Category Archives: Wages

Kate, Allie, and the Fight for Fifteen


If only it was that simple

“I’ve been at Burger King since I was 14, now I’m 19 and still making $9.75,” said Alexis Collins at a protest outside the north Minneapolis fast-food restaurant where she works on Monday. This was another battle in the long running battle to have the minimum wage raised to $15 per hour.

The problem with this view is that a worker’s wage is not a simple function of how long they have worked at a company. Nor should it be. Neither is it a function, at all, of the cost of living or what other people are earning. Nor should it be.

To see the truth of this put yourself in the shoes of an employer named Kate for a second. Kate has the opportunity to hire Allie and thinks that Allie’s work will add $9.75 per hour to her company’s turnover (its income). Assuming for simplicity that Allie’s wage (the businesses’s expenditure) is the only cost that Kate faces, it will make sense for her to employ Allie at any wage up to $9.74 per hour. That is because at any wage up to that, hiring Allie adds more to Kate’s company’s income than it adds to its expenditures.

So what happens if the wage is suddenly raised by government edict to $15 per hour. That means that the cost of hiring Allie has risen by nearly 54%. So, if Kate still thinks that Allie’s work will add $9.75 per hour to her company’s turnover, she will be faced with a choice of adding $9.75 per hour to her income and $15 per hour to her expenditure.

What business would take a decision expecting it to add more to costs than to income? What would happen to a business that did so? Businesses that spend more money than they take in go bust. Knowing this, Kate just won’t hire Allie.

This is why the Fight for Fifteen’s argumentation is composed of irrelevancies and its demands actually counterproductive.

A protester in Minneapolis on Monday said “It’s hard for mothers, single mothers, two parent homes, single fathers, families period to live off the wages we’re making now”. Quite possibly, but, as we can see, Allie’s (the employee’s) cost of living is no part of Kate’s (the employer’s) calculation whatsoever.

Let’s say that initially Allie can get by on the $9.75 per hour Kate pays her. Now imagine that, for some reason – kids or a rent increase – Allie needs $10 per hour to get by and asks for a raise. If Kate still thinks that Allie’s work will add $9.75 per hour to her company’s turnover, she will be faced with a choice of adding $9.75 per hour to her income and $10 per hour to her expenditure. As before, Kate wouldn’t do it. She couldn’t.

What matters for Allie’s wage is Kate’s estimation of the amount of turnover she will generate. No government order will make Kate pay Allie a wage above what Kate thinks Allie will add to her turnover. That is the real iron law of wages. If government arbitrarily raises the minimum wage to $15 per hour, all that will do is exclude those workers whom employers deem to have low (sub $15 per hour) levels of productivity from the legal labour market.

If activists are really concerned about raising wages they need to raise the estimates that the Kates of this world make of the productivity of the Allies. This requires that Allie have better skills which needs better education and on the job training. It requires that she have more and better tools to work with which means more capital investment. And it means that Allie’s labour and Kate’s capital should be brought together as efficiently as possible, which demands better entrepreneurship.

This a longer shopping list of actions than simply jacking the minimum wage up by government diktat. It doesn’t fit into a tweet like #FightFor15. But it does take economic reality into account and it has more chance of helping Allie make $15 per hour.


Wages, immigration (again), and economic methodology


A while ago I wrote about a Bank of England paper investigating the effect of immigration on wages in Britain which found that “the immigrant to native ratio has a small negative impact on average British wages”. Then, some time after, I came across a paper by Julie L. Hotchkiss in the Southern Economic Journal which finds that “illegal immigrants actually raise wages for documented/native workers”. How to explain this contradiction in the economic evidence?

The first thing to note is that the Bank’s researchers, Stephen Nickell and Jumana Saleheen, are looking at slightly different question to Hotchkiss. Nickell and Saleheen are looking at immigration in general, Hotchkiss only at that part of it which is illegal.

Second, they are also looking at different data. Nickell and Saleheen are looking at data from Britain, Hotchkiss from the US state of Georgia.

But should this matter? Should not an economic theory which predicts that, ceteris paribus, an increase in immigration will raise/lower wages in Britain also predict the same for Georgia? In his excellent History of Economic Thought, Lewis H. Haney called the belief that the answer to this question is Yes ‘cosmopolitanism’ and the belief that the answer will be Yes at any point in time ‘perpetualism’.

