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Higher productivity drives higher wages, not the other way around

Yesterday, I wrote about a very interesting Pioneer Press article, ‘Nine business owners give their thoughts on a $15 minimum wage in St. Paul’. One of the business owners was reported as supporting “a citywide minimum wage because happier workers are more productive”.

This is a version of what economists call the ‘efficiency wage theory‘. It acknowledges that pay and productivity are linked. But it says that, for a variety of reasons, the causation runs from pay rate to productivity level, not the other way around.

We can see quite simply that this theory is unsound in two ways.

First, if this business owner thought that raising pay for his workers made them more productive, why wouldn’t he just do it? Why would he wait for government to command him to do it? The same goes for any employer. If the efficiency wage theory is correct and it is in the employer’s interest to raise wages then minimum wage hikes are totally unnecessary.

Second, if raising the minimum wage to $15ph will make workers more productive, why not raise it to $5,000ph and make them super-duper productive? “That is nonsense” is the usual reply. So it is. But why is it nonsense?

Low skilled workers are highly unlikely to generate $5,000ph in revenues for the employers. That would mean that hiring a worker at a minimum wage of $5,000ph would add more to costs than to revenues. This is not something a business wanting to stay in business would do. The employment will not take place. Well, what about $4,999ph? $4,998ph? These would likely have the same result, the employment will not take place. But at what point, then, do we reach the wage above the current wage which will not have this effect? When people say “That is nonsense” to the reductio ad absurdum of a $5,000ph minimum wage, they are admitting that worker productivity is a function of something other than pay. The worker’s skills, being the obvious answer. But how do they know that for a given worker currently earning $10ph that that level isn’t, say, $13ph? In this case, raising the minimum wage to $15ph will have exactly the same effect as raising it to $5,000ph – the actual wage received will be $0ph.

It is true that “High skills = High wages”. But this means that we need to increase skill levels if we want wages to increase, not have politicians simply issue commands. Efficiency wage theories get it the wrong way round. It is productivity that drives wages, not the other way round.

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

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