Pretty much everyone wants a higher standard of living, the question is how do we get there?
Some argue that prosperity results from a wasteful and soul-killing consumeristic culture (so, that’s bad) or from government stimulating something called “aggregate demand” (so that’s good). Let’s assume prosperity is good, and governments have something to do with it.
Many suggest (and most textbooks assert, with either little or with rather spurious evidence) that the growth of labor unions and minimum wage laws played a role in increasing incomes—or if not that, at least in mitigating income inequality. The US Department of Labor states this matter-of-factly: “Labor unions improve wages and working conditions for all workers, whether they are union members or not. Unions help reduce wage gaps for women workers and workers of color.”
Classical economists suggested that we should focus on supply rather than demand, echoing Jean Baptiste Say’s suggestion in 1803 that supplying goods creates income that is sufficient to purchase the goods produced. “The difficulty lies,” he wrote, is “not in finding a producer, but in finding a consumer.” In other words, we’re wise to focus on the supply of rather than the demand for goods.
Who is right?
Let’s imagine a simple model to gain some insights. We’ll call it Orangeopia.
In Orangeopia, a Robinson Crusoe-style island economy exists. But let’s simplify it even more. Unlike Crusoe’s “island of despair,” this economy has plenty of people, but only one good—oranges.
A third of its citizens pick 10 oranges per hour, another third pick 20, and the richest third pick 30. Trees abound.
Why this degree of income inequality is the case is complicated. Several reasons account for it: some of the “10” orange pickers are lazy (though the more astute say they are simply preferring leisure over wages, so lower wages are a choice); some are worse orange pickers; some are voluntarily abstaining from oranges to (supposedly) help provide more oranges for their poor compatriots, while others just have less verdant orange trees. The richer tend to own the orange trees, and/or work hard—some might be labeled workaholics—while others are older; some are just really good at it. To do some deep analysis we’d have to talk about supply choices, supply constraints, and demand choices, but that’s not the point right now. Two important questions are how can we:
1—increase the standard of living, and
2—help the poorest third?
Let’s ignore what people in Orangeopia live in, wear, eat, and drive (apparently orange homes, orange clothing, oranges, and orange cars). Money doesn’t exist—the model eliminates the “money illusion” that often confounds economic analysis. After all, this is a thought experiment.
We do know the median per capita hourly income is 20 oranges, as is the average income.
And how can we increase that? The tautological explanation is that we need to increase the number of oranges grown and picked per hour. That rather self-evident point tends to give Say some kudos for suggesting a very obvious, yet often neglected, insight. The only question is how does a society increase the supply of goods (Adam Smith wisely suggests the trio of peace, “easy taxes,” and a “tolerable administration of justice,” along with time: It’s a bit like kneading a nice loaf of bread and patiently letting it rise).
Other options do exist, of course. Governments could increase the “factor inputs.” Stalin’s economic plans built massive projects (steel mills, cement plants, dams), gulags worked millions to death, and the state vandalized resources for short term economic growth. So, the Soviets’ command economy (which even “planned” the exact number of nails needed per year) increased capital, labor, and land inputs, and, by 1960, it looked as though they just might “bury” Western capitalist states, as Soviet Premier Khrushchev threatened more than once.
But after a generation of extensive exploitation, what finished goods—besides sometimes dicey military equipment—did the Soviets export? How much did an average citizen’s standard of living rise?
I remember my shock of seeing a hand-held, Russian-made (and rather heavy) flashlight for sale in an American mall: when vigorously shaken, it produced a weak beam of light. It was a truly awful substitute for a battery-powered flashlight. The USSR did sell other finished exports: vodka, clunky Lada autos in Cuba, and matryoshka, or “nesting” dolls, but the USSR was, and Russia remains, basically a Third World country with nuclear weapons that exported resources rather than finished goods.
So there must be a better way to increase people’s incomes, one that doesn’t involve state exploitation, inane commands, or environmental degradation.
Let’s return to sunny Orangeopia. Perhaps an Orangeopian union or minimum wage can at least decrease income inequality, or maybe even increase the per capita standard of living?
Let’s think this through.
Assume the poorest third, who pick 10 oranges per hour, collude, waving their orange picket signs, successfully demanding 15 oranges per hour. Or, the government institutes a 15 orange/hour minimum wage law. The economic effects are the same, with both involving restricting competition.
How will this affect their wages?
Best Scenario #1
The poorest third receive 15 oranges per hour. But as they only pick 10, the five extra must come from the middle or upper class. Per capita orange production remains at 20, though. Neither the minimum wage nor the union increased per capita income. But each one reduced income inequality.
Realistic Scenario #2
Given the fact that the bottom third workers are paid more than they are producing, they might become unemployed. Their income is now 0, and the average income drops from 20 to about 17. Worse yet, both the union and the minimum wage actually increase income inequality in addition to lowering average incomes.
Utopian Solution #3
Perhaps I’m too cynical, and the mandated 15 orange wage that unions or minimum wages achieve inspires an increase in productivity. The knowledge that I will receive 15 oranges per hour inspires me to pick 15. Of course, if this were true, my boss would have preemptively increased my salary to increase my productivity in a win/win deal without minimum wages or unions. Stingy bosses who never thought of this will lose both workers and profits.
Dystopian Solution #3a
Or it backfires. I know I will receive 15 per hour when I pick 10, so why even pick 10? I’ll work on my suntan (it’s a sunny island, after all), and pick 0 or 5. Which of course makes both the per capita income lower and the income skewing greater.
Or, for the upper third think about their situation, which involves some significant orange taxes: if my 30 oranges/hour is taxed punitively, I might move (to Lemonville, perhaps?), retire, or evade taxes.
The Moral of Orangeopia
Unions cannot raise per capita incomes, unless they spur productivity growth. If a union were to resist featherbedding and focus on enhancing productivity, it would increase incomes. Unfortunately, history suggests that the incentives they engender will tend to lower average wages. Whether they increase or decrease income inequality is hard to say.
Ditto for minimum wages. They cannot increase overall wages unless they spur more productivity, and they just might actually increase income inequality by helping some workers—who were already relatively productive—and hurting others.
The solution for orange abundance is to pick more oranges. Improvements in both human and physical capital will make us all richer, and absolute poverty will be replaced by relative poverty in a world of abundance.
Supply matters. Say was correct.