YESTERDAY'S RUBBISH..why is a minimum wage different from Free Trade?

Andrew Watt

Germany’s first post-war Chancellor Konrad Adenauer is usually held to be the origin of an often-quoted phrase „Was kümmert mich mein Geschwätz von gestern?“. Roughly: why should I be concerned about the rubbish I talked yesterday? Whatever the rights and wrongs of this attribution, the phrase – used to draw attention to someone who places political flexibility over intellectual consistency – has occurred to me numerous times over recent months in the context of Germany’s debate over the introduction of a statutory minimum wage.

The statutory minimum wage in Germany

The decision was finally taken yesterday in the Bundestag. Germany will, for the first time in its history, apply a statutory minimum wage of EUR 8.50 to almost all workers from the start of 2015. It is estimated that up to 3.7 million workers will benefit, and given very pronounced wage inequality at the bottom of the German labour market, the wage rises for some workers will be substantial. There is a two-year transition phase for pre-existing sectoral collective agreements. A number of groups of workers have been excluded, some permanently the majority for a transition period, from the minimum wage requirement, which has given rise to an intense debate in the country.

This debate about exemptions, as with the battle over the minimum wage more generally, has centred, unsurprisingly, on possible negative employment effects. Once the minimum wage has been introduced it will be possible to analyse its employment effects, even if this will be difficult because its impact will not be easy to disentangle from that of other factors happening at the same time. For the moment, one has to rely on studies focusing on past minimum wage introductions and increases in other countries. The thrust of that literature is that, provided the minimum wage is at a “reasonable rate”, it is very hard to identify negative employment effects in the aggregate. (For a discussion of whether EUR 8.50 is “reasonable” in the German context see here.)

What we will see though is a lot of “argument by anecdote”. Firm A in region B has been forced into bankruptcy by wage increases necessitated by the minimum wage. Worker C in city D was happy about the minimum wage when it was being discussed, but now he is furious because instead of a job paying EUR 6.50 he is unemployed. Indeed, we are already seeing this argument being deployed in the form of threats and predictions. Handelsblatt, the German business daily, recently had a piece whose title asks whether the minimum wage will lead to bankruptcies (“Pleiten dank Mindestlohn?”, Handelsblatt, 15.05.14). The article answers the rhetorical question in the affirmative, based on the opinions of the director of the hotel and catering lobby organisation, the board chairman of a chain of hairdressers, and the president of the German employers association BDA. And this concern has been expressed by many liberal economists, by employer-linked think tanks such as the Initiative Neue Soziale Marktwirtschaft[1], and, not least, by the German Council of Economic Advisers.[2]

Political flexibility or intellectual consistency?

What I find interesting here is less the specific arguments put forward (which are rather weak) than the fact that the basis for the arguments is completely at odds with the way that employers’ representatives[3], and certainly liberal economists, normally position themselves. It is as if, on the issue of the minimum wage they are collectively saying: why should I be concerned about the rubbish I talked yesterday?

Consider the debate on free trade. A country has tariffs that protect a sector of its economy. They are removed, leading to job losses and bankruptcies in the least productive firms in that sector. Do employer representatives and liberal economists favour an anecdotal approach here and call for the reimposition of tariffs in order to protect jobs and companies? On the whole they take a very different line. The production and employment protected by the tariffs is “inefficient”. Free trade brings a welcome does of competition. It enables higher incomes and a shift of production to areas in which the country has a comparative advantage. Workers who lose their jobs move to more productive occupations or regions and everyone is better off. (At least, the more sophisticated would add, this is the case after an intervening adjustment period.) Focusing on protecting “old” jobs is a barrier to productivity and progress. One cannot judge from individual job losses that the overall employment level must fall.

A similar argument is put forward with respect to technological change. Yes, some workers are thrown out of work when new, more efficient machinery and production processes are introduced. Others have to adjust through training. But here, too, the overall impact is beneficial (after a lag), because lost employment can be recouped elsewhere in the economy, as higher-productivity jobs pay higher wages that in turn expand employment opportunities for workers in other parts of the economy. If you are against technological change you are a Luddite and economically illiterate.

