Dead Hand of the Living Wage

Friday, April 6, 2012

The next labor market battle in both the United States and Europe will be over the “living wage.” Long backed by both unions and progressive groups, the living wage looks like an old-fashioned minimum wage, with a critical twist. The national minimum wage, currently $7.25 an hour (up from $5.15 in 2006), applies to a wide range of workers in the public and private sector. In contrast, living-wage laws target only individuals who work in projects that get some sort of government subsidy. As the New York Times put it in an impassioned editorial about the proposed Fair Wages for New Yorkers Act, a city that doles out “hundreds of millions of dollars a year to private developers” should be in a position to ask them to pay decent wages to the workers whose jobs these subsidies created.

The New York proposal was drafted to do just that. It called for imposing one of two living-wage requirements on employers who receive $1 million or more in discretionary financial assistance from New York City: either pay workers $10 per hour in wages plus benefits, or pay them $11.50 per hour without benefits. That works out to a wage boost of 58 percent for workers in that category. Needless to say, that basic requirement was riddled with exceptions for various small businesses and the like, all of which would raise compliance issues. Supporters of new social legislation always underestimate that problem.

Backers defended the proposal by arguing that those who receive government subsidies ought to share them with the workers they hire. They also noted that at least one econometric study by the Center for American Progress concluded that cities that had adopted these proposals had the same level of employment growth as cities without living-wage requirements. The most charitable reading of this finding is that these subsidy programs fail to improve matters, owing to the many unanticipated consequences they introduce into both public finance and the labor market. The reality will prove far worse.

These living-wage laws take for granted two propositions that should be hotly disputed. The first is that the proper way for any municipal government to grow jobs in its community is to shower subsidies on the rich and famous. The second is that even a stiff minimum-wage requirement will not increase unemployment. The New York Times set up its editorial with a feature story by its reporter Michael Powell titled “In Gilded City, Living Wage Proposal Still Stirs Fears.” With ill-concealed contempt toward the latter-day robber barons walking the corridors of power in New York City, Powell takes his reader on a quick tour of Goldman Sachs, Bank of America, and Yankee Stadium to highlight the corrupt subsidies that well-positioned insiders can get for their own real estate developments.

The criticism is right on, at least for the projects named. The lavish subsidies to which Powell refers lead to overproduction in the subsidized areas, and underproduction in those areas that are taxed to supply the subsidy. We can disagree over whether the subsidies should be paid out of general revenues or taxes targeted on some select group (e.g., the top 1 percent), but that is a second-order debate over which distortions are more harmful. The key issue is that the living wage offers no solution to the problem of government largess.

The government, after all, does not pay for the subsidies. Sometimes they are paid by a set of taxes on individuals and businesses (businesses that are often in direct competition with the subsidized firms). And sometimes the subsidies are in fact paid by taxes collected from the same firms that receive the subsidy payments, at which point the circulation of the money has two bad effects. First, the friction of running the subsidy machine reduces total wealth. Second, the convoluted process allows the government a free opportunity to attach conditions on businesses that it could not otherwise impose. Unfortunately, nothing whatsoever about the living-wage program cuts out these distortions, which reduce the overall social welfare. Add in a living wage and the subsidies still remain, with all their baleful social effects.

subsidies that never go away

Indeed, the situation with the living wage will make it harder yet to remove these unwise subsidies when and if some sanity should return to New York City and other municipalities, which are using fad after fad to struggle against a downward economic cycle. Once the living wage is built into the subsidy, additional interest groups will flock to its support, entrenching subsidies further.

Supporters of new social legislation always underestimate the problem of compliance.

In addition, subsidies to bail out banks or build baseball stadiums will become larger still. Insiders at Goldman Sachs, Bank of America, and Yankee Stadium know how this game is played. If government decides to impose conditions, they will be more than happy to pay, so long as they receive an equivalent in cash or kind for their pet projects. The money that comes in on one side can now go happily out the other. In this incarnation, the living wage does not operate as a minimum-wage law that restricts freedom of contract. It works as a covert wage subsidy embedded in a larger grant arrangement. We should therefore not expect it to generate the usual increase in unemployment that accompanies the ordinary increase in the minimum wage. The Center for American Progress study may be right, but for all the wrong reasons.

