Cutting the Minimum Wage Really Is Good for Aggregate Demand
By Bryan Caplan
Paul Krugman repeats his argument that wage cuts are an individually rational but socially destructive way to reduce unemployment. His motive: To quash a politically impossible effort to cut the minimum wage. Paul does address the real balance effect, but he still ignores the main arguments I’ve made before:
1. Cutting wages increases the quantity of labor demanded. If labor demand is elastic, total labor income rises as a result of wage cuts.
2. Even if labor demand is inelastic, moreover, wage cuts reduce labor income by raising employers’ income. So unless employers are unusually likely to put cash under their matresses, wage cuts still boost aggregate demand.
An even simpler way to explain it: Imagine every firm divided its existing payroll between a larger number of workers. How is that bad for aggregate demand – or anything but good for employment?
P.S. If you prefer specific facts to textbook arguments, see Scott Sumner’s legendary Table 12.2 on wages and the Great Depression.