Corbyn’s maximum wage idea? My unlikely defence

The talk of the day has been Jeremy Corbyn’s proposal for the introduction of a maximum wage. Much has already been said about it, so I’ll only give my quick, knee-jerk verdict, in favour of Corbyn’s proposal. When facing a choice between redistribution and the maximum wage, the latter might be a better solution. The intuition is simple: redistribution converts potential investment into consumption, whereas the maximum wage leaves it in the hand of businesses how the money is spent, meaning that more money is invested (rather than consumed), making everyone better off.imported

Imagine that we live in a world where people want to reduce income inequality and they have two means to do it: (1) by redistributing the income of the wealthiest to the poorest through taxation, and (2) by introducing a maximum wage. I argue that, when facing this choice, we would be better off with minimum wage.

One of the fallacies of the arguments for redistribution is that it posits that we should be contrasting consumption by the wealthy with consumption by the poor. Taxing the rich therefore doesn’t sound like a bad idea, given that an extra unit of consumption is valued less by the rich than by the poor. Would the rich care about having or not having another car? Surely not as she would already have many. But the life of the poor (who probably hasn’t got a car) could be made many times better by giving her the money to buy a car (which would probably be her only one). The reason I call this a fallacy is because the wealthy tends to invest her money rather than just consume it. Therefore the trade-off is not between consumption by the rich and consumption by the poor, but between investment by the rich and consumption by the poor.

On the other hand, if society opts for a maximum wage, rather than redistribution, businesses can decide how the money is used. Depending on the level of competition, they will choose to invest some of this money (let’s assume away the possibility that firms can reward their employees through means other than wages – it doesn’t matter for this thought experiment, as the counterfactual solution suffers from the same problem of under the table payments). With more money left in the kitty, they’re going to invest more.

Why is investment so important? Most importantly because it begets innovation. Innovation grows the economy. It can reduce costs, or create better things. Yes, it is true that consumption can also grow the economy and your preference for one or the other is likely to be strongly influenced by your ideological stance. Mine is that investment is the real engine of the economy, or to paraphrase J.S. Mills, consumers do not hire workers, business do. Consumers do not innovate, businesses do.

Moreover, workers capture a large chunk of the value of investments through wages. And that’s not it, with more investment, we all become richer as we have access to better and cheaper technologies in all aspects of our lives. How much of this extra ‘richness’ the poor captures depends on the level of competition. If competition is lacking, and firms are able to appropriate all of the extra rent that was produced through innovation, then we don’t gain as much. But when firms compete neck and neck, and prices are pushed down to near costs, everyone (including the poorest) gains.

Many commentators emphasised today the importance of redistribution as the preferred solution to the maximum wage. I argue that, whilst some redistribution might be justified, maximum wage paired with competitive markets, and the elimination of rent-seeking could be far less damaging than redistribution.

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