Counter Economics

AbstractEfficiency is not well analyzed in respect to US labor markets. The assumption that this market, as with other US markets, is somehow efficient and that it is to use the term of conservative propaganda “a free market.” This is anything but the case and the market for minimum wage labor demonstrates why.

Nothing is more confused regarding compensation and labor productivity than the discussions which take place on the minimum wage in the US. There are deliberately misleading statements from conservatives, and an overall haziness on the topic which applies even to those on the progressive side of the fence. Dean Baker is an extremely important and rare progressive economist. While most economists work for concentrated financial power and tailor their arguments for their masters, Dean Baker is able to practice true economics. In his podcast, Dean Baker spoke on the way in which employment figures are actually insensitive to changes in the minimum wage. Here he states the conservative view of why increasing the minimum wage increases unemployment.

“Workers who earn $5.25 per hour actually only make $5.25 in value (plus profit) for employers and they may not be employed if the minimum wage goes to $5.50 per hour because their employers no longer make money on them.“ – Dean Baker

The issue with this is that it assumes an efficient labor market. This an assumption that does not hold. That is it assumes the following:

1. Employees have an equal ability to leave their jobs for new jobs
2. Employees have access to information about new jobs
3. Employees have the ability to move geographically for new jobs
4. Employees know how to negotiate for better wages

Without this labor mobility, mentality and availability of information its difficult to have an efficient labor market. In all four assumptions, the strength of the assumptions goes down as one gets closer and closer to minimum wage.

Here are several reasons why market efficiency declines with income:

1. People at minimum wage do not have the ability to easily leave their jobs because they do not have a sufficient financial “cushion” to rely on
2. They have poor access to employment information (lower Internet use, fewer associations in different states)
3. They lack the funds to easily move locations to take new positions
4. They have lowered ability to negotiate for increased wages because they are often young and less well educated than higher income workers

What this means is that although an employer may be making $10 to $15 per hour on an employee they can still pay them the minimum wage as there is less upward pressure on wages due to the limiting factors inherent to low income workers. In fact very little discussed is what proportion of the value add of that employee the employer is able to keep. That is companies do not publish their profit margin on employees. In a capitalist society all excess is considered the rightful property of the employer. However, is it? Does Nike really pay its workers in third world countries what they contribute to the value of items when they pay 9 cents in labor for a shirt they sell for $35 (or more accurately for $20 to the retailer)? Is the designers adding $3 to the value of the shirt while Phil Night (Nike CEO) is adding $6 of value? These are very difficult questions to answer. Luckily proponents of “free markets” tell us that whatever people are paid is their contribution to economic value. Their central argument for this is that labor markets are efficient and each group is perfectly extracting the maximum wages for their value added to the productive process. This unsupported view is uncontested in American society. Labor markets are not efficient. Rather some professions are protected from competition, and many of the most highly paid jobs are never advertised. Some groups are overpaid and other groups are underpaid. Employers are so dedicated to underpaying most of their workers that the US began as a slave society, and now actively recruits and employ workers who have no legal right to work in the country. This is because employers, given the right circumstances (less efficient markets) keep the excess they would ordinarily be forced to give employees. Rather it is far more accurate to say that an employee’s productivity may set the maximum wage level they may obtain from employees. We say “may” because employers can chose to take the productivity benefits from some employees and give it to others, as is surely happening with executive compensation. It is impossible to believe that Bill Gates added $60 Billion (an estimate of his net worth) in value over his lifetime, therefore, his compensation must have been taken from the productivity and efforts of his employees and from his competitors which he crushed by violating US anti-trust laws. Furthermore, wages can be transferred to some professions, for legal and other reasons, that should accumulate to different professions. Are attorneys and physicians paid at their productivity level? Are cleaning ladies paid at their productivity level? Attorneys and physicians have powerful barriers to entry that are used in addition to their education to maximize their wages. This costs all of us who have to pay for their overpriced services, in effect reducing our discretionary income. This does nothing to provide incentives to improve these areas as both provide horrid value and horrid service to their customers in the US.

