The Hidden Dangers of the "Living Wage"

Tuesday, January 3, 2012

With 2012 upon us, the next labor market battle, both in the United States and in Europe, will be over the “living wage.” Long backed by both unions and progressive groups, the living wage law looks like a good-old fashioned minimum wage law, with this critical twist: The minimum wage law, which is presently at $7.25 (up from $5.15 in 2006) applies to a wide range of workers in the public and private sector. In contrast, the living wage law is targeted only to those individuals who work in projects that receive some sort of government subsidy. As the New York Times put the point in an impassioned editorial last December, the case for The Fair Wages for New Yorkers Act rests on the simple proposition that 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 Fair Wages proposal, which is now before the New York City Council, attempts to do just that. If passed, it would impose 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 is riddled with exceptions for various small businesses and the like, all of which raise compliance issues, whose impact is always underestimated by the supporters of new social legislation.

 Illustration by Barbara Kelley

The justification for this proposal is that the parties who receive these government subsidies ought to share them with the workers that they hire. It bolsters the argument by noting 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 those cities without the living wage requirements. The most charitable reading of this finding is that these subsidy programs fail to improve matters because of the many unanticipated consequences they introduce into both public finance and the labor market.  In reality, it will prove far worse.

These living wage laws take for granted two propositions that should be hotly disputed. The first of these 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 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 entitled, “In Gilded City, Living Wage Proposal Still Stirs Fears.” With ill-concealed contempt toward the latter-day robber barons that walk 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 new real estate developments.

Running the subsidy machine reduces total wealth.

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 in order 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 one-percent), but that is a second-order debate about which set of distortions is likely to be more harmful than its rivals. The key issue is that the living wage offers no solution to the problem of government largess. The subsidies, after all, are not paid for by the government. Sometimes they are paid by a set of taxes on individuals and businesses (businesses that are often in direct competition with the subsidized firms).

But this account is also incomplete.  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.

Indeed the situation with the living wage will make it yet harder to remove these unwise subsidies when and if some sanity should return to New York City and other municipalities that 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. It will therefore be all the more difficult to remove these subsidies in the future.

In addition, subsidies needed to bail out banks or build baseball stadiums will become even larger than before. Insiders at Goldman Sachs, Bank of America, and Yankee Stadium know how this game is played. If you decide to impose conditions, they will be more than happy to pay the money, 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 particular 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 is found with the ordinary increase in the minimum wage. The Center for American Progress study may be right, but for all the wrong reasons.

The living wage exacerbates the problem of government largesse.

Matters, however, are rarely as simple as this example suggests, for the question arises about whether the living wage law only applies to the big firms that come out net winners from these deals, even if they have to pay living wages. In addition, the tentacles of the law reach further to embrace many smaller firms that are 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 City Fair Wages bill goes far beyond the egregious cases to which Powell refers.  It includes, in addition to big ticket items, any benefit of $100,000 or more which involves such issues as fee waivers, energy cost reduction, environmental remediation costs, and the like.

At this point, it is quite clear that the conditions that could be connected to these grants could prove trivial compared to the wage increases that are demanded. And the situation becomes still more difficult because it is not always clear whether private developers will be able to get any permits if they turn down these various subsidies.

The big picture does not involve only the subsidy. It also covers the hefty minimum wage. On this score, the implicit assumption of the minimum wage proponents is that these increases do not increase unemployment, so that the living wage law is just another extension of the good idea of transferring wealth to poorer individuals, but at a level that is far higher than the minimum wage increases of the second Bush presidency.

Now the calculations get a lot more complicated. If these smaller parties are subject to the living wage requirements, the price tag of this endeavor gets a lot steeper. There is also real doubt about whether it is possible to work out a system of indirect subsidies to multiple layers of businesses, to which the likely answer turns out to be, well, no. Under these circumstances, it looks as though there is no hidden subsidy, so that the living wage now would operate like a minimum wage law that has adverse effects on workers at the bottom end of the labor market, especially black male teenagers. This is just what happened when the minimum wage was raised to the $7.25 level.

Remember this is not a small deal. When the minimum wage law was equal to $5.15, about 6.6 million individuals earned less than the $7.25 wage level. By 2010, after the wage level was increased, unemployment rates did move 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 empirics on matters of degree are always up to debate, given the huge set of other regulations that hit labor markets. 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.

Its exact effect is virtually impossible to tease out empirically because of two related factors. First, 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 level to $25, $50, or $100.

As the wage demanded increases, the jobs offered in the labor market will decline.

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 $0.10, then firms can, for example, just change the way they pay out 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.

Here is one useful example offered by former New York City Mayor Edward Koch in his pungent reply to the New York 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 retail tenants that would occupy the mall. The ostensible purpose of the program 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-to-1 to not 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, as is likely to happen under New York City’s fair wages bill. 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 anti-competitive 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, which we need less of, not more.