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Granted, the urge to seek shortcuts can be a strong one. It’s perfectly natural, after all, to think that if the problem is workers’ wages being too low, there’s at least one solution that’s perfectly simple and obvious: Just mandate that employers have to pay their workers higher wages. Or if the problem is that workers aren’t receiving adequate benefits, just mandate that employers have to give them better benefits. Likewise for working conditions, paid time off, etc. – whatever you think workers should be entitled to, just mandate that their employers provide it for them. But if you recall our whole discussion earlier about all the negative unintended consequences of messing with market prices – and if you also recall that wages (including other forms of compensation like benefits) are a market price just like any other price – it’ll probably occur to you that this seemingly simple solution might not turn out to be so simple after all. And as Heath explains, your wariness would be well-founded:

I argued [earlier] that fiddling with prices is a terrible way of trying to achieve distributive justice. Not only does it lead to waste and misallocation of resources, but it seldom delivers much to those who are its intended beneficiaries. Better to let the market work out a set of scarcity prices, then use progressive taxation as a way of achieving greater equality of distribution. Yet even among those who accept this principle, there is one price that is an extremely tempting target for fiddling. That is the price of labor, better known as wages. When Abba Lerner talked about changing the distribution of income, he was talking about using the tax system to achieve transfers between individuals. But it is easy to interpret “changing the distribution of income” to mean “changing the amount that people earn.” And because this is such an obvious temptation, the advantages and disadvantages of such a policy merit their own special discussion.

One of the things that has always rankled people about capitalism is the fact that what workers get paid seems to bear no relationship to what they deserve. In particular, a lot of the work that we think of as quite hard—backbreaking, repetitive, and stressful—is very poorly paid. Meanwhile, a lot of jobs that don’t seem to involve much exertion at all—to the point where it is unclear why they are even called “jobs”—are extremely well remunerated.

[…]

[This leads some observers to fall] prey to what might be called the “social recognition” fallacy—the idea that wage rates are determined by the value that “society” confers upon a particular type of labor. In reality, wage rates aren’t even determined by the value that employers confer upon a person’s work, much less society at large. Unfortunately, the social recognition fallacy has led many people to think that the problem of the “working poor” can be cured by changing the perception that people have of these workers or of the contribution that they make to society. Barbara Ehrenreich’s book Nickel and Dimed created a small cottage industry of journalists working undercover as low-wage workers in order to report their findings. The moral of the story was pretty much the same in every case: These are good, hardworking people who are woefully underpaid given the backbreaking labor they perform and the humiliations they are forced to endure. This is all true, and worth reminding ourselves of. But what are we supposed to do about it? There are generally two recommendations made, either explicitly or implicitly. First, we should be nicer to them. This seems to me uncontroversial. Second, we should pay them more. Here is where the argument (such as it is) runs into trouble.

While it seems natural to think that good people doing hard work should receive a decent salary, the simple fact is that capitalism doesn’t work that way. It doesn’t work that way domestically, and it doesn’t work that way internationally. The resulting distribution of income is, to say the least, morally problematic. The question is what we want to do about it. The general problem is that wages in a market economy, like all other prices, are not just rewards but also incentives. Engaging in an eleemosynary pricing policy for reasons of distributive justice can have perverse incentive effects. Thus the market, as usual, has a frustrating tendency to transform initiatives designed to help people out into ones that leave them worse off than they were before. As a result, antipoverty initiatives need to be a lot more sophisticated than simply paying people more. Often it’s better just to give people money (typically through the tax system) than to fiddle around with the wage that they’re paid.

Landsburg provides some examples of the kinds of negative side effects that can crop up when employers are simply commanded to give their workers higher wages, better working conditions, and so on, without any other measures being taken:

My Uncle Morris collected meat, which he stored in the freezers that lined his basement. When you went to visit him, he’d take you on a proud tour of his collection, pointing out a roast from 1975 and a prime rib that he’d picked up on his honeymoon.

Me, I collect bad economic reasoning. I scan the Internet for snippets of extraordinary ignorance, and I keep them in a file that I’ve labeled “Sound and Fury,” partly because people who are flat-out wrong are often simultaneously flat-out angry, and partly because, while not all these tales are told by idiots, they are at least told by people who (as happens to all of us on occasion) have succumbed to a moment of idiocy.