Actual Determinants of Wage Levels

What sets the percentage of the maximum wage level any employee will receive appears to be based upon their leverage (unions, barriers to entry, the number of competing employees for the open positions), and the employees willingness to negotiate to keep more of their productive value and deprive it from their employer. Compensation is a zero sum game. Any compensation paid to the employee is necessarily taken from the employer.

There are a number of examples which prove this is to be a much more accurate explanation of how employees are compensated than the “productivity” explanation offered by economists:

When a company relocates a factory to lower cost country, they are able to keep the money, they would ordinarily pay domestic workers, for themselves. Therefore opening factories in low cost countries redistributes money from employees to employers. However, large multinationals tend to want to sell their products in the high cost countries that they have just laid off their workforce in. Furthermore, the employees left behind are left in a worse bargaining position and there is a lower overall demand for the domestic worker due to this action. This depresses domestic wages. The old logic was that the employees in the low cost countries benefit, however actual observation indicates their benefits are minor and far far smaller than the loss forced on domestic employees. The main beneficiaries are employers and consumers, not workers.

Productivity and Wages

Productivity has almost doubled since 1973, however on average the US worker is making less than they did in 1973 (roughly 5%). That is 34 years without a pay raise. How could this possibly be true if productivity is strongly correlated with income? The reason for this is simple. The balance of power has significantly shifted over the past 3.5 decades to benefit the employers. This indicates that far from being efficient, the US labor market is actually quite inefficient. The relationship between productivity and compensation is the central theory of the free market and of the standard view of compensation. However, this fact refutes it. There are differences in compensation between the sexes unrelated to productivity. Prior to the 1980’s it was considered completely acceptable to pay women 1/2 of what a man made because it was rationalized that men were not the primary breadwinners and that 100% of women were married. This is of course reduced their power vis a vis men and made it almost a necessity to be married in order to have a decent standard of living. There are other differences that persist to this day. For instance men have a strong tendency to ask for more money than women of the same education and skill level which has more to do with cultural differences than productivity differences. Do economists seriously continue to proposed that wages are based upon productivity? Is the relationship they promote remotely feasible as an explanatory theory?

Active Employee Suppression

Employers do their best to promote the standard view that they simply rely on the market to fill their worker ranks and that they do not attempt to control labor markets. In reality employers are active participants in suppressing wages using a variety of techniques including propaganda (advertising, internal corporate communications) as well as underhanded and illegal techniques. The US history is replete with union vs. management battles. Employers like Walt Disney reported union organizers as communist agitators to the government. Employers habitually hired private security firms like the Pinkerton National Detective Agency to infiltrate and beat union protesters. In West Virginia” ..the fledgling United States Army Air Service dropped a few pipe and tear gas bombs as a demonstration meant to overawe the labor organizers. It was the only time in the history of the U.S. that the government ordered military aircraft used against its own people..” – Wikipedia. These incidents are almost unknown to Americans and they are certainly not taught in the US educational system. In the modern era employers use more subtle means to control labor markets which are mostly related to propaganda and government influence peddling (lobbying).

For a group that appears to praise the market, it seems curious employers in the US have done the following activities to reduce employee’s bargaining power in the market:

1. Fire or threaten to fire employees who attempt to unionize (while the legal and medical professions maintain powerful union type institutions.)
2. Recruit and hire illegal immigrants
3. Apply for H-1B visas for importing technology workers (lowering the negotiating leverage of domestic employees)
4. Lobby against a federal minimum wage increase when the current minimum wage is unlivable
5. Lobby against state minimum wage laws arguing they are a federal matter (see point 4 above)
6. Offering non-portable pensions. In the recent past non-portable pensions meant that employees had a strong disincentive to move to other companies and negotiate higher wages. No group that supports a true free market would promote the idea of a non-portable pension as it reduces labor flexibility and free labor markets. Pensions could have been made portable, but were not for reasons that suited the employers. Surprisingly, short term employer greed (see our article on the employer contribution to the 401k vs. defined benefit pensions) got the better of them and they actually eliminated these labor market restricting benefit programs.

