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How Not to Raise Wages

June 1, 2001

Tags Big GovernmentLegal System

In economics, people often mix up cause and effect. Observe, for example, that both wages and labor market regulations have increased for most of this century. Did the laws and court decisions cause wages to rise? Or did wages rise despite the interventions; might they be even higher without regulation?

Adopting the view that government can increase wages by fiat is the Santa Monica, California, City Council, which seems to fall prey to every economic fallacy. These are the folks that still defend rent control despite housing shortages, and deal with the problem of homelessness by creating more through subsidies.

In late May, the city council passed a "Living Wage" measure that requires a minimum wage of $10.50, a 68 percent increase over the state-mandated wage floor. Economic logic tells us pricier labor leads to fewer purchased labor hours–that is to say, unemployment. This is a law destined to hurt the people the City Council says it wants to help.

Even stranger, it doesn't apply to everyone: It is imposed only against the most profitable businesses. If you operate in the tourist area on the beach or downtown, and your revenues are $5 million and up, you must pay the high wage. In addition, the law imposes a mandate that employers pay health-insurance coverage up to $1.75 per hour, a level scheduled to increase to $2.50 per hour in July 2003.

Anticipating that businesses would likely cut back hours and employees under the strain of the law, the law mandates that employers not "retaliate" against them. But it’s a fact: many businesses face the choice of either cutting the hours they are open or closing their doors, so, despite the law, there will be a massive reshuffling of labor resources.

Still, the "Living Wage Movement" is celebrating. About 50 such laws exist around the country but they usually apply to government institutions and contractors. This is the first time that such a law has been imposed against private business.

If increasing wages is as easy as passing laws, why be stingy? Why not raise the living wage to $50 or $500 per hour? Somehow the City Council understands that this would be over-the-top and cause bankruptcy and rampant corruption. Why, then, should any steps toward that end be taken?

The City employed economists to examine the issue. Richard B. Freeman from Harvard wrote that he recognizes the dangers of price floors on wages but also notes that coastal hotels have earned unusually high profits ("rents") due solely to their location. By forcing the hotels to distribute their "rents" through wages, he concludes, the living-wage law "strikes a defensible balance."

Thus spake the omniscient economist. In truth, there is no way to know whether the hotel profits are due to location or good service or high demand. They are certainly not to due to the looting of wages that should be going to the workers, as Marxist theory would have it.

In any case, forcibly transferring such profits through the labor market to the workers makes puts the hotels in a double squeeze: paying wages they can’t afford and reducing profits that make expansion and thus higher wages in the future possible.

If the goal is to put more money in the workers’ pocket right now, why not reduced payroll taxes? Professor Freeman dismisses this idea since tax "leakages are not waste, but transfers to the federal and state governments. This is an important point, because [tax] leakages are not an economic cost that reduces the efficiency of the Santa Monica economy."

The idea that government is not a waste is just a wild assertion made with no evidence or argument. It is a doctrine that, once accepted, makes it possible to justify the highest possible level of taxation. And it really begs the question that began this piece: how is it that wages rise in an economy?

The answer: The only way to raise wages over the long run is to allow the free market to work. Capital investment increases to correspond with productivity and consumer demand, so that and businesses find themselves in a position to make higher bids for quality employees. But this happens through a process of development that can't be rushed through legislation.

Imagine the perverse incentives this creates for a business with $49 million in annual revenues, or for a developer who might consider taking over a beach-front business to make it run more efficiently. Suddenly, he is faced with vast new labor costs. Consider the costs of maid service alone: One maid can clean 14 rooms in an eight-hour shift, which means that an entire crew is required. One survey of businesses showed that 70 percent expected to reduce future hirings, but that report was completely ignored.

The injustice of it all nicely illustrates the socialist view of justice: Mistreat the successful and reward and subsidize the less successful. Apply the principle across the board, and you can destroy an entire civilization.

Why would a city do something that is so obviously self destructive? The Santa Monica socialists disregard even the most reasonable skeptic as a tool of the beach-front capitalists who fail to envision the beautiful new socialist world they are creating right there in Santa Monica, even as the homeless walk the streets, teens lose their jobs, and business packs its bags.

And then who will the city blame? Who else but the capitalists and what else but the dearth of regulations?

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Llewellyn H. Rockwell Jr. is president of the Ludwig von Mises Institute in Auburn, Alabama. Send him mail and see his Daily Article Archive. He also edits a daily news site, LewRockwell.com.

See also: Mises's great essays Profit and Loss and  Middle-of-the-Road Policy Leads to Socialism.


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