A Wage Floor Forces Employers To Pay Better

January 22, 2015
By Oren M. Levin-Waldman, Ph.D.

It has become a staple of the neoclassical economics model that when productivity increases, then so too will wages. Why is this? Because in a competitive market each worker receives the value of his or her marginal product, which is the amount of an increase in say a unit of labor.

Therefore, workers earn higher wages when their marginal revenue product increases. The marginal revenue product is often the criterion for determining how many more workers to hire because they are able to calculate how much more output can be expected based on how many units are added. But if the marginal revenue product can be increased from the greater efforts of workers without having to increase their number, it then becomes feasible to raise their wages without eating into the profits of the firm.

If wages are supposed to rise with productivity, then why haven't they? By all accounts the economy is improving. In December 2014, total nonfarm payroll employment rose by 252,000, and the unemployment rate dropped to 5.6 percent, which is the lowest it has been since the end of the Great Recession in 2009. At the same time, since the end of the Great Recession, productivity has been increasing, but those productivity gains have not been shared with the workers.

Is there an attempt to maintain a class based society under the guise of the myth of upward Socio-economic mobility? Is the language of free markets at the end of the day nothing more than a rationalization for a system that distributes income unevenly? After all, if workers are led to believe that by working hard they will be rewarded with higher wages because if nothing else they are justly being compensated for enhancing the productivity of the firm, they are also being led to believe that the system of free markets is one of mutual benefits.

There are perhaps two messages here. One is that mythology certainly serves its purposes of rationalizing the status quo and keeping the masses in their place. In this vein, the neoclassical model, upon which the free market orthodoxy rests is no different that Marx calling religion the opiate of the masses, because it too served to keep the masses in their place unquestioning the justness of a system that produced unfair distribution. The second message, of course, is that the model, like so many other theoretical constructs cannot be applied in the real world because there are so many extraneous variables that cannot be controlled for.

The second message usually has a corollary which is that adjustments need to be made, and one of those adjustments is the creation of some type of countervailing force in the market place because employers and employees don’t share equal power. Institutional economists in the late 19th and early 20th centuries recognized that free markets were not neutral and that they did favor those who enjoyed greater market power. Their solution was to support collective bargaining because that would enable workers to negotiate wages and working conditions on a more even par with their employers.

During the New Deal, the authors of the National Labor Relations Act or what has often been referred to as the Wagner Act, also recognized that the power imbalance between employers and workers not only leads to strife and disruptions in productive enterprise, but instability. They saw this measure as essential to ensuring an equitable distribution of the rewards of the economy.

Similarly, the authors of the Fair Labor Standards Act, which created the federal minimum wage, saw it as essential for ensuring an equitable distribution of the rewards of the economy, particularly for those who would not be covered by collective bargaining agreements. A wage floor, it was maintained, would also serve the economy in macroeconomic terms in that it would enable workers to maintain their purchasing power, thereby maintaining demand for goods and services in the aggregate.

At the same time, there would appear to be an assumption that underpins both of these major pieces of legislation, which also returns us to the question of why productivity gains have not been shared among the workers. That is, employers left to their own devices cannot be relied upon to do the right thing. Now if we subscribe to the idea that mythology rationalizes the status quo, then it would be easy to dismiss employers as simply selfish, in which case mythology conveniently masks their selfishness.

But if we subscribe to the second message that implementation of a theoretical construct in the real world requires adjustments, then it becomes clear that something is missing. Market models in general, and especially going back to Adam Smith assume that individuals are basically selfish. Smith assumed the invisible hand of the market would check selfishness and channel it towards accomplishing the public interest. If there was market failure, as Smith assumed to be the case with monopoly, then regulation would be required.

A wage floor, then, becomes necessary not only to ensure that workers receive a fair and liveable wage in an environment where they don’t have the market power to negotiate with their employers as equals, but to also ensure a level playing field among employers. Remember the same neoclassical model assumes that firms seek to maximize profits while minimizing costs. If their competition is paying low wages in order to maintain low prices, they similarly are going to lower their labor costs. Therefore, no profit maximizing firm would offer to pay higher wages even if it would bring in higher quality workers for fear that the competition will not do the same and then they will be underbid by their competition. In other words, the absence of a standard — a wage floor here — makes it a foregone conclusion that employers will act on their selfishness.

Institutions like unions and the minimum wage in the end force employers to do the right thing and what is ultimately in their own best interests. Of course the critic will cry that the employer is being coerced rather than being allowed to come to this conclusion voluntarily. But we have already seen that with the increases in productivity employers won’t do the right thing voluntarily because so far they haven’t been sharing the gains with their workers. Therefore, it seems logical to conclude that perhaps they need a nudge in the form of, at a minimum, a rising wage floor, which will, through interval effects, force up wages through the distribution.

Otherwise, we might have to conclude that if employers don’t want to share productivity gains with their workers, and they will oppose increases in the minimum wage because it will force them to do so, that they simply want to horde profits at the expense of workers. And yet, they conveniently forget that without workers there would be no profits. If this is true, then market ideology is nothing more than a rationalization that conveniently serves their naked self-interests. That public officials buy into this mythology only means that they too really don’t care for the larger communities they serve. But then again, if by now we haven’t figured that out, then perhaps there is no hope.

January 21, 2015

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