Thoughts on the Living Wage campaign

Here at Harvard, there is a Living Wage campaign to get Harvard to pay all its workers a minimum of $10/hour. Its supporters argue that the workers need this money to be able to live as a part of the community around Harvard, where the cost of living is high. While these students and faculty have good intentions, their idea won't work. It will help Harvard's current workers in the short run, but in the long run it will only distort the labor market.

Let's look at what will happen one step at a time. Suppose Harvard pays a certain group of workers $7/hour, and only these workers will be affected by the pay raise. These are workers with skills that can bring them $7/hour in the market economy. If they were more skilled, they would be earning more elsewhere. If Harvard raises their wages to $10/hour, these workers earn more than they could get elsewhere. They will thus try hard to keep their job. In the short run, Harvard will have a loyal group of employees who are earning a good wage for their skills.

However, in the long run, these workers will quit. When Harvard replaces these workers, they will be offering a job for $10/hour that, in the free market, would pay $7/hour because of the productivity of the workers doing that job and the supply of labor in the Cambridge area. The workers who apply for these openings will be more skilled than those who filled the jobs before. They will be workers with skills that earn up to $10/hour in the free market. Because many skills apply across different jobs, many of the new workers Harvard will hire can be more productive than they are at their jobs at Harvard. Thus other companies who pay $10/hour will get fewer good workers, and they will either lower their wages because the workers are less productive, or instead go out of business because they are no longer making a profit from staying open. Those who lower their wages will then crowd down the wages of firms paying $9/hour, etc. In the end, once all of Harvard's current workers have quit, everyone will be earning what they would have earned before, except for a few who are unemployed because Harvard reduces total productivity by employing labor with skills more advanced than it needs.

In the end, it's better for the government to handle redistribution of income. A higher minimum wage could increase total utility, depending on the current economic situation. Some argue that Harvard has a responsibility to pay its workers more because the cost of living is higher in Cambridge. As I just described, this won't work in the long run. What will work is a government minimum wage that varies by location. Such a minimum wage could be calculated by the cost of living based on a standard basket of goods, similar to the calculation of the CPI (but weighted by the typical goods purchased by low income families).

In the end, all of the arguments about redistribution of income must be based on why the material goods derived from income make people happier (in more formal language, increases their utility). I would perhaps argue that people don't derive utility from material possessions themselves, but rather from comparison of their material possessions to those of others or to those they had in the past. This would imply that a utility-maximizing economic policy would encourage economic growth while discouraging highly skewed inequality.

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LDB,, 1999-05-18