This article first appeared on The Globalist.


Why the United States must boost its minimum wage.

The economies of the rich democracies today resemble patients in a persistent vegetative state where full employment is a rare bubble condition, rather than the norm. Demand is too modest for a full recovery. The prescription with fewest side effects is to raise wages.

The issue of slowing growth in the West (even after the global financial crisis had passed) was perhaps first explored by Robert Gordon, who warned in August 2012 that longer term U.S. growth was ebbing to the slowest trend in a century.

Viewed initially as purely a supply-side phenomenon, it has lately come to be perceived as a demand side phenomenon by Martin WolfDaniel Stelter in The GlobalistLawrence Summers and others. Summers and Stephen King, for example, wonder how the rich democracies can escape from what has become a Japanese-style lost decades.

The new macroeconomic normal features exaggerated trade imbalances and in the West, inadequate demand portending slow growth and thus inadequate progress on public and private debts. Weak demand coupled with excessive debt has unduly raised the odds of destabilizing restructurings and defaults at both the household and national levels.

A look at the facts

The evidence is compelling: Before the credit crisis, the economies of the rich democracies performed less than ebulliently despite rising (debt-financed) household spending and several financial sector and housing sector bubbles. And the recovery continues to feature meek job and GDP growth.

American wages continue to stagnate as well, while the national wage setting mechanisms in northern Europe continue to deliver wage growth for many there, even as income disparities widen. Yet, European commercial lending and thus investment is contracting as banks struggle with the European Central Bank’s asset quality reviews and stress tests requiring them to rebuild as much as €100 billion in equity.

In both the United States and EU, insufficient aggregate demand has replaced the business cycle as the bugaboo of economists, underemployment its hallmark. And the only place to find inflation is in history books and full employment awaits the next bubble. “We have become an economy whose normal state is one of mild depression,” is how Paul Krugman puts it.

The traditional macro tools seem unhelpful: monetary policy is all-in and fiscal policy remains hampered by politics and excessive public debt. Others solutions such as inflation, negative interest rates or public investment should be pursued, but are not sufficient remedies.

What to do?

The most promising option is to raise real wages. That proposition won’t puzzle European scholars familiar with the Australian and northern Europe wage determination mechanisms. For decades, these countries have effectively and providentially linked real wages there to productivity growth.

For example, wages in the German retail sector rose 1% adjusted for inflation this year, and French wages next year are also forecast to rise about 1% in real terms. That’s why wages in those nations, assessed in purchase power parity terms, are $10/hour or so above the United States and inch higher every year.

In contrast, American real wages, as reviewed in my book “What Went Wrong”, have been flat or worse for over a generation. The 180 million or so working- and middle-class employees constitute an enormously and doubtless eager cohort for addressing secular stagnation.

Of all people, the CEO of Goldman Sachs, Lloyd Blankfein recently stated: “This country does a great job of creating wealth, but not a great [job] of distributing it.”

The relatively high marginal spending propensities of lower income Americans suggest the demand impact would be maximized by raising the minimum wage.

Parallels from peers

Germany will soon be imposing a nationwide minimum wage of €8.50 an hour ($10.50 or so), which will spur domestic demand. The latter would be a step in the right direction of moderating its hot-button current account surplus.

In Australia, the minimum wage exceeds U.S. $11 adjusted for purchasing power. Yet, its growth in GDP has exceeded the United States for years and Australia has an unemployment rate of 5.8%, below that of the United States. Labor participation is also higher than in the United States. Clearly, a high minimum wage has not destroyed jobs or crippled growth.

The United States should similarly support demand by raising its nationwide minimum wage, now set at $7.25 per hour, which is well below rates abroad. Federal Reserve Bank of Chicago economists have concluded that a $1 increase in minimum wages would raise incomes in affected households by $250 per quarter and spending even more the following year.

Raising the minimum wage floor will ratchet up wages for as many as 30 million other employees. Moreover, research by economists such as Arindrajit Dube is concluding that raising minimum wages can even have a tiny positive impact on employment, with employer costs ameliorated by reduced labor force turnover.

Importantly, both Germany and the U.S. should adopt the Australian and French policy of indexing minimum wages to productivity growth as well as inflation.

Stop subsidizing low-wage employers

That step would also see the bizarre American taxpayer subsidy to low-wage employers like McDonalds or Walmart wither away. A Democratic Congressional study found that last year public healthcare subsidies alone averaged $3,015 for each Walmart employee in the typical state of Wisconsin. Other subsides raise the total to as much as $5,800 per employee.

Indexing the minimum wage would also end the spectacle of such profitable firms organizing volunteer donation food drives to supplement employee wages. Along the same lines, rather than raise wages, McDonalds recently suggested that its employees should take second jobs and split dinner into two sittings, several hours apart.

A second step is establishing a sweeping American facsimile of the Australian and northern Europe wage determination mechanism. Labor compensation for almost every American has become structurally decoupled from productivity, and utilizing these proven, effective mechanisms to reconnect will address the secular stagnation conundrum.

Raising labor costs will slow job creation, but an extensive analysis by economists at the International Labor Organization recently concluded that the impact on aggregate demand in the European Union (EU) of a broad one percentage point real wage increase was nonetheless sufficient to raise employment on balance.

Decades of evidence

Above all, the weight of decades of evidence in Australia and northern Europe document that linking wages to productivity growth in this fashion will not jeopardize U.S. competitiveness or engender wage drift.

Addressing the new normal of secular stagnation should not be restricted to macroeconomic tool refinements. The American economy offers opportunities drawn from traditional, proven practice in other rich democracies involving wages to considerably enhance aggregate demand.

Raising minimum wages and indexing all U.S. real wages to productivity growth is an efficient solution. If secular stagnation proves to be the new paradigm as economists fear, it can best be addressed by a new American wage paradigm drawn from decades of practice in other rich nations.