Thursday, September 15, 2005

Evaluating hyperwage theory - or, what have you learned from your basic economics? (2)

Okay the action is heating up in the comments section of Part 1 of this post. But on to Part 2, which is actually in reply to the following questions:

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

"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

Answer: there will be no surge in demand, because hyper-mininimum wages do not actually increase purchasing power in the economy, even temporarily.

Why? Suppose you give your household helper a raise, equivalent to 12,000 a year. So her purchasing power goes up by 12,00. But you the employer, suffered a loss in purchasing power, by exactly that amount of 12,000. So there is no net increase in purchasing power in the economy.

Suppose hyper-minimum-wages are in place, and (at current employment levels) it will require employers paying an additional (number-pluck) 2 trillion pesos. This is a simple transfer of purchasing power of 2 trillion from employers to employees. Again, there is no net increase in purchasing power.

Let's see how this transfer effect can be avoided:

1. Suppose employers are entitled to a free cash voucher from the Central Bank to enable them to pay the hyper mininum wages. The vouchers, once converted to cash, must be supported by printing money. Then purchasing power of workers (as they perceive it) goes up, while that of employers (as they perceive it) remains constant. Then perceived purchasing power in total goes up. However this will be the case of high perceived spending power chasing the same amount of goods; this will drive the average price level up. Then the nominal hyperwage goes down. If the minimum hyperwage is kept constant in real terms (through wage indexation), then the CB will always have to print money - and that is the source of hyperinflation.

What about the argument that imported goods will have the same price, and therefore there will be no hyperinflation? Wrong again. Foreign goods and services will appear temporarily cheaper to Filipinos. In a liberalized forex market, they will bid for dollars to buy cheap foreign goods and services. Again, lots of money chasing the same amount of foreign goods: the peso value of these goods go up, i.e. the peso must depreciate.

2. Suppose government pays an additional 200 billion pesos in minimum hyperwage for its employees, but this is not supported by CB printing more money or by new taxes. Then government has to borrow to support what is essentially a transfer payment. Suppose it borrows using T-bills.

2.1. If the economy is under full employment, then the goods procured by the additional spending (of employees) will have to take resources away from other uses, because there can no longer be additional production. This happens essentially through rising T-bill rates, which shifts resources from investment goods to consumer goods. In a sense, purchasing power shifts from investors to consumers, because investors have to pay higher interest rates. This is the "crowding-out" effect.

2.2. Suppose instead there is unemployment due to a shortfall in aggregate demand. Then consumption of government employees can rise, even without taking away resources from investors; idle resources (the unemployed) are given jobs due to the injection in aggregate demand. If the shortfall in aggregate demand (to reach full employment) happens to be 200 billion pesos, then there will be no crowding out and no increase in interest rates. This was Keynes' central insight: if full employment cannot be supported because it fails to generate enough private sector demand (in violation of Say's Law), then the demand gap can be filled by public sector demand.

However the original hyperwage theory has none of these qualifications. Just a sheer assertion that the "circular flow" will take care of it. Sorry, the circular flow is a flow of value and goods; value (and goods) are shifted from one party to another party in the case of a hyperwage policy, but it's still the same value (and goods) flowing around. The policy can not possibly increase aggregate demand, under any circumstances, full employment or underemployment. Hyperwage theory is dead in the water.

Hyperwage claims to be a revolutionary new theory. However it is merely another variation in the endless quest for the free lunch. In physics, this is seen in the perpetual motion machine. In economics, we have Congressmen advocating public debt to be charged to the Central Bank; we also have hyperwage theory. We need honest-to-goodness science to remind us: there ain't no such thing as a free lunch.

[Next post: will the employers take their additional wage bill sitting down? Not at all - let's explore the implications of their reactions in Part 3 of this series on hyperwage theory.]

8 comments:

Anonymous said...

sorry to disagree with you on NO NET INCREASE in purchasing power. You seem to be forgetting that MONEY in the hands of the employer is DEAD money but once it is released to Maid it introduces MORE money into the system. Pls recall that P1,000 in the hands of the employer (saved) is only P1,000 for the entire economy,BUT BUT once that money is given to the maids, there will be P5,000 introduced to the economy (THis is in fact Keynesian multiplier, and is the same multiplier effect EXPLOITED by the banking system).
Thus, in my opinion, your statement is wrong... but dont worry, I used to think like you do.. but I changed with I realized that money is not 1+1=2 but actual 1*5=5.... (this is jumping the gun but I will discuss this in my series...

Now, im sorry i cant continue discussing bec I am very bz writing my book. But I urge you to do one thing. Assume Hyperwage is true, then use whatever knowledge you have to defend it...

I just gave you an example above. The default mindset of the economists is that 1+1=2. Therefore no net purchasing power increase..

On the other hand, I have just shown you that MONEY does not work that way. MONEY is multiplied once it is moved from ONE hand (where it was just sitting there as savings or unused) to the OTHER hand where it can be subject to the multiplier effect.

But then you are the economist not me...

anon said...

so the money that employers saved, they dont find their way to the economy? no investors make use of these savings? how many of these employers are hoarding cash and putting them under their mattresses?

Econblogger said...

I have to disagree. At most what you could get is an increase in the existing multiplier owing to a transfer from a sector with lower propensity to consume, to a sector with higher propensity to consume.
But the story is still dead in the water. Once the economy hits full employment, the multiplier grinds to a halt. No 20-fold increase in income to Hong Kong standards.

The money multiplier of the banking system merely exploits the fact that banks use a fractional reserves. The quantity of money created in this system then affects the economy through the usual channels. It also cannot magically push output beyond its potential.

I am offering fatal arguments against hyperwage theory, hence, I must decline your request to defend it (even on a hypothetical basis.)

Anonymous said...

Anon is confused between consumption and investment and savings....

Anonymous said...

we will never hit full employment (or say attain that in 100 years).. by that time we will ne at hyperwage levels, then as I have written, we will shift to inflation centric economics..

Keynes has recognized that consupmtion is the MOST IMPORTANT of all factors... it is the key to the economy..

Econblogger said...

Actually, Keynes said that it is the inability of the interest rate to match savings and investment which is the reason for unemployment. If interest rates do not equalize savings and investment, another mechanism will - and that is output adjustment. Hence it is not consumption, but the savings-investment balance which is the key.

anon said...

assume you live in a two period world, what is savings and investments today but to allow you to consume more tomorrow. don’t treat savings as a leakage in the system. i think econblogger has shown enough that hyperwage theory is just a new collar for an old dog that’s keynesian economics.

Elevic Pernis said...

I am starting to write a series of blog entries that critique Hyper Wage Theory. But I'm glad to find your site.