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The economy's real problem is that you're overpaid

September 7, 2010 | 11:00 pm

Kevin Hassett thinks he has the solution to America’s employment problem: Pay cuts all around.

“The biggest problem with the labor market right now is that wages are too high,” Hassett, director of economic-policy studies at the conservative American Enterprise Institute, writes in his latest column for Bloomberg News.

He concedes that his proposal is the kind that is “perfectly at home in economics textbooks” but “so beastly in practice that nobody is willing to mention them.”

But he’s willing. He writes:

Economics teaches that full employment would be reached if wages adjust downward, to a level that better reflects current circumstances. At lower wages, employers would desire more workers. Labor markets generate persistent unemployment only if wages are sticky, failing to fall as demand declines.

Many workers’ wages already would be lower, Hassett says, except for government policies that keep  them elevated. Not surprisingly he singles out federal and state minimum wage laws, long a source of intense debate regarding their effect on employment.

Hassett- Kevin He notes that since July 2007 the federal minimum wage has risen three times, to the current $7.25 an hour from $5.15, a 41% jump.

To bring down the 26.3% teen unemployment rate, Hassett says, Congress should scale back the minimum wage to $5.85, its level when the recession began in December 2007.

He also goes after union workers, arguing that “unions should be willing to reopen collective bargaining agreements and accept lower wages.”

Government can do more to abet lower wages as well, Hassett writes: "Government policies should induce workers to take the plunge and accept lower wages. These policies could include carrots -- tax credits that offset large wage declines, for example -- and sticks, such as a reduction in the duration of unemployment insurance benefits."

Putting aside that Hassett seems to be specifically targeting middle- to lower-class wage earners for pay cuts (as opposed to the salaries of Fortune 500 CEOs or PhD economists), he could at least have acknowledged that many Americans already have seen their income and/or benefits reduced since the recession began. He also might have mentioned that companies remain reluctant to hire even though they can easily force reduced salaries on new hires, given the massive labor glut.

But most puzzling is that he say nothing about the risk that his wage-hacking proposal could fuel a broad-based deflation in the U.S. economy -- exactly the nightmare that Federal Reserve Chairman Ben S. Bernanke wants to avoid.

Consumer spending accounts for more than two-thirds of gross domestic product. Spending derives from income. Add millions more people overnight to the ranks of those who are earning less than they were a couple of years ago and you surely would reduce spending.

Wouldn’t that force many businesses to cut prices to try to stoke demand? Note that smaller firms already say their biggest problems are weak sales and uncertainty about the future.

And if consumers spend less, and corporate earnings fall because of price-cutting, what incentive would  companies have to hire more workers to expand their output? Just because workers are cheap?

In short, Hassett writes about across-the-board wage cuts as if they would magically restore job growth and economic growth with no risk of serious adverse consequences.

In some parallel universe, maybe?

-- Tom Petruno

Photo: Kevin Hassett. Credit: American Enterprise Institute