Matters, however, are rarely so simple. The question arises whether the living-wage law applies only to the big firms that come out net winners from these deals, even if they have to pay living wages. No, the tentacles of the law reach further, embracing many smaller firms caught by the subsidy because they do business with firms that receive government grants. Most critically, the definition of what counts as “financial assistance” in the New York fair-wages bill goes far beyond the egregious cases Powell referred to. It also includes any benefit of $100,000 or more that involves such issues as fee waivers, energy cost reduction, environmental remediation costs, and the like.

Once a living wage is built into a subsidy, additional interest groups flock to its support, entrenching the subsidy deeper.

And the situation becomes still more tangled because it is not always clear whether private developers will be able to get any permits if they turn down these various subsidies.

Minimum-wage proponents assume that pay increases do not increase unemployment, thus the living-wage law is just another extension of the idea of transferring wealth to poorer individuals, but at a level far higher than the minimum-wage increases of the second Bush presidency. Yet if even smaller parties are subject to the living-wage requirements, the price tag of this endeavor gets a lot steeper. There is real doubt about whether it is possible to work out a system of indirect subsidies to the multiple layers of businesses affected. The living wage now would operate like a minimum-wage law that exerts adverse effects on workers at the bottom end of the labor market, especially young black men. This is just what happened when the minimum wage was raised to $7.25.

Remember, this is not a small deal. When the minimum wage was pegged at $5.15 an hour, about 6.6 million individuals earned less than the $7.25 goal stipulated by the Fair Minimum Wage Act of 2007. By 2010, after the minimum wage had been increased in several steps to $7.25, unemployment rates had moved sharply upward. Some of today’s workers will be lucky enough to ride the living-wage tide upward, but others are likely to be cast aside. The number of workers affected is always up for debate, given the huge set of other regulations that roil labor markets. But in principle, the law of demand says that as the wage demanded increases, the jobs offered will decline. Unless demand curves are flat, there must be unemployment effects. The only question is their magnitude. The imposition of a high minimum living wage will reduce, all other things being equal, the demand for labor.

forcing workers out of the market

Its exact effect is virtually impossible to tease out empirically. The key variable is the gap between the current market wage and the minimum wage. Where that gap is small, the minimum-wage law will have a small effect. Where it is larger, it will have a large effect. The most ardent supporters of the minimum wage have to recognize that point, for otherwise they would raise the living wage to $25, $50, or $100.

For small changes in regulation, firms can remain in the market by adjusting other terms of the labor contract. So if the minimum wage is increased by a dime, then firms can, for example, just change the way they pay cleaning allowances for uniforms. But the larger the changes, the fewer adjustments are available. The 50 percent-plus minimum-wage hikes, if not tied to increased subsidies, will surely have major consequences on the shape of labor markets, both for the workers who are forced to exit the market and for those who remain.

The living wage, which starts out as a compassionate policy, ends up as a tool to suppress competition by non-union labor.

Here is one useful example offered by former New York City mayor Edward Koch in his pungent reply to the Times editorial. The Related Corporation, one of New York’s most innovative real estate developers, sought to develop a 575,000-square-foot shopping mall in the Bronx. The company was prepared to pour some $310 million into the project. Neighborhood community organizers, known as the Kingsbridge Armory Redevelopment Alliance, sought, through a community-benefit agreement, to secure living wages, not only for the workers on the construction site, but also for all the employees of the retail tenants that would occupy the mall. The ostensible purpose was to prevent exploitation of the local citizenry. Mayor Bloomberg backed Related’s proposal, but it was squashed when, in December 2009, the City Council voted 48-1 not to back down on the living-wage requirements. No developer has come forward to take the deal that Related turned down.

The great danger of the living-wage proposal is that it need not be tied solely to grants received from the government. Under the fair-wages bill, it will also be tied to permission for real estate development that is given by local planning authorities. At this point, it joins the long list of “exactions” that local authorities can attach to permissions to build. The wish lists are very large, and in some cases, the champions of the conditions would rather see the project go down in flames than be accepted without the conditions. Why? In part because unions have a strong anticompetitive urge to stop the development of new shopping centers that could compete with union-dominated shops. And so the living wage, which starts out as a compassionate policy, ends up as a tool to suppress competition by non-union labor.

The living-wage laws plunge governments further into labor market regulation. We need less such legislation, not more.