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Author Topic: The equilibrium of poverty
Pyrtolin
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http://www.frontporchrepublic.com/2010/07/naive-experts-economists-and-the-real-world/

quote:
Standard theory contrasts “work” with “leisure,” and all that is not (paid) work is leisure. But it is a travesty of language to say that people living on the streets are enjoying leisure. Further, much of the time spent apart from paid work is given to other kinds of work, such as that necessary to maintain a family and a household. Leisure, properly considered, is a joint product of free time and purchasing power, and only those with sufficient purchasing power can “substitute” leisure for work. Therefore paid work is balanced against leisure and other forms of work. This gives the supply curve for labor a serpentine form with four equilibrium points, two of which are stable and two unstable. The stable points occur near subsistence,where people must give more hours just to live or to maintain an acceptable lifestyle, and at a higher point where work may be freely traded for leisure. The result is a dual labor market, one which is low wage-high hours, and the other high wage-low hours.

Although standard theory denies the possibility of multiple equilibrium points in one market, Prasch’s description matches more closely the labor markets we actually see in the real world. The problem with the standard theory is that it doesn’t account for the dual market (“work” and “leisure”) represented as one supply curve. In such a case, a supply curve can be serpentine with multiple equilibria.

Is the existence of a low-wage equilibrium point a problem? Yes, and for several reasons. The first is that people who must work at low wages can only get out of poverty by giving more hours to work. But as they give more hours, thereby increasing the supply, they further lower the wage. Thus low wages lead to even lower wages if a significant number of people try to escape from poverty. This is called a “poverty trap,” where any attempt by a group to escape poverty leads to more poverty. But this is just the beginning of the problems. The next difficulty is that low wage workers have less time to devote to family work, to the serious job of raising families and maintaining homes. Thus family structures are weakened, often fatally. But the whole point of a sane economy is to strengthen the family and provide the material basis for the stable family structures upon which any stable society must rest.

We can expand on Prasch’s analysis by pointing out that as bad as the low-wage market is for workers and their families, it also posses a dilemma to investors. The entrepreneur may believe that he is being clever by depressing wages and increasing profits. However, the wage bill for one firm is also the primary component of the demand curve for every other firm. By depressing wages, the entrepreneur lowers demand in every other sector. If this is widespread (e.g., when there is a lot of outsourcing) consumer markets are under-supplied with purchasing power, while capital markets are over-supplied. The entrepreneur makes more money, but he finds there is less opportunity to invest it, because the very success of his strategy has narrowed demand. Since the productive economy offers less opportunity for the excess capital, the investor turns to purely speculative gambling instruments such as the synthetic CDOs and CDSs with which we have become all too familiar.

Understanding the labor market leads to better policies. For example, a minimum wage set below the low-wage equilibrium point will have little effect on the market, but one set above it will tend to drive the market towards the higher equilibrium point. Workers with some excess over their perceived needs will be freer to enter the “leisure” market and thus give more time to family work and actual leisure.


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