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How to really raise wages

We all want to see higher wages. We all want workers to have more money to spend. But, as a great man once said, we have to judge policies on their results, not their intentions. Laws raising mandatory minimums reduce the quantity of labor demanded and leave low paid workers worse off. Economic theory and evidence tell us this. So what policy do we need to raise take home pay for low skilled workers?

Two points to start

Before we start, we should note two things.

First, there is no one policy which will do this. Raising minimum wages is attractive, in part, because it conveys the idea that there is a simple solution, a single, silver bullet. There isn’t, I’m sorry to tell you. What we need if we are really serious about raising worker’s take home pay is a cluster of mutually supporting policies.

Second, policies which have the desired effect of raising take home pay for the low paid are likely to have the effect of raising it for other workers as well. As a result, these policies might do little to lower income inequality. But they will make the low paid better off, and that matters more.

Where do we start?

We need to start by acknowledging what I call the real iron law of wages. This says that no hire will take place at a wage level above the employer’s estimate of what the employee will add to revenue. If the employer thinks the employee will add $10ph to revenue, they will pay up to that. If they pay $9.98, they are adding $10 to income and $9.98 to costs. And profit is just revenue – costs. The employer is making a profit of 2 cents ph.

So the key thing is the employers estimate of what the employee will add to revenue (productivity). If that is high, so will be the wage. How do we increase that estimate?

Better skills, better capital, better mixing of inputs

First, a worker with better skills will produce more output more efficiently. So, we need policies directed to increasing worker skills. Second, a worker with better tools to work with will also produce more output more efficiently. So our second policy aim would be increasing capital investment. These last two look at the quality and quantity of inputs. The third factor is how well these inputs are combined. Broadly speaking this would be entrepreneurship. The best ways to combine inputs change constantly and successful entrepreneurs are always looking for something new. Barriers to this slow the search for better methods. Such barriers, often in the form of regulations, would be a valuable target.

And finally, one way to increase worker’s take home pay is to take less of their wages in tax.

No magic wand 

These aims are only briefly sketched. In detail, they are harder work than simply signing a law. They do not fit as well on a placard. But they do work, and that is what matters for lower paid workers.

John Phelan is an economist at Center of the American Experiment.

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