Monday, January 19, 2009

Set Wages to Correct for Inflexible Exch Rate?

A Newsweek article "Give Them a Raise" hits on the fundamental problem creating huge economic imbalances that contribute to the financial crisis: the incredibly low wages paid to Asian laborers. The American consumer is being castigated for buying too much, but how can we resist buying when stuff is so cheap? When DVD players are $40 and a computer is $300, who can resist?

Low wages are one of the factors (but not the only one) behind the bargain basement prices that we've come to expect. The article correctly points out that laborers with low wages can't afford to buy much. A century earlier, when the U.S. was the world's factory, we also had figured out how to turn out massive amounts of product, beyond the capacity of the market to absorb it. Henry Ford recognized the problem and raised wages so that his workers could afford the cars they made.

The Newsweek writer, however, provides the wrong prescription. He calls for a pan-Asian minimum wage. This is unworkable and misses the even more fundamental problem of undervalued Asian currencies.

The Chinese wage is not that bad in the Chinese economy. It appears incredibly low in dollars because the exchange rate is fixed at an unrealistic level. A wage of $5 day translates to about 34 Chinese yuan per day in China. In real purchasing power, this is enough to buy about 11 kg. of rice at current retail prices in China of 3 yuan/kg. In the United States, $5 can buy 2.8 kg of rice (avg price reported by of $.81/lb=$1.78/kg). A Chinese worker can buy 4 times as much rice in China with her wages as she could buy in the U.S. with those wages if they were paid in dollars. (Sure, U.S. rice may be better quality, etc., but it can't account for the 4-fold difference.)

The problem is that the exchange rate between the Chinese yuan and U.S. $ has not been allowed to adjust in order to even out the imbalances created by artificially cheap Chinese goods. The prescription of setting artificial wages instead of letting supply and demand do it is the wrong approach. (I won't even start on the impossibility of enforcing an Asian minimum wage!) The root problem is that the exchange rate has not been allowed to adjust to equilibrate supply and demand. (China's foreign exchange reserves continue to swell--now over $2 trillion--despite the economic slowdown.)

We need less interference in markets, not an unending chain of price- and wage-setting.

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