The effects of floors on wages, minimum
wage legislation and collectively bargained minimum wages: a labor market
Supply and Demand in the Market Place
most readers realize, the prices of all goods and services in all markets are
determined by supply and demand for the good or service in question. In markets that are not competitive, such as
the markets for petroleum products, the control of supply or demand, will
influence the price and reduce the economic welfare of society in various ways
as we have explained in several newsletters on this website over the years. Government intervention by establishing price
ceilings and floors will also influence the prices in markets as is the case of
farm price supports, the control of rent or legislating minimum wages in labor
ARE WE EVER GOING TO LEARN THAT FREE MARKET CAPITALISM, SO LONG AS IT IS
COMPETITIVE, IS THE BEST POSSIBLE ECONOMIC SYSTEM TO ACHIEVE THE ECONOMIC
WELFARE OF ITS CITIZENS?
determines the supply and demand for each good or service is a much more
complex question. The labor market is
the market in which the productive resource, labor service, is bought and
sold. The price is the compensation rate
labor is paid, which in the U.S. is currently, according to Department of Labor
estimates, composed of two parts. In the recent past, the average labor
compensation rate consisted of about 70% money wages and 30% non-wage benefits paid
for by the employing firms. That rate
has shifted as money wages as a percent of total compensation have fallen to
68.3% for all civilian employees and benefits have risen to 31.7%. Keep in mind that ‘benefits’ are typically
either non-taxable or tax-deferred for employees.
Note: Employer Costs for Employee Compensation (ECEC) measures
the average cost to employers for wagesand
salaries and benefits per employee hour worked.
ECEC includes the civilian economy, which includes data from both private
industry and state and localgovernment.
Excluded from private industry are the self-employed and farm and private
householdworkers. Federal government workers are excluded from
the public sector. The private industry seriesand the state and local government series provide data for the two
Benefits and Total Compensationin
the Federal Government and the Private Sector
federal benefits were about 48 percent higher, on average, than the benefits
received by measurably similar private-sector workers. The most important
factor contributing to differences between the two sectors in the costs of
benefits is the defined-benefit pension plan that is available to most federal
employees. Such plans are becoming less common in the private sector.
Overall, total compensation for federal employees was about 16 percent
higher, on average, than total compensation for measurably similar workers in
the private sector.
The Substitution Effect – the longer the
time involved, the greater the impact
price or in this case, the compensation rate that equates the supply of and
demand for labor, that clears the market by equating the quantity demanded with the quantity supplied is
referred to as the equilibrium price for labor.
When the price in any market changes, it sets off reactions by buyers
and sellers in each market. In the labor
markets, one such reaction is called the substitution effect. The substitution effect is one of the most
powerful reactions in all of economics.
The longer the time period studied, the greater tends to be the total reaction
as the substitution effect.
price above the equilibrium price will result in a surplus of labor, that is,
the quantity supplied will exceed the quantity demanded. Some labor economists view this as voluntary unemployment
since it results from an excessively high compensation rate resulting in a
disequilibrium in that market. Any price
below the equilibrium price will result in a shortage of labor, that is, the quantity
demanded will exceeds the quantity supplied of labor.
slopes of the demand for and supply of labor curves embody such ‘effects’ as the substitution and income effects. For those readers not wanting to delve into
the theory of markets such as the labor market, let us remind you that if you
use the term automation or outsourcing, you are speaking of the vernacular term
for the substitution effect.
a quarter of a century ago, I was lecturing on this subject when a student
commented that he had just returned from a trip to California and had noted
that a fast food franchise he had frequented there, had only two observed
employees, everything else was automated.
As the push for legislation to enact ever higher minimum wages of these employees
has spread eastward across the nation, this type of transformation has been
occurring rapidly in our “neck of the woods.”
need only look so far as most fast food establishment where you receive an
empty cup when you order a drink. It’s
clearly less expensive to hire an additional worker dedicated to filling soft
drink cups than it is to allow the customer to help themselves to refills of
their chosen beverage.
substitution of capital for labor is driven by the increasing cost of labor and
the resulting attempt to pass such costs on the buyers of fast food products. The result has been twofold and triggered the
substitution effect in the product market as eating at traditional restaurants
became more competitive with eating at fast food establishments. The substitution effect gained even greater
strength. This was in addition to the
substitution of capital for labor or automation. As kiosks and the acceptance of debit and
credit cards has begun to replace the need for human labor to take orders and
act as cashiers.
so-called ‘Affordable Health Care Act’ or ACA (The
Patient Protection and Affordable Care Act (PPACA)) has also taken its
toll as most new jobs are part-time in order to avoid the rising cost of health
care premiums paid for by the firms employing labor on a full time basis.
we have argued in this newsletter over the years, the best way to achieve a
less excessively unequal income distribution, is first to promote the economic
growth needed to stimulate job creation and secondly, to promote vigorous
competition so some arbitrary winners in the productive resource mix do not garner
more than their share of the goodies associated with economic growth. This market power controlled by some
productive resources and their employing firms allows some productive resources
to earnfar above their opportunity
costs while many others not so empowered fare far worse and are also exposed to
excessively high prices for the goods and services they buy in their role as
high rollers include a very large numbers of households whose primary source of
income is in the form of labor compensation and not
interest and dividends. Athletes, auto
workers and government employees are among the high rollers
undermining the economic welfare of the economic system.
