Minimum Wage, Inflation and Job Loss

Marc Brazeau over at the Blogonaut 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 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, 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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  1. Gabriel commented on Sep 25

    “Job loss is simply based upon the math of how much firms have to spend.”

    Isn’t this begging the question? If the business really needs 4 employees to complete its work to a sufficiently high standard, then they will be forced to take some of their profit margin and hand it to the employees, meaning the budget must increase (and profit to the employer decline).

  2. Barry Ritholtz commented on Sep 25

    Gabriel, you make a valid point — but if we are relying of the largesse of shareholders and or management to cut profits, well — just look what’s been happening in the present so called recovery: Layoffs being made in order to make the quarterly number and keep the Street happy; Its the ultimate triumph of short term over long term thinking.

    If, as you call it, “sufficiently high standards” must suffer to maintain S/T profitibility, then thats what’s gonna happen.

    Its not a very smart strategy, but its the currently all the rage.

  3. Rob commented on Sep 25

    Very interesting points on corporate governance. I am a big fan of shareholders getting more involved in watching the companies they own, but you are right in that the average investor doesn’t have the time and anyway most people can’t tell a balance sheet from an income statement. I think part of the problem if financial illiteracy in the U.S., and I wish everyone had some basic accounting and finance knowledge (thought I don’t know when you squeeze it in) by the time they left high school. I think it would help if people just paid a little more attention to what companies are doing, but most people are clueless.

    As far as CEO compensation goes, I think part of the problem has to do with company hiring and promotion patterns. Compare it to sports. The best players are those who love the game. If they just do it for money, they usually don’t have long-term outstanding careers. Good players who are traded every few years have killed some sports (baseball in particular) from a fans perspective. Well, boards are afraid that a good CEO will jump to another company, and are willing to do whatever it takes to keep them. Unfortunately, that means paying them ridiculous amounts even when they don’t perform. But many of the people who end up in the CEO position got there because they were chasing the money, not because they love business or they love the company. Companies promote “go-getters”. They like to see people who want to advance and move up. But I think there are plenty of good qualified leaders out there who don’t step up unless they are called on, and companies should try to find and promote these people who don’t always seek so hard to get promoted themselves. I admire those CEOs for whom it isn’t about the money, but about the love of the game.

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