The Insensitivity of The Unemployment Rate to Minimum Wage Increases

Also undiscussed is the age of minimum wage workers. Many are young and do not have very much experience negotiating for their salaries, whereas employers do. Employers are able to control younger workers very effectively and pay them far below their contribution to profit. This is one reason why employment figures don’t changes much with increases in the minimum wage. This is because employers can still make more than more than adequate money on employees, simply not as much. This model is so commonly applied at fast food restaurants, in light manufacturing and meat processing that employers can still make good returns by providing meager training and turning over employees multiple times per year.

The question that begs to be asked is if the minimum wage level of the US is so close to not allowing employers to make a profit, why is the profit margin on minimum wages not published? Also what is wrong with so many employers that they can not train their employees better, or instead are the margins quite sufficient already? Furthermore, when minimum wages are passed they are not indexed to the consumer price index, which means minimum wage workers gradually lose ground as the years pass. Why is this the case? On the other hand Social Security benefits are indexed to the Consumer Price Index.

Deafening Silence from the Mainstream Media

Why this is not pointed out is not hard to say. Employers are much more powerful in the mainstream media than employees. As pointed out by Noam Chomsky, there is a “Business” section in the local newspaper but no section on “Labor.”

How Efficient is the Market at the Upper End?

On the upper scale, executive pay is also not based upon a market. Executive compensation growth has far outstripped revenue or earnings growth over the past 3 decades. Furthermore, executive jobs are rarely advertised and their compensation (stock options at least) don’t show on the P&L statements, and executives can cash out their options much more quickly than any other option holding employee in the company. (executives take part of their compensations by “stealing” or “redistributing” it from other stockholder appreciation). This is in addition to the fact their salaries are awarded to them by an elite club of which they are a member. This club is called the board of directors and it is very cozy. Board members are shared across different companies and the social network is very strong, promoting maximum executive compensation and minimal price competition in executive compensation. This is a group which is part of a super-privileged class that work in jobs that are not published on job boards that effusively promote a market theory of labor that does not apply to them personally.

Conclusion

The first framework that needs to be dispensed with regarding to compensation discussions is that the labor market is somehow “efficient”. The US labor market is nothing close to efficient and appears to be least efficient at the top (executive) and bottom (minimum wage) areas of the wage-scale. In conclusion, labor markets are not free. Not in the US and not anywhere else. Employers may speak about a free labor market but they work tooth and nail to restrict them as free markets in wages would reduce their profit margins and allocate compensation on the basis of economic contribution.

Labor markets have strong impediments to labor movement with the most highly compensated having the greatest artificial barriers to entry. There are substantial social and organizational “clubs” which cause some workers to be overpaid and most workers underpaid. These overpaid workers along with employee representatives repeat propaganda from Milton Friedman, the Heritage Foundation and the CATO Institute about the wonderfullness of the market.

Employees are not paid at their productivity level. For most people their productivity level sets the maximum labor rate, but most never attain this level of compensation. For a special class of the privileged their productivity level is irrelevant for their compensation because they can take compensation from the productivity of others and apply the earned value to themselves due to their position in the employment food chain. This model, while touted as a success is actually quite inefficient and provides incentives in the wrong places in the economy. Evidenced for this is found in the fact that economies where income is more evenly distributed result in higher growth. In US history the best economic growth occurred in the 1950s to 1973, precisely when income was most evenly distributed. Countries with the highest disparities in income (Africa and Latin America) have horrid economic performance. In the case of Latin America what is referred to as their economic system is really just a continuation of the systems of domination imposed during the Spanish colonialization. The reason is simple. For most people, they are never paid at their productivity level, reducing their incentives to improve their productivity. For others, they are overpaid for their productivity level, have little incentive to improve their personal productivity when they can simply extract the earned value from those lower down on the employment food chain. The economy is most efficient when earned value can not be extracted from others but must be earned personally, and when one is fully compensated for their personal productivity and do hot have it extracted by someone else. Understanding this and rejecting the propaganda of employers is essential to developing a high functioning economy in the broadest sense, and the first step for employees to attain more equitable distributions of their earned value.