Monday, September 12, 2005

Evaluating hyperwage theory - or, what have you learned from your basic economics? (1)

I’ve been requested by a reader of this Weblog to take a look at “hyperwage theory.” In response, I’ve decided to review Street Strategist’s (SS) series of articles in Business World presenting this theory. I think it will prove to be instructive illustration of the usefulness of basic economics. Note: Not being a Business World subscriber, I requested a copy of the collated articles personally from SS (streetstrategist@gmail.com), so if want a copy I suggest you do the same.

My interest was piqued by the following:

If you have a PhD in economics, ah, there you are. My ideal audience. Why? Because by this time, with your PhD you have shall been brainwashed by the theories of economics. And I consider it a good challenge to turn your entire education head over heels. If you hear me out, and afterwards, you still say I’m an economic idiot, I always was. (p. 9)

Hmm. I have a Ph.D. in economics. And am directly insulted as a voluntary victim of brainwashing. In fact the entire work is one long slanderous tirade against economists. We’re in good company then – astronomers have been vilified by Velikovsky, archeologists have been damned by von Daniken, biologists have been bashed by any number of creationists. What’s new? In the following though I have decided not reciprocate SS, as I have recourse to infinitely superior tools of logic and evidence.

First, let’s look at the basic claims of hyperwage theory:

The minimum wage shall be set to a level that shall give purchasing power to the minimum wage earners, including domestic helpers, unlike current levels wherein the domestic helpers have almost zero purchasing power. A hyperwage resulting in real purchasing power will stimulate domestic demand which in turn will stimulate production which in turn will stimulate employment. This domestic demand, under the power of the economic multiplier will result in increased production of goods or services which in turn will result in more employment in a positive upward spiral.
The theory rests on the proposition that hyperwage does not automatically result in the same amount of hyperinflation in a Third World country. The logic for this is that many goods and services in Third World countries are already being sold at First World prices.
(p. 12)

For discussion purposes, the minimum wage shall be set to be P20,000 per month for domestic helpers; about P70,000 for fresh college graduates. This is deliberately set comparable to Hong Kong and Singapore to avoid the labor wage arbitrage that is causing our school principals to work in Hong Kong as domestic helpers.(p. 14)

To back up his claim that wages across countries are misaligned, SS argues:

Why not equal pay for an equal amount of work? Or better stated, equal working hours to buy the same amount of goods? (p. 76)

He argues moreover that price increases due to hyper minimum wages will not increase prices of other commodities (much):

If the minimum wage of the domestic helper rises from P2,000 to P20,000, or ten-fold, will those assets also rise by ten-fold? Your computers, your TVs, your stereos, your cement, and everything, think about them. Where were they manufactured and what are the prices of these goods in the First World countries? And then think about your domestic helper. If she has P20,000 how many stores and how many products will benefit from this purchasing power? Will there be deflation? No? Will there be inflation yes, and I welcome it. Think about this. Make a matrix, a table of comparison of prices before Hyperwage and after Hyperwage. Will your HP Compaq Tablet PC currently worth P100,000 rise ten-fold to P1 million? Or will it be lower because many people can now afford to buy them? Higher volume, lower price. Think, go ahead, think. Think of al lteh [sic] product you see in the world. Will oil prices rise ten-fold? Cars? Nokia? Aircons? (p. 95)

Before I proceed, let me throw it back to you, faithful reader. Are any of these claims valid? If invalid, how would you go about refuting hyperwage theory? This exercise is a great illustration of the usefulness of economics - as device for rigorously identifying bad economic policy. So I'll post my evaluation later to give yourself a chance to exercise!

16 comments:

micketymoc said...

Ooh Ooh! (raises hand) since the supply of money is limited in the first place, government will have to print more money to support hyperwages, devaluing the peso and putting us back at square one, if not worse?

---just a guess, am an economic idiot too---

Econblogger said...

Very warm! Yes, hyperinflation will cause a currency depreciation - something SS has utterly failed to anticipate.

Now you have a chance to change your answer: what happens if there is NO accompanying increase in money supply AND a minium hyperwage is effectively enforced?

micketymoc said...

What do you mean, govt. doesn't increase money supply, or govt. doesn't need to?

Question lang: why wouldn't Keynesian economics work in this situation - where increasing demand will create its own supply?

Econblogger said...

Government doesn't need to. Remember, even fractional reserve requirements are mandated by the Central Bank, so the private sector has little leeway to increase money supply by itself. (However by overstepping the reserve requirements they can certainly reduce money supply - hence deposit insurance, rediscount window, etc.)

Keynesian econ doesn't work because - well, wait for my post!

[this part added later]: Oh, there's another avenue where hyperinflation may work: suppose the minimum hyperwage fuels expectations of a hyperinflation. Then (using the Philips curve hypothesis), actual inflation should follow suit. However it doesn't need to - and I strongly doubt it will, for reasons I will elaborate later. Friedman's insight (paraphrased) continues to hold: hyperinflations, always and everywhere, are a monetary phenomenon.

Anonymous said...

This theory is one of the wackiest I've read. In the end, I think the theory rests on one wrong foundation: that nominal prices actually mean something. In the end, nominal prices don't mean a thing. Take away the peso price and think about what 1 hour of labor can produce. This has not changed, so how does hyperwage theory resolve the problem of a sharp increase in demand with constant supply? More people can afford computers, but for the computer manufacturer: 1) their wage costs are now more expensive by a proportionate amount plus 2) they can't really produce more computers, hence an increase in the price of computers.

