With an eye on Germany…

Be careful with the minimum wage

US minimum wage (today): $7.25, US (Bernie Sanders proposal): $15; Germany (govt coalition): $11.98, Germany (Finance Minister Scholz, SPD candidate for chancellor): $13.75. Germany’s US$ equivalent is at 3Y avg exchange rate 2018–20 of 1.146 US$ per euro. At weaker US$, 1.199 seen on 3/11/21, Germany’s US$ equivalents were $12.53 & $14.39 respectively. German govt’s min. wage hike to be done in steps thru 2022; Sen. Sanders proposes in steps thru 2025. Sources: BIS and news reports.

If you’re going to raise the minimum wage, stay inside of Germany’s (and other U.S. competitors’) minimum wage. See chart above. If reducing inequality is your goal, there are better ways to do it.

Inequality in the U.S. is a big problem. Income and wealth distribution are heavily skewed in favor of the rich, poverty levels are higher than in most advanced countries, and racial inequalities persist, notably in education and economic opportunity. See charts at the end of this note.

Democrats in the Senate offered an amendment last week to President Biden’s Covid relief bill which would raise the minimum wage to $15 an hour. The Congressional Budget Office (CBO) has estimated that this could go far to reducing inequality in America, boosting the wages of some 17 million workers and pulling 1.3 million people out of poverty.

But, the minimum wage may not be the best way to help the poor. First, some 1.3 million low-income workers or more could lose their jobs due to higher wages. Second, some people who don’t really need the uplift will get it.

If a retiree with ample savings is selling stocks from his or her 401k, reaping huge capital gains, but also works part-time for the minimum wage, this person would receive an unneeded boost. Not saying that this example is indicative of a large segment of the population, but it makes the point about targeting the neediest.

Raising the minimum wage is popular, but means-testing U.S. entitlements is not. Means-testing Social Security, Medicare, subsidized housing, college grants and loans and other programs is essential to the long-run sustainability of America’s finances.

Means-testing leaves more money available for the neediest, providing more bang for the buck in the fight against inequality. But, few politicians talk about this option.

Case in point — education spending favors the well-off in America. It is based on local property taxes that enable affluent school districts to adequately fund their kids’ education. The federal education budget, miniscule in size at under one percent of GDP, does something to offset this unequal funding structure, but not enough.

One of the largest items in the education budget is Title I funding of disadvantaged schools. However, Title I funding is part of a bargain with the middle class. College assistance, largely a middle class program, is also one of the largest items in the federal education budget.

To garner broad support for anti-poverty programs, the federal government often has to open the spigots to less-needy constituencies. College loans and grants should be means-tested more effectively, freeing up resources for underfunded school districts.

Means-testing is critical to America’s future. It could free up funding for programs that directly impact inequality and poverty — such as education and job training, adjustment assistance, income support and health care.

A fairer tax code is also required. The IMF recommends the U.S. increase the size of, and broaden access to, the Earned Income Tax Credit (EITC) for the working poor. The CBO estimated in 2019 that a family of five tops out with an EITC benefit of about $7500 and loses eligibility for any benefit on income they earn over $64,000. The government should raise this threshold and increase EITC amounts.

President Biden’s Covid relief plan (the American Rescue Plan) expands the EITC as well as the Child Tax Credit. These initiatives should be extended beyond the coming year. Likewise, Trump’s tax cuts favoring the wealthy should be reversed, although this will surely raise partisan temperatures.

Returning to the minimum wage, some adjustment upward makes sense. At $7.25, the wage, unadjusted since 2009, is woefully low. CBO estimates indicate that the smaller the increase in the minimum wage, the lower the uplift in unemployment. At $12, the CBO forecasts an increase in unemployment of about 0.3 million workers.

A good guide for where the minimum wage should land comes from other countries, especially U.S. competitors. Germany’s coalition government — including the center-right CDU/CSU and the center-left SPD — agreed last fall to an uplift in the minimum wage to €10.45, which at the 3-year average exchange rate is about $12.

The U.S. should stay inside of its competitors’ labor costs. The graph that follows shows unit labor costs (the ULC), calculated by dividing labor compensation (largely wages) by labor productivity (output per worker). This ratio is a country’s labor cost of producing goods and services, and is one of the best measures of a country’s cost competitiveness.

Unit labor cost (ULC) index from the OECD: labor compensation divided by productivity. Quarterly ULC in the graph above is calculated as compensation per worker divided by GDP per worker. Wages per hour divided by output per hour is a better ULC measure, but the OECD notes difficulty getting hourly data.

Germany, with a traditionally favorable track record of wage restraint and labor productivity, has lost competitiveness to the U.S. in recent years. (Data in the graph only go to 2019 because the pandemic introduced volatility in the figures.)

So, careful with the minimum wage, please, lest the U.S. lose its labor cost advantage. Furthermore, an additional cushion is required in case the U.S. dollar strengthens against the euro (and other currencies), which could eat away at America’s labor cost advantage.

Germany’s SPD (or Social Democratic Party), similar in ideology to U.S. Democrats, would prefer to raise the country’s minimum wage even more, to €12, or $13.75. A federal election later this year will determine whether Finance Minister Olaf Scholz of the SPD, who is running for chancellor, will get his way with a higher minimum wage.

Even so, this higher wage would be below Senator Sanders’s proposal. Germany’s center-right and center-left parties reached a compromise on the more modest wage hike (to €10.45), a lesson in moderation that should not be lost on America’s political leaders.

To maintain export competitiveness, the U.S. should keep a keen eye on the long-run drivers of country success — such as education and social outcomes, political stability, and sound government finances. These have all been deteriorating in recent years.

This Country Success newsletter is about “how other countries do it; lessons for the U.S.”

Ten Point Plan: Strategic Planning for the U.S., a paper I co-authored, can be found on the Country Success website here. In it, we produced an index of country success. The U.S. scored only 14th best among 71 countries, while Germany was ranked 5th. U.S. policymakers should address the country’s weaknesses while building on its strengths, in order to ensure competitiveness over the long term.

The argument for restraint in raising the minimum wage presented here is in no way meant to dismiss the problem of inequality in America. This results in lower economic growth by excluding a portion of society from aggregate demand and from skills acquisition, and is a key driver of political polarization and frustration throughout the land. The main argument in this article is for a better targeting of the problem than would be provided by a large minimum wage increase.

The indicators of inequality in America remain poor. Witness:

Notes and sources:

Note: Another example of the bargaining done to secure anti-poverty programs involves food stamps and school lunches. They have been linked to legislation providing subsidies to U.S. farmers, a log-rolling exercise that has resulted in a misallocation of resources.

Sources:

https://stats.oecd.org/Index.aspx?DataSetCode=ULC_EEQ

https://www.cbpp.org/research/poverty-and-inequality/american-rescue-plan-act-will-help-millions-and-bolster-the-economy

https://www.imf.org/en/Publications/CR/Issues/2020/08/07/United-States-2020-Article-IV-Consultation-Press-Release-Staff-Report-and-Statement-by-the-49650

https://countrysuccess.net/

https://www.cnn.com/2021/03/05/politics/senate-covid-relief-vote-a-rama/index.html

Thomas Oatley, International Political Economy, 5th edition, pp. 84–85

Roger teaches political economy at NYU, is the former Head of Country Risk at GE, & co-author of Ten Point Plan for the U.S. (https://countrysuccess.net/)