Latest EU Fad: Raise Minimum Wage

After years of fiscal torture of country after country along the southern rim of Europe, the EU recently turned its attention to France. It was time for Paris to be subjugated. But unlike their southern neighbors, the French government got scared of the well-documented consequences of austerity and wanted no part of it. Since France is not as easy a pushover as Greece or Portugal, the Eurocrats in Brussels  found themselves trying to bite off more than they could swallow.

In order not to look like losers, the EU Commission quickly decided to refurbish its agenda. All of a sudden the chair of the Commission, a Eurotarian by the name Jose Manuel Barroso, declared that

the EU’s budget-slashing response to the economic crisis has run its course. Speaking in Brussels at a meeting of European think tanks, Barroso commented that “while I think this policy [austerity] is fundamentally right, I think it has reached its limits.”

In other words, Barroso and his cohorts of fiscal dictators now think they have destroyed enough jobs, raised enough taxes, starved the health care systems to a sufficient level of fiscal anorexia, and killed the future prospects for a satisfactory number of young people. Now they can leave the economic wasteland behind them as if nothing really happened.

Well, if things were at least that good. Even if the EU Commission would escape any accountability for what it has done to the livelihood of a hundred million Europeans – if all  it would do from now on were leave the European economy alone, it might be possible to move the years of austerity into the annals of history. But that is not what is going to happen. As Barroso hinted, his commissioners have tasted blood and will not let go of their new-found instruments of power. They have become far too fond of their self-appointed role as supreme fiscal policy experts.

If they indeed stop shoving austerity down the throats of EU members, it will not be because they have become born-again libertarians who will leave the economy alone. Far from it. The alternative emerging from the hallways of the Eurocracy is almost as ridiculous as a continuation of austerity. From the EU Observer:

EU social commissioner Laszlo Andor has asked Germany to raise its wages in order to boost consumption and help other countries in the eurozone to export more. A shift from budget cuts and austerity towards economic stimulus is needed to help the southern euro-countries overcome the crisis, Andor told Sueddeutsche Zeitung in an interview published on Monday (29 April).

So now it is time to shift from one form of destructive incursions into the free-market economy, to another. Instead of raising taxes and cutting government spending to balance the budget of a member state, Mr. Andor and his fellow EU Commissioners now want to force private employers to pay their employees more.

The minimum wage is an attempt at making private businesses part of a government welfare program.  It is a major issue here in the United States, but its effect on the labor market is even more intrusive in high-unemployment Europe. It has one of two effects:

  • Some employers are discouraged from hiring more people, as the expected revenue increase from the work of that extra employee falls short of what the person would be compensated;
  • Other employees will try to stay in business by raising their prices, thus passing the cost of the minimum wage on to their customers.

Either way, the end result is higher cost of living for consumers and fewer entry-level jobs for new job seekers, especially the young. For a good, in-depth study, see Mark Wilson’s recent Cato Institute Policy Analysis. Or continue to read and we will do a little experiment to show how ridiculous the minimum-wage regulation really is.

First, though, let’s hear more from Commissioner Andor:

“Saving alone does not create growth. That requires additional investment and demand,” he said. Andor, a left-wing economist from Hungary, also pleaded for countries like Spain, Italy and France to be given more time to bring their deficit in line with EU rules. If not, he warned, all these countries will just pile on more debt.

The only right thing to do is to eliminate the Stability and Growth Pact altogether, and thereby do away with the legal mandate that EU member states must balance their government budgets. But relaxing its enforcement is a step in the right direction. Mr. Andor is also correct in that the European economy needs more demand. But after having made that observation, Mr. Andor resorts to traditional statist thinking, namely that government can somehow dictate the course of the economy. He should have learned from the EU Commission’s attempts at dictating a balanced budget in, e.g., Greece. But no:

He advocated a minimum wage in Germany – a demand also being made by the Socialist-Green opposition – explaining that it would help raise overall wages and boost consumption in the EU’s largest economy. “Belgium and France have been complaining about German wage dumping,” Andor added. If Germany continues to keep the wages low and have high export surpluses, the commissioner warned, “the currency union will drift apart. Cohesion is already half lost.”

The currency union was a mistake in the first place. The euro zone is not an optimal currency area as defined by widely accepted economic theory. But more importantly, it was constructed in such a way that the currency union was isolated from fiscal policy and any other policy area with implications for the performance of the economy.

This macroeconomic artifact assumes that the real and monetary sectors of the economy never interact, that money somehow plays an isolated role in the economy. But modern economies are far too complex for any such isolation to take place. Even such simple things as credit cards break down the barriers between real and monetary economic sectors. People’s demand for money is closely tied to their consumption – a part of the real sector – and thanks to the existence of credit the banking system is actually part of creating money supply. Their part of the money supply is entirely driven by demand and credit ratings, which mandates a monetary policy that goes in lockstep with fiscal policy.

Under the currency union such coordination has been impossible. But as soon as things went rough in Greece, Spain, Portugal and Italy the European Central Bank quickly abandoned its independence decree and began interacting very closely with the fiscal-policy authority, the EU Commission. This is strong evidence of the construction flaw that was built in to the currency union. If it had been designed properly from the get-go, the current crisis would not have been nearly as bad.

That was a tangent, albeit an important one. It hints at a systemic error in the entire European construct that has made life worse for almost half-a-billion people. More on that in a later article, though; time now to return to Commissioner Andor’s demand for higher minimum wages in Germany:

Germany’s central bank, the Bundesbank, warned in February against raising wages too quickly, as companies would fire people and invest less. Dramatically increasing wages would only temporarily boost consumer demand, it argued, and in the long run, real incomes and consumer spending would actually decrease.

Correct. Consider the following experiment as an illustration of why a minimum wage is a bad idea in the first place, and raising it is about as bad as introducing it in the first place.

Suppose you have just opened a coffee shop and you have hired six people. Your business is making just enough money to pay the bills, so you are not paying yourself anything. You can only afford to pay your employees minimum wage. They all work 40 hours per week at $7.25 per hour, which puts your weekly employee cost (excluding payroll taxes) at $1,740.

One day EU Commissioner Laszlo Andor and his minimum-wage posse ride through town. When the dust settles you are left with a wage bill of $8.50 per hour, per employee. Suddenly, your costs went up by $300 per week.

How do you come up with that money? You could raise your prices, but the neighborhood is fairly competitive. Besides, you know your patrons are pretty price sensitive, and as a new business you want to encourage them to come back. You do not want to alienate them by suddenly raising prices.

You have two alternatives. You can reduce everyone’s work week from 40 to 33 hours and bring your wage costs down to $1,700, about where they were before the minimum-wage increase. You can also fire one employee and achieve almost the exact same cost cut.

Either way, the harsh reality of doing business will force you to contribute to the job destruction that always follows in the footsteps of a rising minimum wage. As bleak an outlook as this might be, at least it is based on sound economic analysis. It provides, in a very simple setting, the microeconomic foundation for the Bundesbank’s concerns regarding demands for a higher minimum wage in Germany.

There is only one way out of Europe’s crisis, and that is to get government out of taxing and regulating the private sector – and to structurally reform away the welfare state. Mr. Andor’s alternative to austerity may look good at first glance, but its consequences down the road are going to be solidly negative. Unfortunately, it also illustrates the statist mindset that has the EU Commission in a tight grip.