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Saturday, February 6, 2016 Serving Maine and Lincoln County for over a century. Volume 141 Issue 05

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1/22/2014 2:00:00 PM
Coastal Economist
This chart measures the minimum wage as a percent of GDP per person. Initially, when the minimum wage was first implemented, the wage was around 83 percent of GDP per capita. Today, at $7.25 per hour, the minimum wage would have to be nearly tripled to get back to historic norms of the 1950s and 60s.
This chart measures the minimum wage as a percent of GDP per person. Initially, when the minimum wage was first implemented, the wage was around 83 percent of GDP per capita. Today, at $7.25 per hour, the minimum wage would have to be nearly tripled to get back to historic norms of the 1950s and 60s.

It is interesting to witness how things change over time.

On Saturday I spent an hour on my exercise cycle. Typically I listen to my latest jazz CD purchase, while elevating my heart rate. This day I chose an old favorite from my high school days, namely, Jimi Hendrix's "Electric Ladyland."

When I got to Dylan's "All Along the Watchtower," I paused to think about the lyrics for a moment. Although tangential to the more existential theme of the song, the poet did highlight the phenomenon of financial inequality.

A few years prior to the appearance of "All Along the Watchtower," Martin Luther King Jr. gave his Nobel Peace Prize lecture. The year 2014 marks the fiftieth anniversary of that speech. His lecture to the Nobel Committee and the Norwegian Parliament included three main themes. His second dealt with income inequality. I quote a small portion of his words:

"A second evil which plagues the modern world is that of poverty. Like a monstrous octopus, it projects its nagging, prehensile tentacles in lands and villages all over the world.

"This problem of poverty is not only seen in the class division between the highly developed industrial nations and the so-called underdeveloped nations; it is seen in the great economic gaps within the rich nations themselves. Take my own country for example. We have developed the greatest system of production that history has ever known. We have become the richest nation in the world."

"Yet, at least one-fifth of our fellow citizens - some 10 million families, comprising about 40 million individuals - are bound to a miserable culture of poverty. In a sense the poverty of the poor in America is more frustrating than the poverty of Africa and Asia.

"The misery of the poor in Africa and Asia is shared misery; a fact of life for the vast majority; they are all poor together as a result of years of exploitation and underdevelopment. In sad contrast, the poor in America know that they live in the richest nation in the world, and that even though they are perishing on a lonely island of poverty, they are surrounded by a vast ocean of material prosperity."

When MLK Jr. gave this historic speech, he could scarcely imagine the ironic situation of the future in which we now live. We economists observe the alarmingly swift rise in wealth and income inequality of the past decade or two and hold up MLK Jr.'s era as an example of when things were much better. My, how things change.

One of the drivers of inequality, which we enumerated last week, is the fall of the minimum wage. Originally enacted in 1938, the minimum wage has undergone many changes in response to inflation, economic advancements, and political storms.

There are several ways to measure the historic path of the minimum wage. I constructed a measure that I felt to be especially instructive.

This accompanying chart measures the minimum wage as a percent of GDP per person. The construction of the chart is fairly simple. A worker is assumed to earn statutory minimum wage working 40 hours per week, 50 weeks per year. This annual income is then divided by annual GDP per capita to arrive at a ratio of a minimum wage salary to average income per person.

Initially, when the minimum wage was first implemented, the wage was around 83 percent of GDP per capita. The war years' inflation interrupted many things including the real value of the minimum wage. Shortly after the armistice, Congress brought the wage back up to around 75 percent of average income.

There it hovered until the 1970s when it started its dramatic fall. The two factors which drive it down are first, inflation which lowers its absolute real value, and second, economic growth, which reduces its value relative to the mean.

Today, at $7.25 per hour, the minimum wage would have to be nearly tripled to get back to historic norms of the MLK Jr. decade.

What are the economics of the minimum wage? A full treatment usually occupies a few chapters within labor economics textbooks. Here is a superficial, succinct summation:

The chief argument against raising the minimum wage is that it will cause employment to fall. A secondary media favorite is that it will cause inflation. How do these stack up in reality?

The later is simply a misunderstanding. Inflation, a continual rise in the general price level, is a monetary phenomenon having little to do with relative wages. Any change in minimum wage can easily be handled by the Fed.

As for the primary objection, the link between minimum wage rates and unemployment falls out of the standard competitive labor market model. The logic is simple: raising wage rates causes more people to desire to work more hours while reducing the number of workers companies can afford to hire.

Is this real? Theoretically yes; in practice, no. The competitive model assumes that all workers, companies, and jobs are the same, and that perfect information about jobs and workers is had by both employers and employees. Does this sound like the real world?

Many, many studies have focused on the minimum wage. There is some evidence that raising the minimum wage actually leads to higher employment. This is ascribed to the monopsony power of employers and the reduction in job hopping.

When all is said and done, employers in the U.S. have a fair degree of power over their workers. After all, an employer can look for another worker. However, a worker needs a job to eat and pay the rent. This moves the discussion away from the competitive model and puts it into the more realistic yet mathematically messy economics of imperfect markets.

We have talked about this subject in much more detail in the past and will leave it at this for today. Next week we will examine the role that tax policy has played in the rise of income inequality.

(Marcus Hutchins, MA, M. Phil., Economics, Columbia University, NYC, is a former economist, treasury bond arbitrage trader and hedge fund manager. He retired to Southport in 1997 where he resides with his wife Andrea and his youngest daughter Abbey. He welcomes feedback at coastaleconomist@me.com.)



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