Penalty rates: Hip pocket economics

Words by Ryan Aitken

For now, the unions have lost their appeal against the Fair Work Commission’s decision to cut penalty rates. This means several things for university students. Some of you, already on minimum wage, will lose a quarter of what you would normally earn in a day. The worst-faring people in the country will lose $6000 a year, a significant amount for those already struggling to make ends meet. The cuts to public holiday pay came into effect July 1 this year, with weekend rate cuts to be rolled out over the next few years.

Those who pay wages will, by their own admission, be able to achieve higher levels of profits. We can see that this is a direct transfer from your wallet to theirs, creating a change in the distribution of income in favour of business owners. It has been suggested that a cut to penalty rates will create a more “flexible economy” (whatever this means is up to you to guess). However, it’s worth taking a step back and looking at this from the perspective of the whole economy in general, with a brief detour through some economics jargon.

For each dollar you earn, you spend a proportion of it and save the rest (if you can save at all). The respective proportions are called the marginal propensity to consume (MPC) and the marginal propensity to save (MPS). Let’s say I give you a dollar. You spend 80 cents on a soft serve ice cream and pocket the remaining 20 cents. Therefore your MPC is 0.8, and the MPS is 0.2. Too easy.

From this concept comes the multiplier effect: if you spend one dollar, what percentage of this dollar will generate continuing economic activity? In other words, if we have an MPC of 0.5 (50%) across the flow of exchange, the amount given decreases with each exchange. Starting with $10, this would look like $10, $5, $2.50, $1.25 and so on. The sum of these gives the total amount of economic activity generated, 10 + 5 + 2.5 + 1.25 . . .

An increase in income to someone with a greater MPC, over someone with a lower MPC, will have a higher multiplier (percentage of money spent). For example, Nick earning $200 a week could have an MPC of 0.95 (95% spent, or $190), Daisy earning $800/week an MPC of 0.70 (70%, $560) and Jay earning $3000/week an MPC of 0.2 (20%, $600).

Adding $50 to Jay’s wallet means little increase in their livelihood and only a marginal benefit to the economy, whereas increasing person Nick’s income by $50 will provide a much greater outcome in their own livelihood, and in general as their total MPC would be far greater. This can be seen by considering an increase of $50 for both Nick and Jay. Assuming their MPC remains the same, Nick’s spending increases by $47.50, while Jay’s spending only increases by $10.

If we take in to account this relatively simple economic concept, it can be easily understood that redistributing income in favour of business owners and employers will create a poor outcome for the economy in general. Creating a higher income for those who already earn the most, whilst at the same time stripping young people and families of their already meagre pay is not only a bad decision socially. It’s also utterly economically irresponsible. In a time where the economy is slowly but surely stagnating, one would think that obvious ways to increase economic activity would be applied. Yet unfortunately, we do not live in such a world. Instead, the political realities indicate that the distribution of economic power is more important than the economic welfare of us all.