The net effect of hyperwage theory seems to be: let's add 3 zeros in all our currencies. Yes, I'm 1000X richer right now, but everything else will be 1000X more expensive.

And don't get me started on imports! The currency depreciation should appreciate by a similar proportion since in the end, 1 days work is only enough to purchase 10 liters of gas. If the wage rate increases, and the dollar cost of gas remains the same, then the exchange rate must fall.

AT

Econblogger said...

Anonymous,

I think the consequences are even worse than what you envision. You see, unlike your analogy of currency reform (adding zeroes to money), the minimum hyperwage:

1. Only raises the prices of labor;
2. Does not change the value of the currency.

We will probably get some inflationary effect, but the inflation will be biased towards labor-intensive goods, and will be temporary only. In the end we will get hyper-unemployment.

f said...

what a nutty theory. i suppose the theory also proposes to legislate and fix the input mix so firms don't substitute away from the more relatively expensive labor input? otherwise as econblogger said, you'll end up with excess supply of labor.

Anonymous said...

Why wouldn't inflation affect non-labor intensive goods? Let's say it's early in the process, and people can all of a sudden afford to buy these goods. Given that the supply remains constant (nothing indicates any productivity increase), wouldn't that jack up the price?

AT

Sora said...

my point of contention is: Filipinos are just as capable, thereby deserving the same level of merit and credit, as any individual in the global economy.

people are losing faith in economics because it has failed to alleviate our condition.

and since we don't have the luxury of Seven Samurai, music anyone?

Anonymous said...

Currency depreciation? One chapter is in fact titled "Labor as Unit of Currency". We no longer think of Pesos to buy 1 HP computer rather, how many labor hours of min wage needed to buy it. Currency exchange therefore is irrelevant.

Anonymous said...

As a PHD in economics what is your actionable and concrete solution to brain drain? Funny rules like servicing in the Philippines for 5 years before allowed abroad? And how many years do you need to implement your solution whatever it is? What have the economists done except write term papers that cannot even solve brain drain?

Anonymous said...

why is brain drain a problem? people should have the freedom to pursue what's in their best interest. what's this concept of "serving" the country? the state exists because of the consent of the governed not the other way around. if people feel like their efforts are not being rewarded in one place they will choose to leave. much the same way you will choose to leave a company if your efforts are not rewarded.

Econblogger said...

Yes, I have drawn in The Man himself. Thanks for coming, SS.

AT,

Of course price increases will strike across the board, as businesses pass on in part their higher labor cost. However price increases will be greater the more labor-intensive the good.

Sora,

The purchasing power of labor is country-specific. That is the entire point of PPP! In developed economies most labor is highly-skilled and exists in an economy that can make good use of that highly skilled labor. So when the supply-demand thing works itself out, we get highly productive labor in high-income countries getting a commensurate wage. Your claim to shift the unit of currency does not change the fact that a hyperinflation will force a currency depreciation. And exchange rate is one of the determinants of international buying and selling decisions. NOT labor-hours, this is irrelevant, a throwback to the halcyon days of classical economists who reckoned value using labor.

Brain drain is a problem, but this is partly offset by the fact that the returns to human capital (which are higher abroad) are partly sent back home. (remittances). As demonstrated in China, Korea, Taiwan, and now India, if your economy is on a take-off, that will be the natural solution to the brain drain. People still love to live in their own country, with their network of friends, relatives, with their familiarity with the culture and laws, etc. Filipinos are no different, I was an OFW myself for two years.

The test of a theory is not the ability to name simplistic solutions. It is to offer solutions that might plausibly have its intended effect; and if the plausibility cannot be established, to be honest about it. Hey some problems are really too tough. Cancer is still basically incurable; do we damn the medical profession for their "failure"?

There are many highly confident individuals making this-and-that claim of an instant cure for cancer. Does their brash confidence and ability to name quick-working make them right? No, only logic and evidence can establish whether a purported cure is genuine.

Sora said...

Are we low on high-skilled labor? Then it's about time we institutionalized technology-driven education! India did it 10 years ago, there's no reason why we can't.

"a throwback to the halcyon days of classical economists who reckoned value using labor." -maybe that's what we need to do: MOVE BACKWARD. Moving forward, we've seen communism fall. Capitalism seems to be an escalator headed nowhere as well, unless we consider the wanton exploitation of the Lesser as a worthwhile destination.

As for medicine, the medical profession has neither succeeded nor failed because it has equated preservation of life with the prevention of death, 2 very different realities.

How do we know if a cure is genuine? well we dont really know until it gets tested in the lab with mice or chimps now, do we? =)

Econblogger said...

Sora,

Technology-based education? Sure, sounds 1,000 x more credible than hyperwage!

Moving backwards? I disagree. And capitalism is not a system of "exploitation"; it is a system of "greed". Only people thinking in a zero-sum mode (game theory reference, you must be aware of this) conflate the two.

Are asking an empirical test of hyperwage on an actual economy? Might as well test a cancer cure on humans, without making any prior animal tests, without analyzing the chemical composition of a cure, without running computer simulations about its properties. Dangerous and reckless.

Unknown said...

I have a friend who insists that it is possible to power a car using wind turbines. When the car is running at 60 kilometers per hour, the wind turbine can gather power from air as the car speeds through it! I said the idea is interesting, but it just wouldn't work. My friend asked "Why?", and try as I did, I couldn't explain to him in terms that he could understand why it wouldn't work. I only wish he could try to implement his idea one day!

Hyperwage theory is such a wind turbine of an idea. Hey, we can set things in motion without using energy! How wonderful.