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Kooky Keynesian Ideas Infect Minimum Wage Debate
By Dr. Roy Cordato

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Apr. 17th, 2014

RALEIGH — “Keynesianism is indeed a disease on the body politic in democratic society. An economic doctrine of technocratic arrogance, it ... gives scope to the opportunistic behavior of politicians who become unconstrained by Keynesianism in practice.”

George Mason University economist Peter Boettke offered that observation in his book Living Economics: Yesterday, Today, and Tomorrow.

The Keynesian disease has found its way into the debate over increasing the minimum wage. In addition to arguments about the need for a livable wage or, in the words of U.S. Rep. Mike McIntyre, R-7th District, how “those who work full time should be able to make an honest day’s pay to provide for their families” — not a problem that can be fixed by a minimum wage — it is also being claimed that a minimum wage increase will stimulate the economy.

That’s right; higher labor costs for businesses will actually be good for those businesses and good for economic growth.

So how does this work? An analyst from a left-of-center policy group puts it succinctly: “because low-wage workers tend to spend a larger proportion of their income, raising the minimum wage is an important stimulus to the broader economy.” This is knee-jerk Keynesianism, pure and simple.

In the basic Keynesian model, it is spending on consumer goods, as opposed to saving and investment, that drives an economy and causes it to grow. It is the same “reasoning” that was used as an excuse for President Obama’s failed stimulus package in 2009 and former President George W. Bush’s stimulus plan the year before.

So transferring wealth — by increasing the minimum wage — from those who spend a smaller proportion of their income, i.e., business owners/employers, to those who spend a larger proportion of their income, low-wage workers, means the “broader economy will be stimulated.” That’s the theory.

The problem is the theory’s assumption, namely that if revenue is transferred to low-wage workers and spent on consumption goods, it will be used more productively than it would be if left in the hands of businesses, where it would be reinvested, saved in the form of retained earnings, or distributed to shareholders. This assumption is based on a key flaw in Keynesian theory: the notion that saved money is idle money.

In reality, business profits, which are, in the absence of increased labor productivity, where higher wages must come from, do not otherwise reside in a mattress. Without business profit and individual saving, there could be no economic growth.

It is profit and saving that fuel investment and business expansion. Previously earned profits and personal savings finance all new factories, new stores, new office buildings, and ultimately new employees.

Economic growth cannot occur without saving and investment, and saving and investment cannot occur without the generation of business profits or the decision on the part of individuals to save, i.e., not consume, some of their income. All consumption spending is dependent upon having goods and services to spend money on, which is necessarily the result of this previous saving and investment.

Higher wages are the result of capital accumulation and economic growth, not the cause of it. To argue that new economic growth will be stimulated by a coerced increase in the minimum wage shows an unfortunate ignorance of this fact. It is an ignorance that is embedded in the Keynesian model itself.

All of this assumes that, on net, the wealth transfer from employers to employees will actually occur. This is a tenuous assumption at best.

The fact of the matter is that increases in the minimum wage will cause some people to lose their jobs and make it impossible for some of those looking for work to find it. This is because, as the minimum wage increases, fewer low-skilled workers will qualify for the positions that are available.

So while some people will end up with higher wages, others will end up with no wages at all. Therefore, even from a flawed Keynesian perspective, to argue that there will be a net transfer of wealth from those with a “lower marginal propensity to consume,” to invoke Keynesian jargon, to those with a “higher marginal propensity to consume,” one would have to factor in all those workers whose wages have fallen to zero as a result of the minimum wage increase.

Dr. Roy Cordato (@RoyCordato) is Vice President for Research and Resident Scholar at the John Locke Foundation.

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