Former Clinton Administration Labor Secretary Robert Reich and Harvard educated economist Paul Roderick Gregory are not getting along right now. Reich fired the first shot in his piece “Higher wages can save America’s economy – and its democracy” on Salon.com to which Gregory immediately replied with a scathing critique and a failing letter grade.
Reich’s argument is that “for much of the past century, the basic bargain at the heart of America was that employers paid their workers enough to buy what American employers were selling.” He laid out the virtues of this agreement and drew the conclusion that given the current state of the economy, “the bargain has been broken”.
Henry Ford is the model that Reich believes modern day corporations should follow. Pay a wage that allows workers to buy the products they make is his battle cry. With an amazing feat of mental gymnastics, Reich blasted the wealthy for seeking the highest profits possible and made the wild claim that the middle-class are the true job creators “whose spending drives the economy and creates jobs.”
Gregory caught wind of this economic blasphemy and took to the task of grading Reich’s work. In his rebuttal piece: “Robert Reich’s F Minus in Economics: False Facts, False Theories” Gregory did not pull any punches. He provided the logical counter-arguments to raising the minimum wage and explored the consequences of such policies.
First, he spiked the legend of Henry Ford in to the ground.
“Ford’s $5 wage to convert his workers into Model T customers is an urban legend that thinking economist dismiss as nonsense. Henry Ford’s employees would have had to buy forty cars each to absorb the half million Model T’s rolling off his assembly line in 1916.”
He then moved on to Ford’s true motivation for paying higher wages.
“Ford raised the wage to $5 because labor productivity was soaring, not because he wanted to create customers,” Gregory continued. “Wages were rising throughout the economy because of massive increases in productivity, not because Ford and other employers wanted to pay workers enough to buy their products.”
The back and forth between Reich and Gregory is the classical battle that plays out when a Keynesian economist (Reich) and an Austrian School economist (Gregory) clash over whether you can spend your way out of debt, and regulate your way to financial prosperity. Reich says yes, Gregory says no.
The subsequent exchanges between the two have degraded in to ad hominem attacks, but the principles are there if you dig a bit. Fortunately, I have a shovel handy.
Paying workers based on their ability to buy the products they produce is based in fantasy. The true value of labor, the cost of production, and current market conditions are foolishly left out of the thought process. A larger problem still is how to determine how much workers need. Should a person who makes a Ford get paid less than a worker making a Porsche because the Ford is cheaper to purchase? The workers in the Ford plant would likely answer with a resounding “NO!”
Moving on to the larger question of whether or not it is good fiscal policy to set a minimum wage, Henry Hazlitt’s “Economics in One Lesson” is a great resource that follows the Austrian School’s position and warns of the problems that occur when the government interferes with paychecks.
“You cannot make a man worth a given amount by making it illegal to offer him anything less. You merely deprive him of the right to earn the amount that his abilities and situation would permit him to earn, while you deprive the community even of the moderate services that he is capable of rendering,” wrote Hazlitt.
In other words, a minimum wage that is higher than the true value of the labor will lead to unemployment. Some, like Reich, would argue that raising prices and passing the costs of the higher wages to the consumer prevents unemployment, however; this is not the case.
When prices are artificially inflated – like what happens when wages are set to an arbitrary level by the government – consumers will buy less of the impacted product. When consumers buy fewer products, companies make less money. Remember, the higher price covers mandated wages so profits are not increased. Less profit has historically led to…unemployment!
Worse yet, the unemployed workers turn to government programs that pay less than what the job they had paid them. This is a truly terrible deal for the former workers and very costly for tax payers. Not only have the former workers lost the satisfaction of providing for his family, they are receiving less than what they would have gotten had the wages not been impacted by government regulations.
It’s clearly a vicious cycle that unfolds when the government decides to interfere with the market. Detroit is an excellent example of these concepts playing out to their logical conclusions. Wages were inflated higher than the value of labor. This led to mass unemployment. The increased demand on public assistance programs led to higher taxes to cover the rising costs. Those with marketable skills left the city, which shrunk the pool of tax payers. Under the strain of diminished funding, Detroit crumbled and was eventually forced to file for bankruptcy. This once proud city – known for its production – is in mediation where creditors are working out how best to pick apart the assets of the city.
In the end, we must give both Reich and Gregory failing grades. While I agree with the Austrian School of economics that Gregory supports, he missed out on the opportunity to educate others why the government’s current fiscal policies are wrong-minded and detrimental to the economy. For those interested in learning more, you cannot go wrong with Hazlitt’s classic. For those who love economic nerd fights, this one seems like it might have legs.