It makes sense for a firm to offer wages to its employees at the market rate. Equally, staff members should demand higher wages if their skills are undervalued. But if you want low skilled people to earn more, you can’t ignore the consequences of pay deals that force wages above their market rate. The lesson of economics is to go beyond the noticeable effects, and consider the unseen.
The immediate effect of above-market wages is that workers who receive the higher pay are better off. If the aim is to increase low skilled wages, the policy can be labelled a success. But consider some of the less obvious and less immediate effects of raising wages above their market rate:
Firstly, wages are just one part of an employee’s total compensation. If firms are forced to increase wages, they can compensate by offering fewer hours, harsher conditions, reduced training, or pushing more expenses onto employees (like requiring staff to purchase their own uniforms or equipment).
Secondly, if you increase the costs of hiring, people without jobs become worse off. If they were unable to find work at the initial wage rate – perhaps because their productivity is low – it will be even harder if they expect to be paid more. A third effect can be to make it more likely for firms to substitute away from labour, and to use more capital. It is no surprise that petrol companies invest in automated pumps when labour costs rise. Therefore higher wages have the potential to raise returns for owners of capital, not owners of labour.
Politicians aren’t oblivious to the costs of policies like living or minimum wages. That’s why Britain imposed a minimum wage at the same time as other labour market regulations (like the New Deal) to offset the harm.
But this debate cannot be won on emotion. Advocates focus on the prospects of those who benefit from wage legislation, but we should remember those who lose out, namely those excluded from the labour market as a result. Those of us with compassion for the least well off as our guiding force must never forget that there is a big difference between special interests and the genuinely vulnerable. The most vocal are rarely the most neglected.
But when considering a measure that seems obvious, it’s important to understand and probe the full breadth of its implications. The best way to help the poor is to boost their productivity and skills, thus allowing them to earn more on the free market.
Anthony J. Evans is associate professor of economics at ESCP Europe Business School. See www.anthonyjevans.com Twitter: @anthonyjevans