The problem with a ‘living wage’

How many Big Macs can you buy from one hour’s work? Image sourced from www.shutterstock.com

A recent internet meme making the rounds on Facebook compares minimum wages and the prices of Big Macs in the United States and Australia. The minimum wage is more than double in Australia (US$16 per hour versus US$7.25 per hour in the United States), while the price of a Big Mac is about the same in both countries (around US$4.50).

Despite the much higher minimum wage in Australia, unemployment rates in both countries are both around 6% and the Australian unemployment rate remained at this lower level in recent years, while the US suffered from double-digit unemployment at the height of the Great Recession.

If the minimum wage appears to have little impact on the unemployment rate or prices (although other restaurant prices are noticeably higher in Australia, as any tourist will tell you in about 10 minutes upon their arrival in Oz), why are economists generally opposed to mandating a “living wage” to reduce income inequality?

Non-economists might assume that the answer is simple: economists are pro-business. But we’re not. We’re pro-market, not pro-business.

Pro-Market, Pro-Virtue

The possibly surprising reason economists tend to oppose a “living wage” is virtue. In particular, if the goal is to reduce inequality, mandating someone else to pay a higher wage is not a particularly virtuous way to do this.

This is because it prevents an employer and potential employees from engaging in mutually beneficial exchange. At least this is how I saw it as a teenager in Canada struggling to find a summer job during a recession. My frustration with the minimum wage policy was one of the reasons I became an economist later in life.

In typical teenage fashion, I indulged in reductio ad absurdum arguments at the time, wondering why proponents of a “living wage” kept such earthly ambitions. If they truly thought such a policy would have few unintended consequences, why didn’t they propose mandating a “heavenly wage” that would allow all of us to drive Porsches through the pearly gates?

My cynicism was mostly incited by the fact that minimum wage and living wage laws cost politicians nothing (except possibly votes from small business owners). I detected a distinct lack of virtue in a costless mandate from government about what wage a high school student could work for.

If progressive politicians really wanted to be more virtuous in helping the poor and reducing income inequality, they should do something that would no doubt be very hard for them. They should listen to Milton Friedman.

Milton Friedman, of course, opposed minimum wages because they hindered the proper functioning of markets. Instead, he argued for a guaranteed minimum income, whereby everyone (man, woman, and child) would receive a lump-sum income payment to cover basic needs (in practice, he argued for implementation of the program in the form a negative income tax).

Because it does not restrict mutually beneficial exchange or create disincentives to work, a guaranteed minimum income is less distortionary than a minimum wage or a welfare program.

Like a welfare program, a guaranteed minimum income is costly, which is its source of virtue, but a hindrance to implementation. Friedman opposed “means testing” to limit who qualifies for the income payment, although a means test is probably the only way to make such a program financially viable.

However, a graduated means test could reduce the disincentives to work compared to a sudden threshold and make the program more affordable. And, in general, any increase in focus on income rather than employment status would be an improvement over most existing welfare programs in term of incentives to work.

Minimum wages might be okay, but progressive taxes are better

I’ve mellowed since my teenage years in terms of my views about minimum wages (though not about “living wages”). Having also lived in the United States and Australia, I can now see the problems with a very low minimum wage and some benefits of a higher minimum wage.

For example, in the United States, service workers often receive tips in addition to their minimum wage (tipping is much less common in Australia). But they would clearly be better off receiving their compensation and benefits all in one payment, as they do in Australia.

And minimum wages may simply be much more politically feasible than a guaranteed minimum income, with or without means testing. As a wise friend once told me, we should never let the best be the enemy of the good.

At the same time, I recognize the typical hypocrisy of middle age in my mellowing views. Compared to when I was younger, I can now sometimes afford the higher restaurant prices in Australia. And youth unemployment in Australia is quite high and has been increasing relative to the rest of the population in recent years. It is hard to believe this is completely unrelated to a minimum wage that is close to AU$20 per hour in many service industries.

Ultimately, though, I think economists of all political stripes (even Friedrich von Hayek professed to be in favour of a guaranteed minimum income!) have it right that the focus in addressing income inequality should be more on progressive taxes and less on a “living wage.”

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