The Independent Market Observer

2/19/14 – Consumer Spending Trumps All: Minimum Wages and Borrowing

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Feb 19, 2014 8:05:36 AM

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We have two interesting things to look at today: a report from the Congressional Budget Office on the effects of a higher minimum wage, and a report that consumer borrowing has ticked up as banks become more willing to lend.

Let’s look at the Congressional Budget Office report first. The CBO is a widely respected nonpartisan source for independent numbers on legislation—a referee, if you will. The typical CBO report provokes arguments from both sides, which suggests to me it’s usually pretty close to right.

This report is no exception, stating that a rise in the minimum wage will both cost jobs and lift a large number of people out of poverty. The executive summary is explicit about these effects, concluding that the net benefit will be positive but small. The report is already being spun by both sides, but let’s look at what it actually means.

The way the CBO did the analysis, income gains will go almost entirely to families making less than around $60,000–$70,000 per year, while the income losses—largely from small business owners—will come from families making more than $130,000 or so per year. Because the gain and loss numbers are almost equal, you can consider it an income transfer between higher-income families and lower-income families. Arguably, this is functionally equivalent to raising taxes on higher incomes while providing increased benefits to lower-income families, but to my mind, it’s a much preferable alternative, as the increased income comes only with actual work.

Here’s the problem. With minimal net economic benefit, in the form of increased spending, any argument to raise the minimum wage must be based on values (where people can reasonably differ) rather than on numbers (where they really can’t). So, from an economic point of view, despite the potential social effects and the press it’s getting and will continue to get, there will be no significant effects.

That’s not the case, potentially, for the second piece of interesting news today, the increase in consumer borrowing. For the first time since 2008, consumer borrowing rose on a year-to-year basis in the fourth quarter of 2013. The biggest bumps were in student loans, auto loans, and mortgages, with a relatively small increase in credit card debt.

If you think about this, it is encouraging. Going to college, purchasing a home, and even buying a car are long-term, necessary investments. Spending on these items lays the groundwork for future growth in savings and income, unlike most credit card debt, which goes on short-term consumption. Growth in mortgage borrowing was driven by a decline in foreclosures and write-offs, which is also encouraging.

The bigger picture is positive as well. Delinquency rates for all types of loans, except student loans, are down significantly and still declining. Lenders are becoming more willing to make loans, despite their own very real constraints, because they see the improvement in the financial situation of the average borrower. Debt service requirements also remain at multi-decade lows.

The economic effects of increasing consumer spending, especially on longer-term purchases like homes, cars, and education, can be significant. Unlike more short-term spending, this borrowing contributes to future benefits, such as higher incomes for the educated, home equity for homebuyers, and the multiplier effects that surround auto manufacturing and sales.

The increasing willingness of banks to lend, while consumers borrow, is also providing a cushion for the economy to make up for slow wage growth. Something to watch is whether wage growth will also accelerate and support the growing borrowing—but that’s not a problem just yet.

What we can take away from these two pieces of data is that the economy continues to grow, and the biggest piece of that growth, consumer spending, continues to increase in a way that is sustainable. Worries about the economic impact of a rise in the minimum wage do not appear supported, and the end of the consumer delevering cycle should also support further growth.

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