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As Target shows, market forces can drive wages up

Recently, I’ve referred to what I call “the real Iron Law of Wages”. Well, what is the unreal Iron Law of Wages?

Old time economics

The Iron Law of Wages was a belief held by some economists in the late eighteenth and early nineteenth century. It said that wages would always be driven to the bare minimum to keep the worker alive and reproducing new workers. In his excellent history of economic thought, Alexander Gray explained it thus; “The simple labourer is beaten down in his negotiations with a master who has a choice among many workers” Gray explains Adam Smith’s views on it

“Masters are few and can combine easily, whereas combinations of workmen are prohibited. Masters can hold out longer. Despite appearances, “masters are always and everywhere in a sort of tacit, but constant and uniform, combination, not to raise the wages of labour above their actual rate.” In every sense the master is in a strong position, while the workmen seldom derive any advantage from their “tumultuous combinations.” Wages, then, depend on a bargain, but all the bargaining strength is on one side. There is, however, a lower limit below which it is impossible to reduce wages for any considerable time. The labourer’s wage must be sufficient to support himself and to enable him to bring up a family, if the race of workmen is to be maintained.”

…unless you work at Target. Or Gap. Or Ikea…

Today, MPR News reported that

“Target says it will raise its minimum wage from $10 to $11 an hour by October and boost it again to $15 hourly by 2020…The new wage is higher than the minimum wage in Minnesota, which is $9.50 for large employers, and 47 other states.”

CNBC reports that

Many retailers, such as Gap, Ikea, Costco, and Whole Foods, have acted in recent years to offer competitive minimum wages, despite Congress being unwilling to boost the federal standard minimum wage — a number that hasn’t budged since 2009.

Well, doesn’t this show that Congress (and state and city governments) doesn’t have to raise the minimum wage?

So what’s happening here? 

The old Iron Law of Wages was just wrong. On this point, that oracle of economic freedom, Adam Smith, was mistaken.

Employers are not all that few at present and they cannot combine very easily. They may reach a tacit agreement to hold wages down by refusing to hire above a certain rate, say $9ph. But if one of them thought they could add $15ph to their revenue by hiring a worker at $11ph, they will be strongly incentivized to do so. Indeed, their shareholders would demand to know why they didn’t. This coordination and commitment problem is how cartels generally break up. Indeed, as Bloomberg reports,

Target Corp. is giving thousands of its employees a pay raise next month, hoping to stay ahead of Wal-Mart Stores Inc. and other rivals in the war for talent. 

Workers might well be in competition with each other, but so are employers.

Contrary to much myth, free markets do have mechanisms to raise earnings. That is why, despite the gloomy predictions of some nineteenth century economists, earnings have risen. When wage rises are decreed by government, some workers lose out to pay for it. But when those higher wages come from market forces and the competition between firms for labor, we can all get better off.

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