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The Disparity in Income Distribution Persists

By       Message Seymour Patterson     Permalink
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The issue of the disparity in income between wage earners and profit seekers just won't dissipate any time soon. Wage-earner laborers have seen their income stagnate, while profit-seeking CEOs have experienced a protracted escalation in theirs. On average for every dollar a worker makes, the CEO for the company gets compensation in excess of $400. This is an aberration with economic consequences for the economy and it accounts for the rise in income equality that was adroitly addressed by Thomas Piketty in Capital in the 21st Century. Why? Because workers generally are spenders, while rich capitalists have a propensity to save and invest. In times of slow economy recovery the former (workers) need to grow their incomes, but not the latter (capitalists). Right now, companies are hoarding approximately $3 trillion that they refuse to unleash on the US economy as investment to spur economic growth.

It is quite understandable that companies that are in the business to make money would want to keep the rise in wages at bay. After all, worker compensation represents a significant share of a company's cost structure. When labor costs increase companies might be forced to make labor substitutions with capital--like more automation, vending machines, self-banking, self-service--in an attempt to keep labor costs down. However, labor compensation must be tied to something. Firms are not allowed to willy-nilly pay workers anything CEO's feel. One of the things that enters the wage calculus is productivity. The more productive workers become the higher their financial compensation for their labor. Contributors to productivity include education, skill, and experience (i.e. learning-by-doing). Productivity might be defined as output per unit of input, namely, output per time (hours) worked. Hence, if my hours are fixed and my output increases over time, my productivity has risen. Or if my output is fixed and I achieve that level of output with increasingly fewer hours worked, then my productivity has risen. In the broadest and simplest sense, think of productivity as equal to real wages. Thus, spending is equal to price times quantity output and income is equal to wages times workers: pq = wn + ik, recognizing the role of capital, and where p is price, q is quantity, w is wage, and n is the number of workers. A bit of facile rearrangement yields q/n = w/p + ik/pn, which states that the real wage (w/p) equals output per unit of labor (q/n), which is a measure of labor productivity. Clearly, from this if productivity increases, this should translate into higher real wages (higher w/p). Yet, this is not what is actually going on. The rise is productivity is being passed on to capitalists in the form of ik/pn. Example: if productivity increases by 10% and the increase in the real wage is 0%, then all the increase in labor productivity is transferred to capitalists, i.e. 10%: q/n = w/p + ik/pn = 10% = 0% + 10%. Yet, the implication of the rise in income inequality is that labor productivity has been zero. However, Jeffrey Dorfman in Forbes makes a contrarian argument, namely: in the food service sector productivity was zero in 2011, while in 2012 it fell by 2.0 percent and labor costs rose by 2.8 percent, implying these workers were being compensated more for doing less. Anyone believes this justifies that $400 average spread between workers and CEO's?!

There is yet another piece to this wage issue. That is, higher wages not only cost business more and lead to potential layoffs, but also the resulting layoffs have social costs and the unemployed cost society a loss in output (reduction in GDP). Thus, instead of the government collecting taxes from them, Uncle Sam must now turn around and pay out more in unemployment compensation.

What is the overall takeaway from all this, namely, the skewness in the growth of income inequality, the high share of labor in total business costs, and the social costs of unemployment due to higher wages. This begs the question: Should wages never rise since higher wages have externalities? This is no less true about the minimum wage. Therefore, should the minimum wage not be raised, ever? Obviously, raising the minimum wage can result in higher unemployment. In January 2014, more than 600 economists signed a letter in favor of raising the minimum wage to $10.10 by 2016. Seventeen million workers would be affected by a 95-cent increase a year in the minimum wage over a three-year period. They highlighted the positive effects, including positive externalities: more income from $15,000 to $20,000 a year. The letter that the economists wrote states: "The vast majority of employees who would benefit are adults in working families, disproportionately women, who work at least 20 hours a week and depend on these earnings to make ends meet."

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Perhaps, the most important effect of raising the minimum wage has to do with spending. The demographic composition of minimum wage workers in 2012 that stand to benefit from the increase in the minimum wage in 2015 are not teenagers, they are over 20 years of age: 80 percent, while 20 percent are between 16 and 18 years of age. People with low incomes, as noted before, tend to spend whether they are teenagers or older. That is, the high propensity to consume out of additional incomes depends more on one's level of income than on one's age. Thus, rewarding low-income workers can be expected to increase spending in the economy. There are about 3.6 million people on minimum wage. If there were $5,000 more in the pockets of low income workers a year, that would translate into $18 billion more in spending in the economy on goods and services a year. In a $17 trillion economy, this might seem like a paltry share of one percent of GDP. But assuming a rise in employment results, then unemployment compensation falls, and output rises. Win-win all around!

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Seymour Patterson received a Ph.D. in economics from the University of Oklahoma in 1980. He has taught courses and done research in international economics and economic development. He has been the recipient of two Fulbright awards--the first in (more...)
 

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