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  • Writer's pictureOren Levin-Waldman

The Hidden Benefits of Moral Hazard: Higher Wages

If one only listened to right-wing pundits, one might think that inflation and labor shortages are due to excess government spending. Too much spending, the argument goes, creates inflationary pressure, especially when given as stimulus because those who receive it can demand more. This new demand, coupled with a supply chain crisis only leads to higher prices. And more spending which allows workers to stay home only exacerbates labor shortages because workers have no incentive to work. Wow! Isn’t this a bit simplistic?

Let’s take the excess spending claim first. In the world of inflationary pressure, one wonders why government spending is worse than a robust economy with low unemployment. When the unemployment rate drops below a certain point, the Fed often takes that as an indication of inflationary pressure. Government expenditures in response to high unemployment or people dropping out of the labor force because they may still be fearful of the virus is usually the normal course.

It was a Republican administration that introduced the stimulus checks in response to job loss resulting from COVID necessitated lockdowns. What was the logic here? If through stimulus checks demand is created for goods and services, then producers will create jobs, thereby getting the economy going again. Of course, too much demand may lead to a rise in prices, but is this really a case of moral hazard whereby producers assume they can jack up the prices because they assume the new demand is a function of government stimulus checks?

Arguably, there is a moral hazard in anything we do, but that has to be factored into a cost-benefit analysis. The real cause of inflation is the supply chain crisis. When an economy which has been locked down is suddenly restarted with no real planning with regards to getting supply to market, then there is bound to be inflation. Perhaps instead of blaming the government, producers should have asked themselves how they could have better planned for the inevitable reopening of the economy.

Now let’s deal with the claim that too much government spending only exacerbates the nation’s labor shortages. This claim rests on the assumption that if workers are effectively given money to stay home, they will naturally forsake work for non-work. After all, why work if you can derive greater benefit from non-work? Were this indeed the case, then it would be a case of moral hazard.

One again wonders why critics can’t really see the problem for what it is. Those opting not to work, if that is what they are doing, may be doing so for a variety of reasons. First, wages, especially in the service sector, are too low. Second, many workers, especially in services where they come into direct contact with others may indeed be fearful of the virus. When one is combined with two, then many may say it just isn't worth it. Third, with the new Omicron variant, there is still uncertainty over whether the schools will remain open. If they don't, workers still have a childcare problem.

At the same time, the alleged benefits workers are receiving are still low relative to the benefits of working unless the wages paid from work are really low. One wonders if employers complaining about labor shortages aren’t really crying over the fact that they may actually have to pay their workers a wage that makes it worth their while to work. Moral hazard? Hardly. Supply and Demand? Absolutely.

The same employers who justify raising prices based on supply and demand have a problem with workers using the same arguments to justify higher wage demands. One wonders where they got this idea that they are entitled to cheap labor. And yet, if government programs have the effect of raising workers’ reservation wages, wages beneath which they won’t accept a job, then arguably that could be a good thing.

The reason why critics of government programs, including minimum wage laws, yell moral hazard is because they do work to an extent. They effectively create a putative minimum wage, especially when the federal government has failed to raise its statutory minimum wage. Critics of the minimum wage have always approached the issue from the demand side, arguing that higher wages will result in lower employment because employers will demand less labor.

The often-neglected corollary is that an increase in the minimum wage will increase the supply of workers as higher wages attract more workers who may have previously shunned work. The lower employment that they cite as a problem may not be due to a disemployment effect, i.e., employers laying workers off. Rather, it may be a function of more workers in the market chasing the same number of jobs.

The case could be made that when the statutory minimum wage is stagnant, as it has been for about fifteen years now, government programs that critics claim lead to labor shortages, can have the same effect. That is, if employers cannot find workers, they should then increase their wages to the point where workers are knocking on their doors. From the standpoint of increasing wages where they have been stagnant, these programs effectively create a putative minimum.

Of course, one might ask whether public policy makers are really that smart? The answer is probably no. Rather wages may increase because they are the unintended consequences of policies developed for other purposes, most notably to provide relief in the wake of COVID-19. But let’s not look a gift horse in the mouth. They may have the effect that we want.

That they are contrary to the low-road priorities of paying low wages is well too bad. On the other hand, higher wages could lead to some inflation because workers with more purchasing power will demand more goods and services. The irony is that these same employers who complain about labor shortages also complain about inflation. And yet, the solution to inflation might be counterproductive.

Usually in response to inflationary pressure, the Fed tightens the money supply by hiking interest rates and increasing cash reserve requirements. But this invariably leads to a recession whereby workers are thrown into unemployment. Surely, as we are trying to recover from a pandemic, we cannot want that now. Or it could be that critics of government spending really don’t know what they want, other than to complain and to fault others.

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