Really want to harm the poor? Try the "Living Wage."
Statement of Harry Messenheimer, Ph.D. (economics)
Co-Founder, Rio Grande Foundation
May 20, 2005
The proposal for a "living wage" is an ineffective way
to help the poor. In fact, it is more likely to harm the poor. The
reasons why are grounded in fundamental economics.
You don't have to be an economist to understand that "living
wage" proposals do not meet the test of common sense. Why not
raise the wage floor much higher than is proposed? For example,
why not raise the wage floor to $100 per hour? It does not take
much reflection to understand that $100 per hour wage floor would
not work. Why is it that common sense fails when the proposed wage
floor is a mere $7.15 per hour? Principles of economics textbooks
show clearly that wage floors result in surpluses of workers (unemployment).
How does being unemployed help the unskilled poor? Actually, the
wage floor for those unlucky persons who can't find work as a result
of the wage floor is ZERO dollars per hour. ZERO is the actual wage
floor; and there is nothing government can do to prevent it. Unfortunately,
minorities are more apt to find themselves in this situation as
a result of "living wage" laws.
"Living wage" will be quite ineffective at helping the
poor, even for the lucky workers who do find jobs. Firms will always
find ways around the wage floor. The market for unskilled labor
is highly competitive. As a consequence an unskilled worker's effort
must result in value of product equal to the worker's total compensation,
including that part of compensation that goes to training.
One way around the wage floor is for the firm to substitute capital
for labor where possible. Repetitive tasks can often be automated
in some way. A second way around it is for the firm to substitute
higher wage for lower benefits where possible. It is the total compensation
package that matters; and the firm will have wiggle room when that
package includes non-wage benefits. A third way around it is to
substitute non-wage labor for wage labor where possible. For example,
the firm may move to piece rate compensation or contract separately
for the needed function. A fourth way around it is to move outside
the wage floor jurisdiction where possible; and potential firms
can choose not to locate within the wage floor jurisdiction. A fifth
way around it is to reduce or eliminate training of the unskilled
where possible. At the higher wage floor more skilled workers will
be attracted to previously unskilled jobs. If these ways of coping
with the wage floor are not available, the firm can go out of business.
Much of the "living wage" argument is fueled by what
proponents cite as evidence that it works. Unfortunately even a
few economists have tried to prove in effect that water flows uphill.
Prime among these has been the study by economists D. Card and A.B.
Krueger (1994). David Neumark summarizes that study and the avalanche
of evidence refuting it in his research summary "Raising Incomes
by Mandating Wages." It may be found online at www.nber.org/reporter/fall02/higherWages.htm.
Even though Card and Krueger have been thoroughly refuted, wishful
thinkers advocating living wages continue to cite them as "proof"
that water flows uphill. Fortunately, the vast majority of economists
do not agree with them.
Some have claimed that the higher living wage will be spent, thereby
stimulating the economy. This is pure nonsense; the higher wage
floor will actually have a depressing effect. The money that goes
to pay higher wages has to come from somewhere, such as from company
profits or from consumers who have to pay higher prices and don't
spend as much elsewhere. The net depressing effect will come from
the kinds of adjustments enumerated above.
Finally, I wonder about the morality of the living wage. What business
does government have preventing voluntary trade between two individuals
when no one else is harmed? Surely the individual worker, not the
nanny state, can decide what is best for him or her. Moreover, if
there is a principle that unifies the last three hundred years of
economic research it is this: When two adults voluntarily consent
to trade, each gains. The process of trading itself is what leads
to prosperity for the traders. Why would we want to further reduce
economic freedom to trade when the overwhelming evidence is that
economic freedom is the real key to prosperity?
"Living Wage" Hurts the Poor
Subsequent to my statement of May 20, 2005 I have seen several
more empirical claims that the living wage will not hurt the poor.
These claims constitute voodoo economics in the extreme.
Many factors (such as tax climate, regulatory climate, education,
local entrepreneurial opportunities, what is happening in other
states and localities, what is happening in other countries, business
cycles and so forth) in addition to the "living wage"
determine whether a local economy expands or contracts. In order
to tease out an economically sound estimate of the effect of the
"living wage," the empirical economist must account for
all the factors. Empirical studies that purport to show that the
"living wage" does not hurt the poor and perhaps even
expands employment and helps the poor do not account for all factors.
Studies that do account for all factors show overwhelmingly that
wage floors hurt the poor. And those hurt are the least effective
interest group in society (minorities, low skilled, relatively uneducated).
They have no voice in the matter. All many of them know is that
there is no job available when they go looking. For them the legal
living wage becomes ZERO.
An excellent summary of the history and all the empirical evidence
of wage floors may be found in: David Neumark in his research summary
"Raising Incomes by Mandating Wages." It may be found
online at www.nber.org/reporter/fall02/higherWages.htm.
There are lots of things we can do to help the poor. The "living
wage" idea is not only ineffective; it is counterproductive.