That seems to depend on which theory you mean. As I wrote of Nickell and Saleheen’s paper, “In the short run at least, this is what economic theory would lead you to expect. If you increase the supply of anything relative to the demand for it, ceteris paribus, the price of that thing, whether it is shoes or labour, will fall.” But Hotchkiss applies a different bit of economic theory, that of comparative advantage, and finds the opposite. So which theory to apply?

The theory of comparative advantage is one of the old workhorses of economics. It states that Country A should specialise in the production of the good or service A that it produces most efficiently, even if it also produces good or service B more efficiently than Country B. This will lead to more efficient production and, via trade, make both countries better off. The more countries there are, the more they can specialise, the more productive they become, and the better off everyone is, so the theory goes.

Hotchkiss applies this to illegal immigration. Illegal immigrants “with limited English skills” (I’m quoting Art Carden’s write up here) coming into Georgia and finding jobs   “frees up low-skill American workers who can then specialize in tasks that require better English”.

That makes theoretical sense, but it isn’t happening in Britain, according to Nickell and Saleheen. Perhaps this is because the premium on speaking English particularly well isn’t all that high lower down the value chain in the UK. Consider Mike Ashley’s Sports Direct warehouse where the signs are posted in English and Polish. There would seem to be little advantage accruing to a native English speaking employee over his or her Polish immigrant colleague from their greater language skills.

It is interesting to speculate on the microeconomic differences between the British and Georgian labour market that allow for so much more specialisation in linguistic ability lower down the value chain in Georgia than there would seem to be in Britain. After all, these differences would seem to determine whether we apply standard supply and demand analysis to the question of immigration’s impact on wages, or the theory of comparative advantage.

But how much of this is fitting theory to the facts? When I read Nickell and Saleheen’s paper I thought “Well, that’s what standard supply and demand analysis would predict”. Did Hotchkiss, I wonder, see her results and think “Well, that’s what the theory of comparative advantage would predict”? Imagine if the British results had also shown a positive impact on wages from immigration. Would I then have thought to myself “Well, that’s what the theory of comparative advantage would predict”? If so, whither economic theory?

Prior to conducting the analysis on British and Georgian data, we would not have known which theory to apply and, hence, could have made no predictions. If, for example, you assumed that comparative advantage applied to the British labour market you would have predicted that immigration would cause wages to rise, as in Georgia. When confronted with the result, that immigration actually causes wages to fall in Britain, you would conclude that your prediction was wrong and that your theory had been falsified. But if you had gone through the same process in Georgia, your prediction would have been borne out and your theory would stand.

These are fundamental questions of economic methodology. Economists generate theories which make predictions such as ‘if X then Y‘.Governments spend large sums of money according to these predictions based on these theories. Is it the case, however, that the appropriate economic theory is entirely contingent on the particular circumstance in which it is applied?

I generally consider myself a cosmopolitan perpetualist in economic methodology. This can lead to situations where, when data contradicts theory, I assume that the data is faulty, that it must be failing to take some relevant factor or magnitude into account. But if there is even a question over which theory to apply in the first place, whither economic methodology?

Wages and immigration in the short run

The Bank of England has a new paper out titled The impact of immigration on occupational wages: evidence from Britain. Its key finding is that “the immigrant to native ratio has a small negative impact on average British wages…Our results also reveal that the biggest impact of immigration on wages is within the semi/unskilled services occupational group.”

Why, then, does the Bank of England correctly state that “There seems to be a broad consensus among academics that the share of immigrants in the workforce has little or no effect on native wages”? The reason is that “These studies typically have not refined their analysis by breaking it down into different occupational groups”, which the Bank’s paper does.

To de-jargon this, studies which find no effect of immigration on wages make no distinction between the wages and workers they are examining; they lump the falling wages of nine road sweepers in with the rising wage of one City banker and say that, on averages, the ten workers wages haven’t fallen. A paper from Oxford University which also dug down into the averages found similar results to the Bank of England; immigration disproportionately reduces wages at the bottom end of the labour market.

