Higher wages are good for the economy

This is an extract from my new manuscript Sunburnt: Fixing the stories we live by in the wide brown land.

One more thing about recent economic history. The prosperity of the postwar decades was widely shared: incomes at the lower end rose steadily and inequality was at historic lows. This was because unions were strong and they insisted on the pie being shared around. Big business interests routinely claim that raising wages will cause unemployment and slow the economy, but the experience of the postwar decades was the opposite: ordinary people got regular pay rises, unemployment was at historic lows (1.3%, even in spite of high immigration!) and the economy boomed. How could this be?

Here is a different interpretation. What is good for one boss is not necessarily good for all bosses. To see the point, imagine all bosses stopped paying their workers. No-one would have money to buy anything and the economy would collapse. The bosses would go broke too. More realistically, if all bosses reduce the wages they pay, people will have less to spend, the economy will slow and profits will fall. The economy flourishes when everyone gets busy and is rewarded for their efforts. The money has to circulate to do its job.

Now imagine that one boss, say a Mr. Harvey, was a bit smarter and demanded the right to pay lower wages but insisted that all the other bosses should pay higher wages. Then the other boss’ employees would be able to afford Mr. Harvey’s products, sales would be high, he would be paying low wages and his profits would boom. Do you think Mr. Harvey could persuade his Business Council colleagues to go along with this scheme? Unlikely. Paying lower wages is good for one boss to do, but it is self-defeating if all bosses do it.

This point seems to elude the Business Council of Australia, which keeps droning on about labour market flexibility and wage restraint. This is plausibly a major reason why the economy has been increasingly anaemic over the past decade or more: wage growth has slowed and almost stopped.

The point is reinforced by the 2021 ‘Nobel’ prize in economics (it is from the Swedish central bank, not Alfred Nobel). The prize was awarded to people who actually looked at the real world instead of just theorising. They showed in 1993 that in the real world a rise in the minimum wage led to an increase in employment, because there was more money circulating.

The response of the neoclassical establishment was hostile. Fellow Nobelist James Buchanan said

‘Such a claim, if seriously advanced, becomes equivalent to a denial that there is even minimal scientific content in economics, and that, in consequence, economists can do nothing but write as advocates for ideological interests.
‘Fortunately, only a handful of economists are willing to throw over the teaching of two centuries; we have not yet become a bevy of camp-following whores.’

Buchanan’s first statement is accurate: there is no scientific content in neoclassical economics. His second statement is a statement of faith and a personal attack in lurid language.

There will of course be a limit on how high wages can go. Too high and the wage bill will cut into re-investment in the business. Too high and inflation might be triggered. In the extreme the business would go broke. There will be an optimal level of wages. The experience of the postwar decades seems to indicate we are well below the optimum wage level.

Inflation will not be a concern while unemployment is high. Inflation occurs when too much money is chasing too few goods. If wages were increased slowly, the extra spending would stimulate businesses to take up slack and increase their production, so that more goods would be available (and unemployment would fall). Only when unemployment is almost eliminated would businesses be unable to expand production, a point stressed by US economist Stephanie Kelton, who we will meet later32. Inflation would then be a possibility. We know low unemployment is possible because it averaged 1.3% through the 1950s and 60s, and inflation was also low.

Bob Menzies almost lost the 1961 election because unemployment was approaching 3% (from below!). After he squeaked back in he stole Labor’s supposedly wicked big-spending policies and the economy picked up again. If a handful of votes had gone the other way in a couple of electorates Menzies would be less of a demigod to Liberals. It is worth noting that Labor had to recover from a disastrous split in 1954, and that Menzies’ opponent was Arthur Calwell, whose grating voice and soap-box rhetorical style was not very appealing to many voters compared with Menzies’ smooth and witty barrister’s delivery, yet Menzies still only scraped in.

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