Job Creation Through Wage Policy

June 3, 2013
By Oren M. Levin-Waldman

The official unemployment rate is still around 7.5 percent, although the actual jobless rate (those who simply gave up and dropped out of the job market is considerably higher. It is curious that as the official rate has fallen, we hear less about the need for policy to address the slow economy. And yet, one problem that appears to persist is that of long-term unemployment. There are a couple schools of thought as to the source of long-term unemployment.

The neoclassical school holds long-term unemployment to be a function of wage rigidity. If only government policy supporting collective bargaining and minimum wages didn’t prevent workers from lowering their wage demands until the point that their labor services are consumed. Add to this, Unemployment Insurance (UI) only prolongs unemployment because it raises workers’ reservation wages. Or so this is the argument for why we have unemployment. We have long-term unemployment because structural changes in the economy have meant that jobs that disappeared are never going to come back. Another school of thought holds that while it is true these jobs most likely will not come back, the underlying problem is still insufficient demand for goods and services. This would imply that the problem s basically cyclical.


To date the public policy approach has been for the Fed to tinker with interest rates in the hope of stimulating investment. In fact, with quantitative easing interest rates are practically at zero. And yet, the recovery has nonetheless been slow. Democrats still call for investments into the economy while Republicans call for tax credits — especially to business. Both investment and credits can be said to fall into the broad category of fiscal policy. At a certain level, however, we need a mixture of both fiscal and monetary policy. Both are important stabilizers. Missing from this mix is what Sidney Weintraub almost four decades ago referred to as “incomes policy” or simply wage policy.


Conservative economists like Milton Friedman thought that incomes policy would serve as a means of maintaining wage restraint. While advocating roughly a three percent steady growth in the money supply to maintain stability, he was also assumed that money wages would be accommodated. In short, wages would increase to match productivity. Weintraub sought to go further with the argument that incomes policy was really the missing stabilizer and that proponents of both fiscal and monetary policy should actually welcome incomes policy as a supplement to their proposals.


Although the term incomes policy was often used as a euphemism for wage and salary restraints, perhaps on the assumption that our economic problems were due to wage rigidity, an incomes policy should be viewed as an essential ingredient in shoring up the middle class and maintaining economic security through its potential to arrest wage stagnation. The reasoning is actually quite simple. Fiscal policy involves huge expenditures of public monies which, if not properly targeted, will not necessarily have the desired effects. Sure, various interests will benefit from grants and contracts. Moreover, because fiscal policy, especially in the form of increased spending, it would necessitate a new tax structure to pay for it. Monetary policy, because it affects the money supply may achieve more because any would-be entrepreneur can take advantage of easier money to invest and create jobs. But monetary policy, at least as it is executed by the Fed comes with a huge cost. Statutorily, the Fed serves the banking interest and its primary responsibility is to ultimately ensure the solvency of banks. As inflation rises, the Fed typically applies the breaks with higher interest rates and reserve requirements, and the inevitable result is unemployment. Inflation would surely arise from greater government expenditure as more workers would seek an increase in their wages to pay the greater tax.


Weintraub was only too quick to point out the immorality of economists applying the breaks to control for inflation, as they themselves were unlikely to lose their jobs. Therefore, Weintraub was suggesting that if wages could be governed directly, price stability would avert economic damage occasioned by conventional stabilization instruments. 


We can actually define wage policy more broadly to include a set of labor market institutions — unions, minimum wages, living wage ordinances, or the types of centralized wage setting institutions found in Europe — for the purpose of bolstering wages. Wage policy is important because without it the erosion in the value of workers’ wages means that they are unable to continue demanding goods and services. Without a wage policy that would have the macroeconomic benefits of allowing workers to maintain their purchasing power, traditional fiscal and monetary policy as tools for job creation are only bound to fail. If workers do not have the wherewithal to demand goods and services, it does not matter how low interest rates fall or how flexible workers are in their wage demands. At the end of the day, the issue is aggregate demand for goods and services. An economy, after all, needs to be built from the bottom-up; not the top-down. In the end, this might be the best solution for the long-term unemployed.

June 2, 2013

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