Forget Minimum Wage – Let’s Talk about Wage Subsidies

In 1914, Henry Ford did something that many managers would regard as absurd: he unnecessarily raised the salary of his employees.  And he raised his employee’s salaries a lot – from $2.34 a day to $5 a day (given inflation, this would be about $120 per day).  Ford made this decision, motivated by a desire to decrease recruiting costs and increase employee retention…and it worked.

Even more importantly, Ford’s pay raises allowed his employees to escape a “poor” livelihood and experience a “middle class” livelihood.  By helping to create a stronger middle class, Ford helped reinvigorate the economy (at least for awhile; the Depression was only a decade or so off).  Interestingly, the US economy is currently in a situation where Ford’s “altruistic” actions would be very beneficial. (Business Insider: Dear American Companies: Here’s How to Fix the Economy)

In America today,  corporate profitability and income disparity are at all time highs (see charts below – the chart on the left analyzes wages and the chart on the right analyzes corporate profits.  These charts are courtesy of Business Insider)

Wage Inequality   Corporate Profits

As a result of this disparity, the middle class is extraordinarily weak.  William Galston points out in the WSJ that while Wal-Mart and Neiman Marcus are thriving, stores like JC Penny and Sears are not.  Businesses that appeal to the middle class simply cannot succeed if a strong middle class does not exist.  And because most American businesses do not specifically target the rich or the poor (like Wal-Mart and Neiman Marcus arguably do), a weak middle class is leading to poor overall health of the US economy (Notice this implies that the record corporate profits shown in the chart above are distributed similarly to private income – the richest corporations make the majority of the profit). (WSJ: The Eroding American Middle Class)

So how do we strengthen the middle class?  Many have supported a boost in the minimum wage.  Personally, I believe such a solution is foolish, as minimum wages are not precise enough.  According to Noah Smith, minimum wage mostly benefits high school students working at the local drive-through, and as such, minimum wage laws do not foster the type of employment America wants to see (for example, manufacturing).  As an alternative to minimum wage, Noah proposes a “wage subsidy.”

A wage subsidy behaves exactly as it sounds – it subsidizes wages for certain jobs.  The government helps corporations pay higher wages to employees with income below a certain wage threshold.  In doing so, the wage subsidies act like minimum wage in that low-wage employees have higher “wealth.”  That said, wage subsidies are distinct from minimum wage in two important ways.  First, the government, not businesses, pays for wage subsidies.  In this way, deadweight loss is minimized because wage subsidies do not distort the hiring behavior of firms (compare the deadweight loss of a subsidy to a tax – minimum wage is much more similar to the tax, which causes a higher deadweight loss).  Second, the government can be selective with wage subsidies and only subsidize industries that will benefit the American economy most. (Noahpinon: Wage Subsidies)

I am not claiming that wage subsidies are a solution to America’s weak middle class.  But I would argue that they are an out-of-the-box alternative to a rather ineffective policy like minimum wage.  While wage subsidies may or may not be effective, I think they represent the type of thinking economists need to engage in: how can we reinvigorate America’s middle class without making enemies with the private sector?  Ultimately, I believe that cooperation between the government and the private sector (which is not a fan of minimum wage laws), is the only way to replicate the middle class that Henry Ford helped create.

One thought on “Forget Minimum Wage – Let’s Talk about Wage Subsidies

  1. gkugler

    Very interesting concept! I really enjoyed reading your blog as I also think that minimum wage laws are extremely ineffective and do more harm than good. As a result, I think this idea of a wage subsidy could be very effective in increasing wealth for the middle class without causing the negative side effects that accompany minimum wage laws. The middle class is the largest segment in the U.S. population and its health is crucial for the U.S. economy recovery. The middle class is what drives consumer spending and in turn encourages business investment. If we are serious about an economic recovery in the U.S., then we need to become serious about reducing income inequality and there is no better way to do that than creating a healthier middle class.

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