When I wrote this paper in 1994, there was a "Rebuilding America" movement in the federal government to improve the economy. Here is a condensed version of the movement's goals, and how to reach them:

1.   Lower unemployment rate without increasing inflation.
2.   Increase private investment.
3.   Increase public investment by 1% of GDP
4.   Lower current account and trade deficits.

My recommendations:
  Eliminate the minimum wage.
  Reduce expenditures on welfare programs, esp. social security.

The most difficult point of the agenda is the first. As the renowned economist Arthur Okun has pointed out, no industrial nation has ever been free of both excessive unemployment and inflation simultaneously. In fact, Okun's Law is a well-supported macroeconomic phenomenon which states that inflation is inversely proportional to unemployment. The sad implication of this is that if you lower the unemployment rate, inflation will rise. However, I believe there is a loophole in this theory, because it assumes that certain things remain constant in the economy. The policy I advocate to take advantage of this--and to let you have both higher employment and stable inflation--is to eliminate the minimum wage. To explain why this should work, I must explain what drives Okun's Law.

One of the main causes of inflation, and the one that appears to tie it to unemployment, is known as demand-pull inflation, which works as follows: As unemployment falls, there is more money looking for a relatively constant supply of goods (in the short-run), which bids up their price. The higher prices allow for higher wages, which increase income and thus tend to reinforce the cycle. Cutting inflation under this system amounts to firing people to reduce the supply of disposable income. However, with no minimum wage, unemployment is absorbed first by lower wages, which balance the labor market and actually cause a temporary deflation (higher output, same costs). Lower wages also reduce unemployment by reducing the number of people who want to work at the going wage. Once the market picks up the slack, inflation may still occur. But although deflationary fiscal policies must still reduce output, unemployment is now allowed to correct itself via the labor market.

I realize that initially this suggestion will be unpopular. However, everyone must realize that the country will be better off as a result. All the minimum wage does right now is create an inefficient illusion. People believe that their labor is worth the minimum wage when it's not; any policy that distorts information and competition is economically bad. A simple microeconomic analysis indicates that the minimum wage is probably the sole cause of unemployment, excepting market inefficiencies. Dropping the minimum wage will actually increase output, because people will be paid their competitive value rather than the monopolistic minimum wage. Furthermore, because real disposable income will not fall, and should actually rise in the long-run as it catches up with the higher per capita output, citizens will be no worse off overall than they are now. Also, this normalizing distribution of the no-minimum-wage policy can be attached to a political platform of financial equality: Even though it affects the poor far more than the wealthy, it undoes the current arbitrary bias of the minimum wage toward those who are lucky enough to find jobs.

It may seem at first that lowering the minimum wage will cause some difficulties in enacting the second point of the agenda. One of the best ways to increase private investment is to increase the amount of money available for saving. Although dropping the minimum wage puts earned money in more people's pockets, the normalizing effect causes the amount in each person's pocket to drop. The problem here is that people do not save any money at all until they reach the "break-even" point (empirically on the order of $25,000), and actually tend to borrow when they are below it. However, since the bulk of normalization will occur in near-minimum wage workers, whose income generally falls under the break-even point, the net change in saving due to the normalizing effect will be negligible. Likewise, although it is likely that more people will require welfare assistance, each person will now need less.

Even if the number of people who save decreases under this policy, it is still possible to increase net private investment by changing people's marginal propensity to invest. One way to do this is to offer capital gains tax breaks. However, a much more econocentric method is to reduce the price of money--interest rates. It is true that lowering rates will reduce overall saving, but by reducing the return to money left in banks, capital investment becomes more lucrative. I will leave it to the econometricians to estimate the exact figures, but I expect that the increase in marginal investment will outpace the reduction in marginal saving.

How do you reduce rates? The government does this most easily by reducing expenditures (which IS-LM analysis quickly demonstrates). And it happens that reduction of spending is also the key to part of the fourth item of the agenda: reducing the budget deficit. To do this, you will have to make significant budget cuts. However, this is a very tricky thing to do in any large degree without upsetting the economy by reducing government employment. For this reason, welfare programs are easy targets because that money is not distributed to people with high marginal propensities to invest.

Large cuts in welfare programs will reduce interest rates (increasing investment) and reduce the budget deficit. For political purposes, most cuts should probably be made to segments of the population not hurt by the elimination of the minimum wage, such as those covered by the social security program. Cuts in this program will also probably increase the population's marginal propensity to save, as people try to compensate for their own individual security. To the extent that transfer cuts are used to relieve debt (as opposed to increasing output), inflation will fall.

The lower interest rates achieved above tackle the last point of the agenda--trade deficits. The only way to reduce these is to increase the export/import ratio. The most practical way to do this (because the marginal propensity to import is more or less exogenous) is to weaken the dollar. Relatively low rates make other currencies more attractive, reducing demand for the dollar. This reduced demand makes the dollar less expensive, which in turn makes U. S. goods less expensive, which increases demand for them. Conversely, foreign goods become more expensive so that demand for imports falls.

As has been shown, eliminating the minimum wage serves to drastically and permanently cut unemployment. Not only will this increase output in the short-run, and real disposable income in the long run, but it will also help to normalize what is currently an inequitable and relatively arbitrary distribution of income. Furthermore, it will result in an immediate deflation, and a long-term loosening of the ties between unemployment and inflation. Cutting transfer programs, especially social security, and distributing these cuts especially toward debt relief reduces GDP, which in turn reduces both interest rates and inflation. The drop in interest rates both increases private capital investment and weakens the dollar, reducing the trade deficit. Some of the cuts from transfers can be used to finance capital investment without raising taxes. Thus, you can have your cake and eat it, too.

David Bookstaber