The Fallacy of Inflationary Wages

Sometimes it’s just a good idea to just let history be your guide. There’s the usual argument between Academic Economists (pdf) and the Wall Streeters who are at odds over whether or not raising the minimum wage would cause inflation. Basically, the Academics say raising wages would not create inflation, and Wall Street disagrees. The disagreement is (in essence) over inflationary wages, also known as a price-wage spiral.

The crux of the Wall Street argument is that by raising the minimum wage from $7.25 to $10.10, an increase of 28%, it would lead to either a) mass unemployment (as if we don’t have that already), or b) inflation. Their “new” (old) argument is that a 28% increase in wages would be too much of a shock to the economy. Academic Economists disagree. So let’s look at history.

In 1958, the steelworkers shut down the U.S. Steel industry (causing a recession) because they wanted an increase from $1.45 per hour to $5 per hour (the minimum wage at the time was $1 per hour). Let’s forget about the ludicrousness of a steelworker making just above minimum for a moment. Their demand was a 344% increase! The steelworkers eventually won their $5 per hour, so how’d that work out for the economy? Not so bad…

fredgraph

Essentially, the fluctuation in hours worked matched wages, and had no relationship with production output. The production index measures output, and fluctuates based on retooling, recession, surplus inventories…everything except labor productivity. So industry didn’t suffer.

How about the over all economy? After the strike was over, we saw a whopping 6% growth in GDP, while real prices (CPI) remained low (a.k.a. NOT inflation). The 1968 spike in inflation and drop in GDP growth was caused by 2 things: the run up to the stagflation of the 1970s, and the peak of the Vietnam War. Otherwise, we see no effects from the 344% increase in steel wages.

fredgraph1

And never again, would consumption have much to do with the CPI…

fredgraph2

The Academics, those folks who sometimes make theory based on real-life observations were right – imagine that!

Even if the Wall Streeter’s ideas stood the test of time, what the Wall Streeters are forgetting is that unlike in 1959 when the U.S. was tied to the Gold Standard, we have an unfettered Fed that can control the M2 to protect against inflation. That means that in 1959, the “free market” made everything okay in a 344% increase in wages for the larges labor sector in the land. Wage inflation didn’t happen, prices didn’t spike, GDP didn’t suffer, and the world didn’t suddenly come to an end.

In fact, there is no record ever, of inflationary wages (price-wage spirals), or inflation tied to wage hikes ever happening in history. Inflationary wages is a theory that’s never been proven in real life, which is, I suppose, happens when non-economists start dabbling in economics.

 

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