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Minimum Wage, Inflation and Job Loss

Posted By Barry Ritholtz On September 24, 2003 @ 5:19 pm In Finance,Web/Tech | Comments Disabled

Marc Brazeau over at the Blogonaut [1] asks the question:

“Two common arguments against raising the minimum wage are possible inflationary effects and job loss. Why aren’t these issues raised in relation to executive compensation? “

Lets parse this complex question into thirds: 1) Political; 2) Economic; and 3) Corporate Governance. Each may provide insight via varied perspectives:

The most obvious distinction is Political. Raising the minimum wage requires Congressional legislation; Raising executive compensation does not — hence, very different rhetoric accompanies the exec comp debate.

Broad economic arguments which paint the issue in terms of nationwide job losses is an effective rhetorical political strategy. That method has far less resonance with the issue of CEO pay, which is set by the board of Directors.

That contrast goes the furthest in explaining the rhetoric used to defend or support raising the minimum wage. Until the recent brouhaha over Dick Grasso’s outsized pay package, one hardly ever heard much chatter about exec comp, unless outright fraud (i.e., WorldCom, Enron, Tyco) was involved. (Kudos to Blogonaut [1] for initiating this discussion).

It doesn’t take much bombast to frighten Congress into fearing less job creation; On the other hand, it takes several 100 million dollars in CEO pay to get investors worked up into a lather.

Economically speaking, the inflationary effects and job loss arguments are fairly parallel between execs and min wage workers. The caveat is that the latter is true, while the former isn’t always so.

Job loss is simply based upon the math of how much firms have to spend. If the minimum wage is bumped to $10, and a firm has $1200/week budgeted for a new hire, they’ll hire 3 full time employees ($1,200 = 40 hours x $10 x 3 workers). If the minimum wage is $6, they’ll hire 5 full time employees ($1,200= 40 hours x $6 x 5 workers). The $4 difference in minimum wage just cost 2 jobs. Companies cannot pay someone with money they don’t have.

Similarly, if a company replaces a $1 million/year CEO with an exec who gets $11 million a year, then there’s $10 million less for other items. That’s 200 less $50,000 per year employees.

So the job loss arguments does apply, buy its rarely mentioned in “polite” company. The recent Verizon union negotiations provides a good example of how those data points can be used; The union ran ads in newspapers comparing how many workers health care coverage (a key issue in negotiations) was equivalent to outsized executive’s pay package. (“The $69 million in executive bonuses could cover the healthcare costs of 13,800 workers”). It was a very effective technique.

Economic argument “Part B” — is it inflationary? My short answer is “depends upon the macro environment.” Longer answer: Consider the present. We have massive fiscal and monetary stimulus: tax cuts, increased money supply, 2 wars, lower interest rates, deficit spending, more tax cuts, and a weak dollar. All of these items might have been considered inflationary at a different time. Now, the hope is that its reflationary — stimulating (but not too stimulating) to the economy.

Yet if you took any one of these factors, and dropped them into the 1970s, it would be horrifically inflationary. Whether a given factor is inflationary is relative to the complex and chaotic machinations of the world’s largest economy.

Does the fine line between stimulus and inflation still exist in 2003? Has inflation has been vanquished once and for all? (I doubt it). Quite possibly, this kitchen sink economic plan (throw everything possible at the economy but the kitchen sink) may lead to inflation again one day — though I kinda doubt that. There are simply too many deflationary forces at work — China’s exports, surging productivity, lack of corporate pricing power, economies of scale lowering tech prices, etc. — for there to be much in the way of deflation any time soon.

Corporate Governance: Parallels exist between elected representatives and corporate board members. Compare Tammany Hall patronage jobs with crony capitalism, as it applies to exec comp.

The framing issue is the expertise and resources required to evaluate any theft from shareholders via pay packages; To evaluate these exec comps approved by lackey board members is time consuming, expensive and difficult.

For the individual investor, it’s a matter of transaction costs. Does it make any financial sense for each and every shareholder to invest the time, energy and money into researching the relative merits of all the potential board members voting for these giveaways for each of all their 100 share odd lot stock holdings? No.

Large institutional holders, on the other hand, have the resources, expertise and incentives to do so. There is a fiduciary obligation to do so. They represent pools of millions of investors, and they certainly know (or should know) what’s in a shareholders best interest financially.

Aside from Calpers [2], why other Pension and Mutual Funds haven’t done so yet is one of the great mysteries of the recent round of corporate scandals . . . Perhaps it’s a glass house / stone throwing thing . . .

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URL to article: http://www.ritholtz.com/blog/2003/09/minimum-wage-inflation-and-job-loss/

URLs in this post:

[1] Blogonaut: http://marcbrazeau.blogspot.com/

[2] Calpers: http://www.calpers.ca.gov/

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