Friday, February 17, 2006

Part 19 - Hyperwage theory

Hyperwage Theory Part 19

Hyperwage Theory Part 19

Hyperwage Theory Part 19

If you want to solve world poverty or realign the unequal distribution of wealth the last idea you would entertain is Hyperwage Theory. And that is why the concept of Hyperwage has continued to elude even the brightest and the best economists.

By the way, do not forget that Hyperwage has non-economic benefits and more often than not, economists attack Hyperwage without realizing that the theory has more non-economic benefits compared with other theories. I warn all economists, don’t fall for this trap of economic-only analysis. Hyperwage has both economic and non-economic benefits.

Non-linear thinking
I have often emphasized that the reason for this failure to appreciate Hyperwage lies in the fact that one has to go deeper than the ordinary theory in order to understand the logic and elegance of Hyperwage.

The fears of hyperinflation, for instance, is brought about by our ordinary sense of ratio and proportion. That is, if one variable is increase ten-fold, we expect the other variable to increase ten-fold as well. But such mathematical brainwashing applies only to linear relations. That is linear thinking. Since our usual mathematical education stops are linear ratios and proportions, we tend to generalize that all relationships are linear as well. In fact, take an IQ test. The questions there are mostly linear. If one person can do a job in 2 days, how long will it take for 3 person to do the job. See what I mean? That is exactly linear relations, linear formulas, linear thinking.

But once I pointed it out to you that the curve of inflation against wages could an exponential decay, you were able to appreciate the value of asymptotes. Thus, I invented the term “asymptotic hyperinflation.”

Logic without theory
The next big challenge for Hyperwage is unemployment. In the past few chapters, I laid the foundation for the opposite, that in fact, jobs will be created in net positive terms. That was just using logical arguments. Then came the very surprising CK 1994 study which strengthened the arguments I built up earlier.

I never imagined Hyperwage could stand on its own this far, and even find an empirical study that could support the theory.

But aside from my own logic and arguments, and aside from the empirical study of Card and Krueger, is there any economic theory that could support my thesis that Hyperwage will create employment rather than increase unemployment?

At first, I thought no, there couldn’t be a theory like that, therefore, like all the knee-jerk reactions of the economists I did not waste my time looking for one.

Until a few months ago.

Bear in mind that I conceived Hyperwage about a decade ago but I relied on logic and actual observations of the economies I lived in. I never ventured into finding theoretical support for my idea of a high minimum wage. It was because I thought that all the economists of last 300 years should have discovered all the possible angles of world poverty and that we must accept the fact that some countries should be poor and some should be rich, and that the idea of an equal economic footing between countries is not possible. Poor-rich equilibrium but never rich-rich equilibrium.

A few months ago I was going over old books discarded by a university and took home two of them. One was book on the history of economic thought. Although I have been reading books on economics and its history for the last several years hoping to debunk my own Hyperwage Theory, I never really knew what I should be looking for. It was all random reading.

Intellectual ecstasy
Then it happened.

I saw a chart that involved employment and wages. I have never seen this chart before. I have seen the Philips Curve, the Laffer Curve, and many other famous economic curves but it was the first time I saw this one.

Then I began to read the dusty book. I must have inhaled millions of 20-year old bacteria lying between the pages of the old book. With each paragraph, my heart pumped faster. With each phrase, my light bulbs in my head switched on in rapid succession. With each word, I swooned to intellectual ecstasy.
Eureka! Eureka! Eureka!

At that very moment, my search for a theoretical foundation for Hyperwage reached a tremendous milestone. I have re-discovered a long forgotten concept of economics that says that increasing wages may actually theoretically result in positive increase in employment – high wages, more employment.

I exclaimed, “My goodness. This is staggering. This is simply amazing. Incredible. Now I can say Hyperwage is in the right direction and I never realized I had theoretical backing all along.”

Theory of the firm
Ah, I guess you have to be a PhD in order to understand this but I will start with zero knowledge.
This is about the theory of the firm, the theory of markets, and macroeconomics.

