Wage levels reveal poor public policy approach

Despite the continued tightening of labor markets, average wages are stalled at 1990s levels. This can only be partially explained by the recession.

Something else more worrisome is occurring. That trend and its causes are far more worrisome.

The flat average wages masks the underlying reality that highly educated folks have seen their incomes rise over that time, while poorly educated have seen them decline. Much of this may be tied to inevitable technological change that favors skilled workers over the unskilled. If so, the role of effective public policy will be limited to helping better educate workers.

Alas, there are no limits to ineffective public policy. For this reason, it is time to ask again whether public policy has played a role in speeding this technological adoption and whether that has made our labor markets worse. Let me explain.

Businesses combine workers and equipment to provide goods or services. The price of the people is their wages and fringe benefits, and the price of the equipment is the cost of capital, primarily interest rates and taxes.

People and machinery are what economists call “gross complements,” which is a jargony way of saying that men and machines work together. So, more capital investment will tend to increase the demand for labor.

In the long run, capital is a “gross complement” to labor, but individual capital investments and many new innovations are “substitutes” to labor. These substitutes replace expensive skills and expensive workers with machines, reducing the demand for labor in a particular factory or skill.

In the long run, we call this economic growth.

Typically the change is sufficiently gradual that workers can adapt.

But what if our public policies have mistakenly accelerated this change, making it so rapid that workers in large numbers had no time to learn new skills? That may be what is happening. Since the run-up to the Y2K bug, interest rates have been kept very low, for very good reasons — potential computer problems, two recessions and wars. These lower interest rates have dramatically reduced the cost of capital, while the cost of labor and their fringe benefits rose. This means that the economy has been through a decade and a half of much reduced capital costs, while labor costs have risen. It would seem almost impossible that this would not have hastened the substitution of capital for labor.

At the state level, taxes on capital have been slashed. Indiana alone forgives taxes on more than $8 billion of new investment a year.

As an aside, this means the reduction in local revenues of perhaps $1 billion per year.

To be clear, we need business investment to grow, but hastening investment past the rate at which free markets would dictate is not necessarily a path to prosperity any more than raising the minimum wage to $20 an hour.

For as long as wages have been stagnant, we have in place public policies that heavily favor capital over workers. It is time to question this approach.

Michael Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to dr-editorial@greenfieldreporter.com.