Obama's Minimum Wage Beliefs Are As False As Can Be

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President Obama would like everyone to believe that raising the minimum wage will help those in poverty, will cause no drop in employment, and will probably even boost the economy. Unfortunately, these beliefs are as false as can be and come from a fundamental misunderstanding of the very Keynesian economics he professes to follow. In reality, it is likely to slow growth and will do less than he claims to help the poor. We can address and dismiss the President's three claims one by one.

To the first point, it is useful to understand that only a small percent of the wage gains from an increase in the minimum wage go to those officially in poverty. According to the Congressional Budget Office, only 19 percent of the benefits end up in households currently below the poverty line. This is in contrast to 29 percent of the benefits that flow to households with income of at least triple the poverty line. The reality is that not that many low-wage workers are in poverty now, so this is a poorly focused anti-poverty program. Making changes in the Earned Income Tax Credit is the smarter way to assist the working poor since then all the money flows to the targeted group.

The second of President Obama's points in favor of the minimum wage is also disputed. Many minimum wage critics have argued against raising the wage because they fear large job losses will result. I believe there will be some job losses, although not an enormous number. However, it is a bad policy either way.

The CBO says it is an inefficient way to help the poor. On the jobs front, it certainly won't create jobs, so the debate is really just over whether job losses would be large or small. Thus, for the policy to have anything to recommend it, it would have to be the President's third point, that raising the minimum wage will increase economic growth. Unfortunately, that is not going to happen.

The key is the Keynesian multiplier. The idea is if I earn an extra dollar, I spend it somewhere. The owner and workers of the business where I spend it get some extra money, which they spend. On and on this continues, creating growth. The limit to this process is that some money leaks out either through savings or because money is spent outside the local economy. Many liberals believe that because the poor spend all their money while the rich save some, the multiplier is higher for poor people. Thus, income redistribution can raise economic growth because the multiplier effect increases in size.

We are not that lucky. If the Keynesian multiplier worked like Keynesians think, the multiplier for the world economy would be infinite or nearly so since there is no leakage. However, let's humor the Keynesian theory for a bit.

If the multiplier theory worked as people think, redistribution to the poor would still face two problems in terms of being good economic policy. First, the rich overall spend almost as high a percent of their money as the poor and most of what they do save gets lent out and spent by someone else. The only real "leakage" would be the fraction of savings that banks keep as a capital reserve rather than lending it out. Thus, the multiplier for rich people is not much if any smaller than for the poor.

Second, poor people spend more of their money on the sort of consumer goods that tend to be imported while the rich spend more on services that have to involve local businesses. You cannot import a pedicure, massage, or lawn service from China, but we certainly do import clothes, toys, and lots of other consumer nondurables. Thus, more of the poor's spending leaks out (say, to China). This difference in the mix of spending means that any Keynesian multiplier is quite probably smaller for poor people than the rich unless growth in China is the goal.

As I suggest, belief in a Keynesian multiplier is somewhat naive once you think about it at the global level. Eventually the only way to increase the size of the economy is with more production because without more stuff to buy higher spending can only produce inflation, not economic growth. However, for those who wish to believe in the Keynesian multiplier, reality still intrudes into the minimum wage debate to suggest that more spending by the poor is at least as likely to lower national economic growth as it is to raise it. Sadly the only thing this policy is good for is class warfare and political campaigns.


Jeffrey Dorfman is a professor of economics at the University of Georgia, and the author of the e-book, Ending the Era of the Free Lunch

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