 1929 was that wages were not allowed by the government to fluctuate in 1929 like they had in 1920. The result was that the depression of 1920 was over in a year (unemployment was at 3.2% in 1923!). While the 1929 depression lasted for over a decade with unemployment rates of over 10% until the 1940s!

Now, remember those confusing employment numbers from January. How the unemployment rate fell but the job loss continued? The main reason this was possible is because of the increasing number of people who are self-employed according to reports. Self-employed people still respond to the actual market for labor much more closely than labor protected by union and government imposed wage restrictions. The result is that despite the government's attempt to continue to bungle the economy by keeping wages high, there remains enough freedom through avenues like self-employment for wages to fluctuate enough for the economy to recover.

To let the economy (and jobs especially) recover faster we must let wages be flexible.