Thursday, March 26, 2015

How Wages Work

I was writing today about immigration, wages and employment (an essay I hope to post soon), and I realized that, in the past, when writing about wages I stuck pretty closely to the classical, or in some cases Austrian, arguments about wages, and why the market will inevitably tend to push wages close to the productivity of a given worker. It is a simple argument, and one that makes sense, at least superficially. However, as I thought about it more, I could see how some could find fault with it, as, though it is technically correct, as normally presented, it sounds wrong, mostly because it omits a number of steps in the process. As a result, the argument makes it sound as if employers have some sort of omniscience, or at least superhuman abilities when it comes to determining productivity. If you want an example, read my essays "Employment A to Z", "More Thoughts on Wage Disparities", "Capitalism and Its Consequences", "Competition", "Another Look At Exploitation", "Fairness and the Free Market", "Exploited Labor", "Capital Investment", "Exploiting Workers?" and "Two Sided Processes and Claims of 'Unfair' Outcomes", . In each essay my argument follows the same lines, and in each case it glosses over some very important steps. Allow me to demonstrate.

The basic argument is simple, and is used to argue against everything from antidiscrimination laws to minimum wage to, well, pretty much any intervention in matters of wages*. The argument goes as follows: There is no reason to try to force fair wages**, nor to assume the market must be run by ethical or virtuous people, as the market mechanism itself ensures that the greed of employers and employees will keep wages close to worker productivity***.

The mechanism is as follows. Assume I am employing individuals far below their productivity. It may be just employees in general, or women, minorities, whatever. If I do so, I am making a considerable profit. However, regardless of why I am underpaying, be it racism, sexism, simple greed, or come collaboration with my fellow employers to suppress wages, the fact is, there is a considerable profit to be made by paying slightly more than I am, thus poaching my best workers, and still making a considerable profit. However, those employers, if still paying less than a worker produces, will find themselves subject to the same poaching, and so on, and so on, until workers' wages are inevitably driven close to the value produced by their labor. It is a simple mechanism, and makes sense, except for one thing.

How does an employer know I am paying too little?

This where the explanation kind of falls apart. I was considering it in terms of immigrants and realized there was a considerable gap in the explanation. If I am an immigrant who just took a job, how do I know my employer is making $10/hr from my efforts and only paying $7? What would make me seek better pay? Or, from the other side, if I am a competitor, how do I know that my rival is paying only $7/hr to workers who should be earning $10? And if neither side of the equation has a means to figure this out, then how does the average wage get adjusted so that it rises toward the level of productivity? Unless workers and employers possess some magical sense telling them what workers are truly worth, and what they are being paid, the explanation above seems to fall apart.

But there is an answer. Profits. Rivals can tell when an employer is underpaying because of profits. Of course even that is not so simple. Fine, if you are a public company, your earning statements will reveal pretty clearly you are underpaying, but what about privately held companies?

Well, in those cases, there are more subtle signs. Your ability to undercut the competition, for example. Or the rate at which you expand. Maybe your ability to weather bad times when your rivals cannot. Or your ability to reduce prices charged when other cannot. In hundreds of little ways, companies earning above average profits can be spotted by those with an interest in doing so.

And once we establish a company is earning above average profits, there will inevitably be an increase in interest in that market, as those seeking better returns jump on the elevated profits they can detect in that industry. Now, granted, that will not immediately tell employees they are underpaid, and, while we speak of "poaching", in most industries employers do not directly approach the employees of a competitor. But, if there are new jobs to be had, and wages are higher, odds are very good at least one dissatisfied employee will discover it, and once that happens, word will spread. Which is all that is required for us to bring together underpaid workers and employers with higher wages, and get our argument back on track.

Obviously, there are other steps involved. Our employers need to identify who is underpaid (if it is not everyone), but that is handled, as is all employment, through a combination of interviewing expertise, educated guesses, references and trial and error. And we also have to determine how high wages really should be running, and may even, in some cases, for a time pay above the level of production. And then there are a few cases where the elevated profits are either an illusion, or the product of something other than substandard wages, meaning our investment is for nothing. But that is simply the way of the free market. As I have said before****, it tends toward the ideal, but it is not perfect. There are mistakes, false starts and all the other problems we find in all human endeavors. However, flawed as it is, the free market remains the best mechanism for producing the greatest satisfaction from a given pool of resources.


* A similar argument is used to argue against antitrust laws and laws against "price gouging", but in those cases, oddly, the missing steps are normally included, making for a much more convincing argument. See "Imperfect Competition, Abstraction and Anti-Trust", "The Difference Between Public and Private, Or, The Real Monopolies and Cartels", "The Problem of Antitrust", "Consumer Protection, Cartels and the Failure of Regulation", "Put Your Money Where Your Mouth Is, Or The Logical Implications of Price Gouging Laws", "Price Gouging", "'True' Prices" and "Technology and 'Natural Monopolies'".

**  For a discussion of how the free market harnesses greed to the benefit of society in general. For a discussion of why I do not like the word fair, especially in this context see "One More Meaningless Word and Its Consequences", "The Most Misleading Word", "Luxury and Necessity", "Protean Terminology", "Semantic Games", "Can We Ban the Word 'Scarce'?", "Confucius, Aedes Aegypti, Pluto, Sub-Species, Conservatives and Republicans", "Misunderstanding Arbitrary Definitions", "A Brief Thought on Poverty", "We Have Won the "War on Poverty"", "The High Cost of Not Wasting Food", "Fiscal Discipline", "Misleading Terminology", "Be Careful When 'Sticking It' to 'Big Business'", "Peanut Butter and Disability", "Selfishness as Reason - 'Wants', 'Needs', 'Fairness' and Other Guises for Arbitrary Decisions" and "Weasel Words and Hollow Words".

*** See "Greed Versus Evil", "Of Ants and Men", "Moral For Me, But Not For Thee", "Big Box Stores and the 'Climate of Greed'", "Symmetry and Greed", "Competition" and "The Basics".

**** See "Government Quackery", "You Gotta Have Faith", "The Threat of Perfection", "Utopianism and Disaster" , "Government Quackery", "Misunderstanding the Market", "The Importance of Error", " Adaptability and Government ", "The Secret of Success, or, Why Government Fails", "The Case for Small Government", "Why Freedom Is Essential", "De Gustibus Non Disputandum Est" and "Third Best Economy".

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