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The case for Minimum Wage

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By: Bernard K

The late LKY had said that the reason why we don’t have minimum wage is that Economics 101 showed that if the market won’t bear it, it will mean unemployment. His adage was that full employment is paramount. Not an unusual objective, e.g. one of the objectives of US Federal Reserve is to sustain a high level of employment.

A synopsis of the theory is that as demand for products falls, less workers are needed to produce, thus, this will cause unemployment, this will in return create surplus of labor resulting in lower wages. Production costs will fall as labor becomes cheaper and this will lead to lower prices for goods/products. And as prices for goods fall to a certain level, demand will start to pick up again and then employers will start to rehire, returning the economy to full employment. But with minimum wage, this cycle will be stymied by not allowing employment and wages to fall far enough to the level where demand will pick up.

The theory espoused by LKY sees unemployment as temporary in a short term demand cycle within the long term cycle determined by supply side such as technology. LKY prognosis was said in 2009, but by 2013, Larry Summers had an entirely different take on ‘demand’ in his speech to IMF. He reaffirmed his beliefs with an update The Age of Secular Stagnation this Feb 2016.

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The macro-picture is that we have conditions where the propensity to save is greater than to invest dragging down demand and real interest rates. This is not what will flip LKY’s prognosis in general, what will flip it is that the demand cycle is no longer short term but has structurally changed. And this is what Larry Summers pointed out in 2013, and all data so far proved him right.

First let’s address the relationship between demand and interest rate. If demand is down, interest rate is lowered so that it is cheaper for people to get money to spend. And if demand is too high which will lead to inflation, interest rate is jacked up to make money more expensive which will lead to lower spending and inflation. And if you look at the demand and full employment relation (2nd para) and then you add interest rate into the mix, there is a clear nexus between interest rate-demand-employment.

Interest rate is the tool for monetary policy to try to effect demand, and hence employment. Lowering interest rate will jack up demand which in return will raise employment. But what if interest rate is near zero or even turned negative and demand is still lackadaisical?  This is the scenario before us today.

Larry Summers presented some enticing arguments in his alluding to Secular Stagnation as the long term condition of US economy and developed countries; which inevitably will affect Singapore. He made six points as to why demand is structurally rather than temporary weak. And if this is the case, LKY’s prognosis or PAP’s arguments about minimum wage is inadequate because the context has shifted, i.e. full employment cannot be attained by an economic cycle relying on demand as was the belief prior to GFC 2008.

I will not go into all the 6 reasons, but let’s take one of the major reasons why demand is structurally changed; the ‘character of productive activity’. Larry Summers had used Apple and Google, but for me Facebook is a better example. When Facebook was started it was self-financed by Mark Zukerberg and Eduardo Saverin. The first outside funding came from Peter Thiel at USD 500,000 for 10.2% stake. Out of this, USD 200,000 was used to buy the facebook.com domain name. And now Facebook is valued greater than Exxon Mobil; where an oil rig can cost up to USD 650 million to build.

The need for capital or debt financed investments which make out a big chunk of demand is now colossally reduced. And so when we say technological disruptions, it is not just technology, but a total disruption in economic, social and political models (think Brexit). This is something no monetary policy can effect to raise demand and hence employment.

So reactions liked Universal Basic Income (UBI) and the anti-establishments all over the globe, show the intuition of some politicians and most of the ordinary folks are ahead of the curve (think Brexit again). The intellectual and operative mechanisms may not yet be clearly articulated because all these changes are quite new, besides, a lot of the MSM anywhere in the world, not just Singapore are pretty status quo, oppressing alternative views.

So, Professor Lim Chong Yah  who argued for minimum wage of $1500 is right, and Dr Tommy Koh is right. All those arguing let the market decide is also right, but the market has changed!

What is Larry Summers prognosis? He gave an account of the Federal Reserve Model that showed that a federal stimulus in the form of repairing infrastructures etc could possibly drive up demand. It essentially is using government money as capital where the private sector has gone missing. In fact, the model shows a reduction in the federal deficit in the long run.

Paul Krugman is more provocative. Given the amount of money in government bond worldwide with negative rates, estimated at USD 8 trillion, it is a good time for government to spend given that it actually pays to spend more given the negative rates.

Or even ‘helicopter money’ conceptually similar to UBI: ‘..as the rich world continues to stumble along in a world of low inflation and weak growth, despite rock-bottom interest rates, a new policy proposal is entering the discussion: “helicopter money”, shorthand for printing money to fund government spending or to give people cash. In March Mario Draghi, the president of the European Central Bank, described helicopter money as a “very interesting concept”. Haruhiko Kuroda, the Governor of the Bank of Japan, ruled the option out for now when asked recently. Yet the longer stagnation continues, the greater the odds that government eventually gives the policy a shot.  The Economist

What is clear is that the fundamentals of demand have changed, and LKY’s prognosis cannot bring full employment to Singaporeans anymore. And hence, the question of rejecting minimum wage resting on the adage of full employment is dinosaur.

Appendix:

  1. Mcdonald’s wage hike pays off
  2. Moral Arguments for higher taxes
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