Sunday, October 29, 2017

South Korea: Managing Growth by Increasing the Minimum Wage

A significant number of economists have begun to realize that the US economy has been experiencing a state of stagnation in which not enough demand has existed in order to induce corporations to invest their earnings in new production.  Usually this situation is addressed by the federal government providing a fiscal stimulus by funding investments in projects that will provide more economic activity via the purchase of goods and services.  The stimulus to the economy then comes from the increased sales some companies will see and the extra wages that will be paid in providing those services.  The economy as a whole will benefit to the degree that the effects of additional production and increased wages are widely distributed.  There is no guarantee that increased production will generate spin-off production directly, but it is certain that a large fraction of any increase in wages will be spent and contribute to general economic activity.

Given the above reasoning, it would seem most efficient to directly increase wages if one wishes to stimulate the economy.  One can try to accomplish this effect by tax cuts, but those tend to go preferentially to the highest tax payers who are the least likely to spend any largess in stimulating the general economy.  One could conjure up a tax cut that would deliver money directly into the hands of lower income people, or one could declare a tax holiday that would benefit some sector of the population preferentially.  In this case, consumers who are also debtors will tend to use much of the extra income to help pay off bills, particularly if the increase in income is viewed as temporary.

It would seem that the most efficient way to inject money directly into the economy is to increase the wages of people who have no choice but to spend the money.  Fortunately (or not) the US has a large number of workers living at or near the poverty line who are in great need of the means for increased consumption.  An efficient way to boost the economy, and by so doing provide income to those most in need, would be to increase the minimum wage.  Presumably, the greater the increase, the greater will be the stimulus.

Such a move is said to produce severe economic consequences.  Businesses will be affected with higher wages costing some to raise prices, some to eliminate workers, and some to close up shop.  However, the increase in wages will show up as increased activity which will have a counterbalancing effect.  Will such a move improve the economy and the life of its workers, or will it diminish both?  No one really knows.  Small changes in minimum wage or large changes that were only applied locally have led to arguable results.  What one needs to understand the dynamics is for a large increase in minimum wage to be applied throughout the entire economy and to observe the long-term results.  Fortunately, South Korea seems poised to perform that experiment for us.

An article in The Economist titled Promising the Moon in the paper edition (a play on the name of the new President of South Korea) became the more relevant South Korea tries to boost the economy by hiking the minimum wage online.  South Korea might seem an unlikely nation to pursue such a policy.  The country has long been blessed with high growth rates that reflected its ability to produce high-value goods that sold well throughout the world.  But all growth brings with it problems.  One is the inequality that inevitably comes with capitalism.  The dependency on export-driven growth can also leave a nation too vulnerable to the whims of international markets.  The goal of the new President, Moon Jae-in, is to address both issues by increasing the minimum wage by about 55% by 2020.

“On the face of things, the South Korean economy is doing well. Growth has averaged 3% annually over the past six years, a decent outcome for a period when global trade was sluggish. Income per person is about two-thirds of America’s, up from a third 25 years ago. The unemployment rate is just 3.6%. South Korea spends more as a share of GDP on research and development than almost any other country.”

“Nonetheless, poorer Koreans resent rising inequality….A study by the International Monetary Fund last year found that the top 10% of South Koreans receive 45% of total income—a greater concentration than in other big economies in Asia. The proportion has risen sharply over the past two decades as the wages of the rich have grown faster than those of the poor….Adjusted for inflation, household incomes fell last year, something that in recent decades had happened only in the wake of financial crises.”

“The bet is that the jump in wages will feed through to stronger consumption, particularly as low-earners tend to spend more of their pay than the rich do. In addition to propping up growth, stronger consumption would make South Korea less reliant on exports and so less beholden to the whims of China and America, Mr Moon predicts. It should also help reduce inequality.”

The article provides this chart to help place what South Korea intends to do in comparison with policies in other countries.

Since The Economist is quite conservative in its economic principles, it suggests that disaster might be the outcome.  Let us hope not.  History tells us that a required minimum wage provides a very stable floor to wages.  The only way to improve the wages of the lowest-paid workers is to raise that minimum.

The interested reader might find the following articles informative:

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