In the short run at least, this is what economic theory would lead you to expect. If you increase the supply of anything relative to the demand for it, ceteris paribus, the price of that thing, whether it is shoes or labour, will fall.

But that, too, is to fall into the trap of looking at ‘the average’. There is no labour market in which we are all willing sellers of homogeneous labour. I am not offering the same skills on the job market as Sergio Aguero or Stephen Hawking. The market for the labour of economists and the market for the labour of footballers are different markets, they are not part of ‘the’ labour market. Labour, like capital, is heterogeneous.

To simplify, consider an economy with two types of worker, highly skilled and lower skilled. The markets for each are shown below, for highly skilled labour in chart a and lower skilled labour in chart b.


Immigration of  lower skilled workers increases the supply of lower skilled labour – the rightward shift of the supply curve on chart b from S1 to S2. Ceteris paribus, this pushes wages for lower skilled workers down from P1 to P2. But, and this is the point the Bank of England paper makes empirically, this has no effect on the wages of highly skilled workers, as shown on chart a.

If the immigrants were skilled then the opposite would be the case. The wages of highly skilled workers would fall and those of lower skilled workers would be unaffected. It is doubtful, however, that this is currently the case, at least in Britain.

This debate over the effects of immigration on wages, in the short run it should be stressed, is another example of the difficulties economists can find themselves in when thinking of lumpy, homogeneous aggregates. Lumping all labour together for anayltical purposes makes no more sense than, for example, lumping all capital goods together. The Bank of England’s new paper is a welcome step towards greater acknowledgment of the heterogeneity of economic variables.

Who gets what?


Worth every penny

“If, therefore, the choice were to be made between Communism with all its chances, and the present state of society with all its sufferings and injustices; if the institution of private property necessarily carried with it as a consequence, that the produce of labour should be apportioned as we now see it, almost in an inverse ratio to the labour—the largest portions to those who have never worked at all, the next largest to those whose work is almost nominal, and so in a descending scale, the remuneration dwindling as the work grows harder and more disagreeable, until the most fatiguing and exhausting bodily labour cannot count with certainty on being able to earn even the necessaries of life; if this or Communism were the alternative, all the difficulties, great or small, of Communism would be but as dust in the balance.”John Stuart Mill, 1848

It is one of the oldest fallacies in economics that reward is or ought to be linked to effort. Indeed, as well as appearing in works by august economists like John Stuart Mill it has been solemnised as ‘the Protestant work ethic’ – a fair days ways work for a fair days pay. The attitude persists. Many people think it outrageous that Christiano Ronaldo earns €18,200,000 a year for kicking a football around a couple of times a week while people are fishing cigarette butts out of nightclub urinals for minimum wage.

But, as the generation of economists after Mill realised, reward is linked to productivity. If buckets of water sell for £1 each then someone who can run 100 buckets a day from a tap and drive them to the market in a van will make 10 times more with a fraction of the effort than someone who has to walk to a well and carry by hand 10 buckets day to the market.

This is one of the reasons wages are higher in developed countries than developing ones. There is plenty of effort going on in poor countries but very little capital (like the tap or the car) to augment its productivity and productivity is what counts.

More accurately in modern economies reward is linked to an employers estimation of the workers (likely) productivity. Real Madrid pay Christiano Ronaldo his €18,200,000 a year because they think he will add at least that amount to their profits. People want to watch a team with Ronaldo in, they want to wear shirts with his name on them and they are willing to pay for that. They are willing to pay something or more than they would otherwise to do so.

For a concrete example, consider Real Madrid shirts with ‘RONALDO’ on the back.

1 – Adidas have a bunch of white cloth and thread which they could sell for, say, £1 a sq yard.

2 – They build a factory in Pakistan, buy a bunch of sewing machines and hire a local worker to sew these into plain white T shirts which they can sell for £2 each. The workers sewing and Adidas’ factory and machine have, between them, added £1 of value.