Unlike some of my other hobbies, this one occasionally pays off, in the form of a choice exam question that begins with the words “Prove you are smarter than the editor of the New York Times (or Forbes, or the Wall Street Journal) by identifying the irredeemable error in the following article.”

Let me give you a brief tour of my collection.

—

From the front page of the New York Times (June 7, 2010):

New York Nannies May Get a Workers’ Bill of Rights

New York may soon become the first state to offer employment protection for nannies.

The state Senate passed a bill of rights for domestic workers this week, a measure that would require employers to offer New York’s approximately 200,000 household workers paid holidays, overtime pay and sick days.

Supporters say the step will provide needed relief to thousands of women—and some men—who are helping to raise the children of wealthier New Yorkers without any legal workplace rights beyond the federal minimum wage.

Now a reporter with the opposite bias might just as well have written:

New York Nannies May Suffer from New Employment Restrictions

New York state may soon become the first state to restrict employment opportunities for nannies.

The state Senate passed a bill this week that would prohibit New York’s approximately 200,000 household workers from accepting any position that does not include paid holidays, overtime pay and sick days.

Opponents say the step will bring unnecessary hardship to thousands of women—and some men—who have found employment because of labor markets that operate freely, except for constraints imposed by the federal minimum wage.

A more neutral observer might have noted that this bill, if passed, will be good for some nannies who retain their jobs, bad for the many nannies who will be driven out of the business, bad for those nannies who would prefer to take less vacation in exchange for higher pay, and extremely good for people like Ai-jen Poo, director of the National Domestic Workers Alliance, who will represent the winners and can conveniently ignore the losers. Instead Ms. Poo is quoted, without apparent irony, as calling the measure “a huge step forward in reversing the long history of exclusion that domestic workers face.”

The mistake here is to confuse the legislation’s stated purpose with its likely effects. If you make workers less valuable to their employers, then employers will hire fewer workers. Then, as workers compete for a smaller number of jobs, wages are likely to fall.

Sometimes people find this hard to believe, because they know too many people who would never give up their nannies over an issue of overtime pay. Here’s what that overlooks: First, it’s not always safe to generalize from the people you happen to know. Second, and more fundamentally, there always must be people who are on the verge of firing their nannies. If there were no such people, then competition for nannies would intensify, raising nannies’ wages and pushing people to that verge. (This is one of the key insights of labor economics.) And third, it doesn’t take very many laid-off nannies to have an effect that cascades through the whole profession.

—

My collection contains a whole subgenre of stories that declare some piece of workplace legislation a “victory” for precisely the group that has the most to lose from it. Family leave legislation requiring employers to provide lengthy maternity leaves is hailed as a victory for female workers, but it seems odd to label as “victors” those whom the legislation comes closest to rendering unemployable. Job applicants aren’t even allowed to opt out of the program in a voluntary bid to rise to the top of the applicant pool, or in exchange for a higher wage. Therefore the natural advantage that the legislation confers on male workers (who are also eligible for family leave benefits, but are much less likely to claim them) is really cemented in. In my “Irony” subfolder, I have a transcript of an old presidential debate where Al Gore hammered away at the first Bush administration on the issue of family leave (“Did you make it mandatory? Why didn’t you make it mandatory?”)—immediately after extolling the virtues of choice in the abortion segment of the program.

Likewise when a court ruling made it easier for surrogate mothers to renege on contracts and keep the babies they had carried, a spate of editorials were quick to hail a victory for potential surrogate mothers—but it was a “victory” that for several years rendered surrogacy contracts all but obsolete. (Since then the legal situation has evolved differently in different states.) If the court had ruled that henceforth all mortgage payments are voluntary, would the same editorialists have hailed a victory for home buyers, or would they have realized that the court had made it nearly impossible to buy a home?

—

In the same genre, the New York Times reported on the plight of Harriet Ternipsede, an airline ticket agent whose employer monitored her every keystroke, so that her supervisor was alerted instantly if she so much as stopped to stretch her muscles.

