Matt Yglesias: Creating Jobs by Cutting Wages

[jimM47]

Originally Posted by miceelf

Wages are kind of a collective action/free rider problem. Most companies depend on some kind of middle class consumer base for their profitability. But each individual company also profits most by paying its workers lower than middle class wages. So a company will be most profitable when it pays its workers low wages and most other companies don't. It's a classic example of free riderism. Simply increasing the number of jobs that don't support the middle class isn't at all a solution to this problem.

I think that rests on at least two fallacies. First, firms in a particular economic environment may depend on a middle-class consumer base, but firms do not inherently depend on the middle-class. Second, firms are most profitable when they maximize the difference between the cost of their (labor) inputs and the product of those inputs; that can mean that the greatest profits come from very highly paid workers. The incentive of firms are not to pay wages that are lower than middle class earnings, but to pay wages that are the minimum amount higher than the next-most-productive use of their employees' labor.

The story you are telling appears to be one in which middle-class laborers across all sectors are taking home large amounts of rents (payments not needed to induce them to provide their labor for its current use) extracted from employers, without which the middle class would be unable to afford anything like its current basket of consumption goods; and if employers were able to stop those rents from being extracted, then producers of that current basket of goods would cease to be viable.

But I see no evidence whatsoever for that theory, which, at best, holds true only for limited number of sectors mostly corresponding to those with high unionization. I think the reality is that middle class laborers do the lion's share of consumption and investing in this country because they also hold the lion's share of valued productive resources (their labor and their human capital therein) that exists in the economy. Their wages and spending power are not the result of what they have been given, but the result of what they have the power to demand.

It is perfectly easy to imagine an economy (or several thousand years of economies) in which ordinary laborers do not hold the lion's share of valued productive resources — because the resources that command the greatest returns are agricultural lands, or slaves, or monopoly rents or other things held by a small aristocratic minority. Such an economy can hum along quite nicely, producing good returns for firms that produce consumable goods. But the basket of goods that they produce will be the goods that the aristocratic minority wants to purchase, not the goods that laborers want.

Now, it has become reflexive for some to say that you can't have stable consumption based on rich people, because rich people don't spend all of their money the way middle class people do, and so that money doesn't go back into the cycle of production and consumption the way it should. But that overlooks two things. First, consumption is not the sole form of economic transaction — the money that rich people don't consume is either spent on capital goods or is lent out to others who either consume it themselves or invest it in capital goods, all of which cause the money earned by the rich people to continue to cause the full employment of productive resources.

Second, it is by no means inevitable that the rich won't consume all their income — rich people now invest large amounts of money because there are good investments to be had, but history shows us lots of examples of times when there weren't great investment opportunities and rich people just lived extravagant lives, and what they didn't consume themselves was lent to other (over-mortgaged) aristocrats who consumed beyond their means.

I know I must get a bit tedious always railing against the Henry Ford fallacy on these boards, but I think it is really important to stress that capitalism is mostly indifferent to the distribution of wealth, and the distribution of capacity to take future returns, that exists in the society at large. Capitalism won't collapse, eat itself or correct itself, before it produces what we might, for other reasons, regard as highly undesirable distributive outcomes. Which is to say, there are interventions we can make that will produce these outcomes and the system won't cry foul.