3 – Next they ask the worker to sew an Adidas badge on the shirt. Now it can be sold for £10. Adidas, via their brand, have added £8 of value. You might say that it was the worker who added the value as they did the sewing. But, in fact, only a fraction was added by the worker. To see how true that is consider how much value would have been added if, for the same effort, the worker had sewn ‘JIMMY SAVILE’, ‘MICHAEL VICK’, or ‘GHI PUINNJNULJ’ on the back of a shirt. It wasn’t the worker’s sewing but what they sewed that added the value.

4 – Now they ask the worker to sew ‘RONALDO’ on the back of the shirts. Now they can be sold for £50. Christiano Ronaldo has added £40 of value.

Christiano Ronaldo gets a lot of money because he adds a lot of value.

We can also see why ‘wicked’ capitalists get money for little apparent effort. Think back to our water makers. If a capitalist builds a tap and a car which now enables the second person to bring 100 buckets of water a day to market without all that walking and carrying, that capitalist has added £90 of value.

Is this ‘fair’? I’m an economist, not a philosopher. But plenty of people must think it was fair or it wouldn’t happen. You often hear football fans complain that the prices of tickets or replica shirts is a disgraceful rip off – then they hand their money over for a ticket or shirt. At the moment they hand over £80 for a match ticket or £50 for a shirt they are signalling that they would rather have the ticket/shirt than the £80/£50. Quite simply, it is worth more to them. Which action reveals their true preference; The complaining, which is free to do, or the buying, which costs money?

The real Iron Law of Wages

Lots of labour, little output

One of the oldest fallacies in economics is that the amount of work done should be reflected in the amount of pecuniary reward received for doing it. How can it be fair that someone who slaves away for hours slicing kebab meat in a kitchen on a sweltering day earns £6.19 per hour while someone who kicks a football around for a few hours a week gets £2,040 per hour?

In fact, the amount of work we do is not commensurate with how much we are paid. Nor should it be. In the late 18th century for every bit of effort the average Indian textile worker put in he or she was paid just one sixth of what a British textile worker was paid for the same amount of effort because the British worker, with their greater capital stock, produced six times as much with that given amount of effort. Whatever our gut reactions, what wages reflect is not the ‘effort’ of the worker but their output and the market’s and the employers subjective valuation of that output.

When deciding whether or not to hire, and at what wage, an employer will only employ that person if  they think doing so will add more to turnover than to costs and they will not pay that person more than he or she is expected to add to turnover. To pay more would mean that that the employer is paying to employ that worker. This is the real Iron Law of Wages.

If a landlady has to pay £100 per week to hire a barman she will hire him if she expects doing so to add more than £100 per week in revenue. If hiring that first barman adds £150 per week to turnover, and a second barman (because of diminishing returns to labour) adds £140 both will be hired. If hiring a sixth barman adds £100 in revenue and hiring a seventh barman adds £90, then the landlady will hire six barmen at £100 per week.

If, however, a minimum wage is introduced which raises the cost of hiring a worker to £115 per week the fifth and sixth barman are now being paid more than they generate in revenue, their marginal product, so they will be laid off. The first four barmen are £15 a week better off, five and six are looking at their P45s.

The lesson is that raising minimum wages, as the Conservatives are now rumoured to be considering, makes some people better off but they also make some people worse off.

Some will deny this and say that the mass job losses predicted when the minimum wage was introduced never materialised. But what about the jobs never created? Number seven in our example who was never employed lost a job just as surely as did barmen five and six when the minimum wage was raised. Indeed, many advocates of higher minimum wages implicitly admit this by not pushing for a much higher minimum. Doing so, they admit, would lead to unemployment. But they can never explain why, if the demand curve for labour is downward sloping at one point, it is not so at another.

The only way to raise wages is to raise the marginal productivity of labour. To make labour more productive we either need to train it better (sending one of our barmen on a cocktail course so he can entice a lager drinker to splash out on a Pina Colada) or give it more capital to work with as in the textile example (optics on spirits bottles as opposed to measuring cups).

Sadly there is reluctance in Britain to pursue either of these paths. Our education system has been slipping compared to those in other nations and our financial system, with its addiction to low interest rates and focus on consumption, is inimical to capital accumulation. If the government is worried about low pay it needs to get serious about these issues. They are fundamental questions and attempts to mollify their symptoms with minimum wages are a waste of time.

This article originally appeared at The Cobden Centre