The Times took it for granted that Ms. Ternipsede would have been better off without a supervisor breathing down her neck at every moment. But strict supervision doesn’t just allow the employer to observe low productivity; it also allows him to observe high productivity—and to reward it. An employer who can observe, reward, and thereby elicit high productivity is an employer willing to pay higher wages.

If you doubt that, consider the opposite extreme. Imagine a world where your employer had zero information about your work performance, to the point of not even being able to tell whether you’ve been showing up every day. Unless you are an extraordinarily motivated employee, you won’t put much effort into that job. Your employer, recognizing that fact, won’t be willing to pay you very much. Clearly employees are better off with some monitoring. If some monitoring is good, then it’s an empirical question how much monitoring is optimal.

Not all examples of this kind of incentive distortion involve governments imposing mandates from the outside; in some cases, it can involve workers’ unions trying to artificially keep their compensation levels higher than their productivity levels – or conversely, it can involve employer organizations trying to keep workers’ pay lower than its market value. Either way, though, there are still negative side effects – and they occur for the same reasons. As Sowell writes:

In earlier centuries, it was the employers [rather than the labor unions] who were more likely to be organized and setting pay and working conditions as a group. In medieval guilds, the master craftsmen collectively made the rules determining the conditions under which apprentices and journeymen would be hired and how much customers would be charged for the products. Today, major league baseball owners collectively make the rules as to what is the maximum of the total salaries that any given team can pay to its players without incurring financial penalties from the leagues.

Clearly, pay and working conditions tend to be different when determined collectively than in a labor market where employers compete against one another individually for workers and workers compete against one another individually for jobs. It would obviously not be worth the trouble of organizing employers if they were not able to gain by keeping the salaries they pay lower than they would be in a free market. Much has been said about the fairness or unfairness of the actions of medieval guilds, modern labor unions or other forms of collective bargaining. Here we are studying their economic consequences—and especially their effects on the allocation of scarce resources which have alternative uses.

Almost by definition, all these organizations exist to keep the price of labor from being what it would be otherwise in free and open competition in the market. Just as the tendency of market competition is to base rates of pay on the productivity of the worker, thereby bidding labor away from where it is less productive to where it is more productive, so organized efforts to make wages artificially low or artificially high defeat this process and thereby make the allocation of resources less efficient for the economy as a whole.

For example, if an employers’ association keeps wages in the widget industry below the level that workers of similar skills receive elsewhere, fewer workers are likely to apply for jobs producing widgets than if the pay rate were higher. If widget manufacturers are paying $10 an hour for labor that would get $15 an hour if employers had to compete with each other for workers in a free market, then some workers will go to other industries that pay $12 an hour. From the standpoint of the economy as a whole, this means that people capable of producing $15 an hour’s worth of output are instead producing only $12 an hour’s worth of output somewhere else. This is a clear loss to the consumers—that is, to society as a whole, since everyone is a consumer.

The fact that it is a more immediate and more visible loss to the workers in the widget industry does not make that the most important fact from an economic standpoint. Losses and gains between employers and employees are social or moral issues, but they do not change the key economic issue, which is how the allocation of resources affects the total wealth available to society as a whole. What makes the total wealth produced by the economy less than it would be in a free market is that wages set below the market level cause workers to work where they are not as productive, but where they are paid more because of a competitive labor market in the less productive occupation.

The same principle applies where wages are set above the market level. If a labor union is successful in raising the wage rate for the same workers in the widget industry to $20 an hour, then employers will employ fewer workers at this higher rate than they would at the $15 an hour rate that would have prevailed in free market competition. In fact, the only workers that will be worth hiring are workers whose productivity is at least $20 an hour. This higher productivity can be reached in a number of ways, whether by retaining only the most skilled and experienced employees, by adding more capital to enable the labor to turn out more products per hour, or by other means—none of them free.

Those workers displaced from the widget industry must go to their second-best alternative. As before, those worth $15 an hour producing widgets may end up working in another industry at $12 an hour. Again, this is not simply a loss to those particular workers who cannot find employment at the higher wage rate, but a loss to the economy as a whole, because scarce resources are not being allocated where their productivity is highest.

