Friday, April 6, 2012

Mark Thoma, Paul Krugman and the San Francisco Fed All Illustrate Why the Economy Cannot Recover Faster – Wages and Hence Income is Not Rising

A Part of Basic Econ That Policy Makers Fail

If one listens to those whom Paul Krugman calls ‘Very Serious People’ the problem with the economy is that taxes on wealthy people are too high.  See in their minds wealthy people are so discouraged by high taxes that they will not invest and work to create jobs.  It’s not that they don’t want to, it’s just that the burden of taxes is so high they are clinically depressed. 

This logic requires public policy that reduces taxes on the wealthy, something Rep. Paul Ryan (R, Wi) has put in his budget plan and something that is enthusiastically endorsed by Mitt Romney (whose taxes would presumably be lowered by a huge amount).  The truth of course is something a lot different.  Businesses invest and create jobs when there is demand for the goods and services they produce.  No one has ever been able to document a single investment that takes place when demand or expected demand is not present, but a business invests in higher capacity anyway just because taxes have been lowered.

But increases in demand require increases in personal income or increases in personal indebtedness.  The economy has already done the increase in personal indebtedness thing, which in the short term does produce prosperity and in the long term where we are now produces disaster.  So the only way to get the economy moving stronger is to increase personal income.  Alas, that ain’t happening.

The excellent economic commentators Paul Krugman and Mark Thoma have commented on this chart from an economic study by the Federal Reserve Bank of San Francisco.

Measuring nominal wage rigidities
Figure 2
Distribution of observed nominal wage changes
Distribution of observed nominal wage changes
Sources: Current Population Survey (CPS) and authors calculations

What it basically shows is that for the large majority of American workers, the increase in nominal wages has been zero, or very close to zero. 

The figure’s most striking feature is the blue bar that spikes at zero, indicating the large number of workers who report no change in wages over a year. This spike stands out in the distribution of actual wage changes, suggesting that, rather than cutting pay, employers simply kept wages fixed over the year. This is supported by the large gap to the left of zero between the actual distribution of wage changes and the dashed black line representing the normal distribution. This gap suggests that the spike at zero is made up mostly of workers whose wages otherwise would have been cut.

So we have the very logical and expected outcome where the economy is not growing as fast as it should and as fast as it could because consumers don’t have the increases in income to buy stuff.  This is why the policy prescription of cutting taxes on the wealthy and expecting that to grow the economy is a triumph of faith over truth, logic and experience.

One is reminded of the story, probably an urban legend where the head of an auto company was showing the head of the union a factory floor full of robots.

“How many of those robots will you organize?” the auto company executive was reported to have asked the head of the union.

“How many cars do you expect those robots to buy?” was the reply of the union chief.

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