The attempt to
directly redistribute income to lessen excessive inequality in that distribution
by such things as the ‘War on Poverty’ of the Lyndon Johnson years and the ‘Affordable
Health Care Act’ of the Obama years has proven to be a resounding failure both
in reducing the excessively unequal income distribution as well as ca using a
slowing rate of economic recovery and growth that is causing a falling medium
real income of society.
“In the U.S. since 2007 the
real median Household Income has fallen by $4,497, from $56,436 to
$51,939. In addition, the Gini Index (sometimes referred to as the Gini
Coefficient) has also shown significant signs of increasing income disparity
over the last several years. There’s little doubt that the monetary and
fiscal policies employed to combat the recession and the subsequent failure of
the labor markets to adequately rebound has led to lower incomes and increased
disparity. In a normal environment – in this case, meaning a robust
recovery accompanied by policies promoting competition, those competitive
forces would move to both increase the median income level by drawing more
people into the labor pool, which would in turn reduce disparity (lower the
Gini Ratio) due to those same competitive forces working in a like manner in
the labor (productive resource) markets.”
those good-hearted people crying for such things as “living” wages, we ask them
to drop such clichés and do a bit more analyzing of what is a sustainable income
for productive resources such as labor.
The demand for labor is not too difficult to understand. It is determined by the revenue that the
productive resource [labor] generates for the firm employing the labor in
question. What does this mean in
everyday terms? It equates to the money
value of the production contributed by the additional labor employed.
If a person is compensated $35 per hour for performing a given task in the
production process, the assumption is that the $35 of labor employed
contributes a certain amount of revenue (typically much more than $35 is
required to justify that expense) much more in terms of revenue for a firm for
that one hour of performance.
additional production requires dropping the price to sell the additional
quantity, it is the marginal revenue, not the price or average revenue that is
used to monetize the added physical production resulting from labor’s
contribution to the production process.
the $35 per hour cost related to the employee begins to eat into the
profitability of the item produced and cannot be offset in some manner, it is
logical that the firm’s manager begins to reconsider the productive resource
mix (labor, capital, entrepreneurship, land) to see if there might be some way
of reducing cost.
decisions are made at the margin as labor theory argues, then the physical
contribution of labor to the production process should be monetized at its marginal
revenue and not its average revenue, which is the price to the consumer.It
should be noted that as the degree of competition in the product market
increases, the divergence between the price and the marginal revenue of the
good or service in question converges toward zero.
labor’s compensation, so determined, is less than a living wage; whatever that nebulous
term means, then that labor had better find a more productive job or work longer
hours. Labor could also put in the extra
effort to embody greater human capital in itself by additional training,
education, etc. Paying labor a “living
wage” if it is higher than labor’s marginal revenue product, will simply result
in job loss and it is unsustainable in the real world.
word ‘sustainability’ in a real world context, must be must be realistically
defined and not borrowed from fantasy land.
last several years have been in many ways tragic in terms of employment and real
wage growth, no matter the intention of policy makers. Adoption of clichés and their incorporation
into legislation does not good policy make.
While the path to hell may not be paved with good intentions the path to
bad economic policies can be so paved.
Last Point: Falling Labor Force
Participation in the 16-54 Age Group (2007-2014)
2007, the Labor Force Participation Rate for the 16-24 year old demographic was
59.4%. The Labor Force Participation
Rate is equal to the Labor Force (those employed and those unemployed (U3
Unemployment) actively seeking employment) divide by the Civilian
Noninstitutional Population (those 16+ year olds not in the military, prison,
or otherwise counted in institutions).
In 2014, the LFPR dropped to 55.0%.
If that Labor Force Participation Rate would have remained at 2007 59.4%
level, then 1.7 million more people would be in the labor force in 2014.
around 50% of minimum wage earners are in the 16-24 year old age group, does it
make sense to raise the minimum wage?
at or below the federal minimum are:
young: 50.4% are ages 16 to 24; 24% are teenagers (ages 16 to 19).”
in mind that the LFPR is significantly lower than it was in 2007. If you increase the cost of hiring these
people for minimum wage jobs, what is the more likely outcome? Increased hiring by employers on the margin
(those facing other cost pressures due to such things as the implementation of
Obamacare and higher cost of other inputs), or reduced hiring?