Wage Story

Last Monday morning I was sitting at airport, seeing off my better half, when I chanced upon a small advertisement for a shoe shine service. Like everything else at airports this also seemed a bit overpriced. My thoughts moved to broader topic of high minimum wages in certain countries. Are they beneficial for economies or harmful? Do high wages impede economic growth?

 

One can argue from both sides. Disadvantages of high wages include reduced efficiency in the system, higher manpower cost for companies and higher hurdle rate for starting new companies. Thus higher wages can impede job growth. However, on the positive side, higher wages promote more equitable distribution of wealth. By putting more money in pocket of poor they help increase domestic consumption (since poor spend a greater proportion of their income than the rich).

 

Okay, so what are the conditions where higher wage system is more appropriate? If a country has higher wages, then companies will need to charge more to offset manpower costs. So prices will be higher (Price levels only. Inflation may or may not be high). A rich society will be able to afford these elevated prices, poorer society will find cheaper alternatives (informal economy). Additionally, in most cases the society with high price levels would need to have relatively low population growth rates. This is because high wages would lead to relatively slower rate of job creation. (This assumes that the economy is not dominated by fast growing high value add industries). Then, one can conclude that high minimum wages are more appropriate for developed economies (high GDP per capita, high PPP, slow population growth), while low wage system is more appropriate for developing economies (low GDP per capita, faster population growth, need for more job creation).

 

A high wage system, however, is more difficult to maintain in recessions and slow growth periods. High price levels imply more difficulty for poor to survive. Thus a need for government support programs like social security, unemployment benefits etc. However, if this support is removed or reduced then it’ll have direct implications for society in magnitude (roughly) proportional to number of unemployed. Variants of results are visible in developed economies all over – political tilt towards socialism (US), increase in support for extremist parties (Netherlands, France), breakdown in social order (Greece), and governments avoiding reforms (taking short term measures to solve long term problems) to appease masses (France).

 

Efforts to counter this via money printing can have only limited success. In fact, certain amount of deflation would help, by bringing prices down to affordable levels. Of course, economic activity would still need to accelerate to avoid a downward spiral.