Assume you are the only seaweed processor in the island. In fact, you are the only company or employer around. The people are begging for work outside your door.
Worker: “Sir, please give me a job. You are the only employer in town.”
Firm: “Okay, I will give you work. Will you work for zero pesos per day? No salary?”
Worker: “Sir, just give me a small salary.”
Firm: “Ten pesos per day.”
Worker: “Can you make it higher?”
Firm: “Twenty pesos.”
Worker: “Sir, that’s not even enough to pay for the tricycle from our side of the island. Sir, I wouldn’t even consider working if I’m paid less than P60 per day. I’d rather stay at home and watch the dolphins.”
Firm: “P60 then.”
Worker: “Sir, a little bit higher than P60, please.”
Firm: “Okay, P70 per day, and that’s my last offer.”
Worker: “Okay, sir, P70. Thank you very much sir. I’ll give you my chicken as a thank-you gift. I’ll make you godparent of my child. I’ll vote for you in the next election. I’ll worship your photo. Thank you sir for saving my family from hunger. Thank you very much, sir.”

Single employer
If you have noticed, the firm is only one employer in town. The worker’s reservation wage is P60. It is the threshold wage that makes jobless and having a job as equal conditions. The worker will accept wages higher than his reservation wage.

The agreed salary is P70. For this particular contract, the P70 is equilibrium point.
Question: Is P70, the best point for the firm?
Of course, you will immediately wonder at the logic of the question. Surely, P70 being the lowest wage that the worker will accept is also the point where the firm incurs the lowest wage expenses, therefore it should be the best point for the firm, isn’t it?
Hmm, ahh… not really. The lowest cost is not really the optimum point. There’s this concept of marginal utility.

Price and marginal utility
Under this particular market condition of single employer the price is lower than both marginal utility and marginal cost (p < mc).

If you don’t know what these two concepts are, let me define them for you, but I probably cannot explain it to your level. I have already warned you in the being of this series that my target audience are the PhDs in economics. If you are not, sorry, I can’t give you a tutorial.

Anway, let’s proceed. In contrast, when there are other employers around, the equilibrium happens when the price is equal to marginal utility and marginal cost (mu=mc). This pure competition.

Now, what happens when the price of the commodity is constant, even at varying levels of demand for a single buyer? Answer: The quantity purchased will be the same as in the case of pure competition. Is that good or bad? It’s good because when this happens, the employer will be force to pay above the agree labor price of P70.

In fact the best level, the optimum point is for the firm to pay the labor price levels equal to the levels under a regime of pure competition.

So what?

Well, hold your breath. When this happens, the optimum level for the single employer when the price of labor is forced to be a constant is the price of labor corresponding to a pure competition. And then the magic happens – this equilibrium point corresponds to an increase in labor demand. Whew!

In case, you didn’t understand the preceding few paragraphs, here is the summary. Under the case of a single buyer (or single employer in our example) there is an agreed price. However, there is an additional condition that if the price of a commodity will rise above this agreed price, and such increase in price is constant notwithstanding the levels of demand, then the buyer has to buy more quantity in order to be optimal (that is, marginal cost = marginal utility).
(I can email a slide presentation explaining this complicated chart.)

Maximum profit
Translated to labor-wage (price) and labor-demand (employment), a higher fixed minimum wage will automatically result into a higher employment if the firm is to maintain its optimum equilibrium point at which marginal utility is equal to marginal cost. This is the point of maximum profit.

In short, under a market of single employer, maximum profit is attained by the firm by increasing its labor employed whenever the minimum wages are increased. Can you imagine that? Buried in the annals of economics is a theory of a firm that almost every economist ignores, and yet turns out to be a strong foundation for Hyperwage Theory. Higher wages means higher employment. It was an overwhelming discovery for me. And yet, many economists do not know the concept and the staggering implication of this single buyer theory, and that is why they fail to appreciate Hyperwage. And I’ll explain more next time.

For the moment, let me shout in maximum decibels: Hyperwage Theory loves monopsony!

(Thads Bentulan, Sept. 15, 2005)
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