Where unions set wages above the level that would prevail under supply and demand in a free market, widget manufacturers are not only paying more money for labor, they are also paying for additional capital or other complementary resources to raise the productivity of labor above the $20 an hour level. Higher labor productivity may seem on the surface to be greater “efficiency,” but producing fewer widgets at higher cost per widget does not benefit the economy, even though less labor is being used. Other industries receiving more labor than they normally would, because of the workers displaced from the widget industry, can expand their output. But that expanding output is not the most productive use of the additional labor. It is only the artificially-imposed union wage rate which causes the shift from a more productive use to a less productive use.

Either artificially low wage rates caused by an employer association or artificially high wage rates caused by a labor union reduces employment in the widget industry. One side or the other must now go to their second-best option—which is also second-best from the standpoint of the economy as a whole, because scarce resources have not been allocated to their most valued uses. The parties engaged in collective bargaining are of course preoccupied with their own interests, but those judging the process as a whole need to focus on how such a process affects the economic interests of the entire society, rather than the internal division of economic benefits among contending members of the society.

Even in situations where it might seem that employers could do pretty much whatever they wanted to do, history often shows that they could not—because of the effects of competition in the labor market. Few workers have been more vulnerable than newly freed blacks in the United States after the Civil War. They were extremely poor, most completely uneducated, unorganized, and unfamiliar with the operation of a market economy. Yet organized attempts by white employers and landowners in the South to hold down their wages and limit their decision-making as sharecroppers all eroded away in the market, amid bitter mutual recriminations among white employers and landowners.

When the pay scale set by the organized white employers was below the actual productivity of black workers, that made it profitable for any given employer to offer more than the others were paying, in order to lure more workers away, so long as his higher offer was still not above the level of the black workers’ productivity. With agricultural labor especially, the pressure on each employer mounted as the planting season approached, because the landowner knew that the size of the crop for the whole year depended on how many workers could be hired to do the spring planting. That inescapable reality often over-rode any sense of loyalty to fellow landowners. The percentage rate of increase of black wages was higher than the percentage rate of increase in the wages of white workers in the decades after the Civil War, even though the latter had higher pay in absolute terms.

One of the problems of cartels in general is that, no matter what conditions they set collectively to maximize the benefits to the cartel as a whole, it is to the advantage of individual cartel members to violate those conditions, if they can get away with it, often leading to the disintegration of the cartel. That was the situation of white employer cartels in the postbellum South. It was much the same story out in California in the late nineteenth and early twentieth centuries, when white landowners there organized to try to hold down the pay of Japanese immigrant farmers and farm laborers. These cartels too collapsed amid bitter mutual recriminations among whites, as competition among landowners led to widespread violations of the agreements which they had made in collusion with one another.

He adds that this kind of thing has also occurred in historical instances of workers’ unions successfully winning higher-than-market-level wages, only to be confronted with the reality that these gains couldn’t be sustained without making their jobs too expensive for the company to keep:

Faced with the prospect of seeing some employers going out of business or having to drastically reduce employment, some unions were forced into “give-backs”—that is, relinquishing various wages and benefits they had obtained for their members in previous years. Painful as this was, many unions concluded that it was the only way to save members’ jobs. A front page news story in the New York Times summarized the situation in the early twenty-first century:

In reaching a settlement with General Motors on Thursday and in recent agreements with several other industrial behemoths—Ford, DaimlerChrysler, Goodyear and Verizon—unions have shown a new willingness to rein in their demands. Keeping their employers competitive, they have concluded, is essential to keeping unionized jobs from being lost to nonunion, often lower-wage companies elsewhere in this country or overseas.

Unions and their members had, over the years, learned the hard way what is usually taught early on in introductory economics courses—that people buy less at higher prices than at lower prices. It is not a complicated principle, but it often gets lost sight of in the swirl of events and the headiness of rhetoric.

One way or another, market forces have a way of asserting themselves. Whether we like it or not, then, our choice is to either find ways to work with them, or face the negative consequences of trying to ignore them and inevitably having them come back to bite us.

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