Notes on the Economy – 07/19/09

William Dunkelberg

Professor of Economics at the School of Business and Management, Temple University (Formerly Dean of the Fox School of Business)

Learn more about Prof. Bill Dunkelberg.

1. Congress has increased the cost of unskilled labor by 10.7%  in the middle of the worst recession since the early 1980s.  The unemployment rate is 9.5%.  It is unclear how this is supposed to help the economy – unless you are Labor Secretary Solis or the Economic Policy Institute.  The claim is that this will produce $5 billion in increased income and spending.  One simple question – where does this $5 billion come from?  Apparently the Administration thinks it appears from nowhere because if it doesn’t, then it has to come out of the pockets of someone else.  Where do small business owners get $5 billion to give to minimum wage workers?  Do the funds magically appear?  If so, let’s make the minimum wage $50 an hour, eliminate poverty and stimulate the economy.  The fact is that every new dollar a minimum wage worker receives must come from the pockets of business owners and consumers paying higher prices.  Minimum wage workers may get more to spend, but other consumers lose an identical amount, there can be no “stimulus” here.

If GM has too many “unemployed cars” on its lots, it reduces prices to get them “employed” providing transportation.  But with 14 million unemployed workers “on the lot”, Congress raises the price of labor.  This defies logic and common sense.  The Law of Demand applies to everything, even labor.  The higher the price, the lower the quantity taken.

Companies cannot afford to pay workers more than they add to the value of the firm.  The higher the minimum wage, the greater this hurdle.  A higher minimum makes it more difficult for young, unskilled and handicapped workers to get jobs that justify the higher wage now required.  This PERMANENTLY reduces job opportunities for these workers, denying them the opportunity to enter the labor force and get “on the job” training, making them more productive workers.  Instead, they return to the street corners and the underground economy.

From the Tennessean:  ” ‘The way the economy is now, and for a man who is trying to raise a family, it’s not enough’ said Julius Stoval, 26, who earns minimum wage as a worker at Shur Brite I Speed Car Wash here. He has two children in Chicago and a third on the way in Nashville.”  If the minimum wage is supposed to be a welfare program supported by taxes on business owners and customers (through lower profits and higher prices), it is very poorly focused.  About 40% of all minimum wage workers come from above median income families.  They are not “in poverty”.  The earned income tax credit is designed to help people like Mr. Stoval who has more family responsibilities than he can support.  The minimum wage is not an effective “anti-poverty” program.

Of course, the estimated $5 billion increase in wages that results from the increase is just the start of the problem.  A worker hired at the minimum wage last year and who worked hard and got a raise now finds that new unskilled workers get the same pay.  Now, a more valuable worker after a year of experience, this individual will be able to get a higher wage with the skill premium included.  Thus, the increase will “bubble” through the entire wage structure over time.  As prices rise to cover these costs (and they will, firms that can’t raise prices will fail, sacrificing all jobs at those firms).

So, here’s the bottom line:  (1) there is no “stimulus” from the increased minimum wage.  Every dollar a worker received comes out of the pockets of consumers and business owners; (2) a 10.7% increase in the cost of less skilled labor will cost jobs (David Neumark estimates 300,000 for those under 25 years of age); (3) a higher minimum permanently reduces job opportunities for unskilled and handicapped workers, denying them the opportunity to become productive members of the labor force; (4) the higher minimum requires business owners to pay more for the same labor (with no increase in output), raising unit labor costs which reduces profits in a weak economy, puts pressure on prices in a growing economy; (5) a higher minimum is a poorly focused poverty program, missing its target almost 50% of the time.  Less skilled workers losing their jobs are seriously harmed and opportunities for them to get a job in the future are reduced.

If there were ever a bad time to raise the cost of labor, it’s now.  What is Congress thinking?  Or, are they?

2.  The administration has, at long last, recognized the importance of small business to the health of the American economy.  Collectively, small businesses produce half of the private sector GDP and employ well over half of the private sector workforce.  They are the creators of most of the new jobs as well.

Sadly, but no surprise, the government is going to rely on another government agency, the Small Business Administration, to possibly make funds available to “mom and pops” from the now widely abused (by the politicians) TARP funds.  For starters, fewer than 1 percent of all small businesses have a government sponsored loan.   So, the SBA reaches relatively few small businesses and the SBA loan programs are primarily administered by the large, now troubled, banks since the paperwork burdens are substantial.  So, most of the 8,000 banks that serve small firms don’t make SBA loans.

The best way to get money into the hands of our nation’s small business job creators is to give it to their customers.  Small businesses need customers, not more debt.  There was strong support for a tax holiday as a stimulus plan.  This would have immediately put money into the pockets of consumers (and small business owners paying all of the FICA tax), a chunk of which would be spent.  If consumers saved some, all the better, as the need for savings by our banks is critical as illustrated by the large banks like GE, GMAC, Wachovia and others paying very high rates to attract savings deposits (which made it difficult for small banks to get the funds to lend to their small business customers).  Alas, too logical, and not enough pork to hand out that way.

Instead we have a $787 billion “stimulus” bill, little of which has been spent, much of which is allocated to 8,000 + odd special pork projects.  Can’t wait for work to start on that LA to Vegas high speed railroad for Senate Majority Leader Reid.  What a job generator that one!

A tax cut would have delivered a huge stimulus 6 months ago and would still be fattening paychecks, making labor cheaper to retain or hire, and boosting spending and saving, both of which are needed.  Instead, the government is competing with private businesses for available savings to finance a deficit that could approach $2 trillion.  Go figure.

3.  I thought I would be protected from having to pay for the barrage of spending programs that Congress has passed or is considering.  After all, I was promised that I would not see my taxes go up even a nickel if I earned less than $250,000.  Heck, I was even safe with the Biden revision to $200,000 as the definition of “rich”.  But now I am beginning to see the con, the semantic straw man behind the curtain.  We will soon be told the president meant “income taxes”.  95% of us got a tax cut?  Well, even it that were true, how about the other taxes?  Mandating employer provided health care will definitely cause money wages to fall and the prices of goods and services to rise (25% of employees of small businesses would prefer cash to a health care plan).  That’s a tax.  How about the higher minimum wage that will raise prices?  And I guess taxing my health care benefit will be called something other than an “income tax” (or maybe only rich people will pay this).  Then there are higher sin taxes being considered, on cigarettes, soda, and the like.  And “cap and trade”, estimated to add thousands to the electric bills of consumers and to raise gasoline prices to pay for the permits.  Sales taxes are being raised by states and even cities.  This is the stealth taxation that Congress loves.  Instead of being angry at Congress for raising taxes, consumers will rail against utilities, refiners, snack food manufacturers, and every business that will have to raise its selling prices to cover the increased costs imposed by this legislation.  Bottom line, consumers will notice that their incomes buy less stuff because prices are up everywhere, ultimately filling the tax coffers.  Governments will have more, consumers will have less.  It’s as inevitable as the bankruptcy of GM (that I predicted in commentaries a decade ago, I have a friend who ignored that warning and bought a dealership!).  In that instance, unions used their market power with government backing to tax the purchasers of cars – until imports arrived to expose the extortion.  That’s what markets do well.  And how about the $50 billion taxpayer investment in GM?  Well, GM’s market value will have to reach an all time record high to give taxpayers their money back.  Want to put odds on that?  Well, at least there are “jobs saved” – union workers still get paid above market wages and benefits at the old Big 3.  Sigh!