Welcome to Andrew Samwick & Indexing the Minimum Wage

Angrybear has managed to attract as guest bloggers two Republicans who belong to the Reality Base Community and care about fiscal responsibility: CalculatedRisk and Andrew Samwick. At times, Dr. Samwick and I have agreed on issues and we both happened to be drinking beer in some pub in the British Isle when America hosted the World Cup. There was one difference – Dr. Samwick was enjoying a pint in a London pub, which had to lament the fact that the English team did not make the 1994 World Cup – whereas I was enjoying several pints in a Dublin pub as Ireland beat Italy in the opening game. Dr. Samwick and may have also differed a bit on the strength of the labor market so maybe our exchanges could become scripts for the worthy opponent segments of the Colbert Report (my favorite half hour on TV).

But his opening contribution to this blog had this very sensible suggestion:

I’ll agree and go one step further: if someone can convince me that we should have a minimum wage law, then the further argument that it should be indexed to inflation would be an easy one for me to accept.

I want to take this statement a couple of steps further. The Economic Policy Institute provides a nice chart of the real value of the minimum wage. In the late 1950’s, its value represented about $6 an hour in 2006$ term – while it reached almost $8 an hour in 1968. I’m sure liberals would love to index its value to the latter, while conservatives might prefer the former if not the current $5.15 value. If the compromise to set the real value closer to $7 an hour – perhaps liberals should declare victory.

But I have a question as to which price index should be used for the indexation. While consumer prices today are 2.28 times what they were 25 years ago, the GDP deflator is only double its level in early 1981. So had we indexed the minimum wage to the GDP deflator in 1981, its real value would still have declined somewhat relative to the consumer price index. Indexing to the consumer price index, on the other hand, shifts terms of trade risk to businesses. Given the possibility that we will have to experience a real devaluation in order to reduce the current account deficit, which index we choose may make a significant difference.

Update: Kevin Drum has some interesting “noodling” over the possibility that the COLA system of indexation has effectively been a floor for median wages. This is certainly worth the read – even if you are like me in thinking market forces drive wages.