This begs the question why different standards seemingly apply in the case of the minimum wage. Firms facing a rise in labour costs in the wake of its introduction have a number of ways to adjust. (These are not mutually exclusive in practice but can be separated for expositional purposes.) They can increase prices. Given that the minimum wage applies across the whole economy (i.e. will not just affect individual firms) this is likely to happen. Relative prices will adjust: the prices of goods and services produced with the use of large quantities of low-skilled labour will increase relative to those using more high-skill labour and capital. The economic (not technical) productivity of the low-wage workers will rise, thanks to higher product and service prices, to match the increase in their wages. Or firms can raise their productivity (in the technical sense), through innovation and reorganisation, just like a firm facing a dose of wholesome foreign competition because tariffs have been cut. Companies may also accept a lower profitability, and the wage share would rise somewhat. (If nothing else, this would make Thomas Picketty happy).

But, undoubtedly, in some firms these adjustment strategies may not be practicable or sufficient. Some may lay off workers and others be forced to close. This is the basis for the anecdotal argument. But surely, given their normal argumentative pattern, business representatives and liberal economists should be vociferously pointing out that this is actually not a problem, certainly not an inevitable one. For as we have seen a minimum wage has very similar effects to a bracing dose of foreign competition or the “creative destruction” associated with technology. Induced productivity gains and higher wages generate additional income that sustains employment in firms across the whole economy. Those employers that cannot keep up are forced out of business. And the labour that is displaced will, or at least should[4], be rapidly deployed to other regions or sectors where it can be put to more productive use.

Yesterday’s rubbish?

From the macroeconomic point of view it makes no sense at all to lock a large proportion of the workforce into low-paid, low-productivity jobs. If they were consistent, liberal economists and employers’ front organisations should be making that point. But they are not. It could be that they have suddenly abandoned liberal views as yesterday’s rubbish. This is implausible, however. The argument still applies in other areas; see for example the salutatory effects that such commentators ascribe to the TTIP (Transtlantic Trade and Investment Partnership).

Rather the discrepancy is presumably because the same effect is produced by two different causes: trade or technological change, on the one hand, which are seen as market outcomes, and the minimum wage, on the other, which is perceived as an market intervention. This dichotomy is wrong, or at least oversimplistic, of course. Trade and technology are also highly regulated, while many economists argue that the minimum wage (at a reasonable level) is correcting a market imperfection that gives undue power to employers. But even those who believe in it should be aware of the inconsistency of using anecdotal argument from individual companies as a stick with which to beat the minimum wage.

It will be quite some time before careful studies, with all the required controls, are made of the employment impacts of the introduction of the statutory minimum wage in Germany. Until they are done, expect a lot of heart-rending anecdotal argument about job losses and bankruptcies. And when you hear or read them, remember to confront those making such arguments with Konrad Adenauer, or whoever it was who said: Was kümmert mich mein Geschwätz von gestern?

[1] In its „eight facts about the minimum wage“ the INSM states baldly (translation mine) „ The introduction of a minimum wage, whatever ist level, destroys all those jobs that no longer pay. And a job no longer pays when the employer gets less from it than he pays the worker. And so it is clear: the higher the minimum wgae, the greater the job losses.“
[2] In their annual report 2013/2014. It is worth emphasising that one of the „Five wise persons“, Peter Bofinger, dissented from the majority view on the minimum wage issue.
[3] The following may not apply to heads of individual companies, who can be very protectionist, but it usually does to those representing employer interests at national level.
[4] The word “should” here can be understood in the sense that redeployment will happen if appropriate measures are in place to maintain aggregate demand and smooth the adjustment process through active labour market policies. And of course provided the increase in the minimum wage is “reasonable” so that the employment reallocation system is not completely overwhelmed.