Why Wages Rise
Artificial Measures to Increase Income Cause Unemployment and Economic Inefficiency
AUGUST 01, 1996 by MARK SKOUSEN
“For low-paying jobs that already exist, public policy must aim at supplementing the income of the working poor. . . . One way would be to raise gradually the minimum wage.”
—Wallace C. Peterson, Silent Depression
In the recent debate over the minimum wage and the working poor, I was reminded of a little book, Why Wages Rise, by F. A. Harper (The Foundation for Economic Education, 1957). In his book, Harper made an important distinction between legitimate ways to raise the average wage and artificial means of raising workers’ income.
Genuine Means of Raising Wages
First, let’s discuss the genuine ways that wages can rise. Here Harper focused on the critical role of production and worker productivity. Production comes first, he explains. Higher wages come from increased output per hour of work. (p. 19) Harper produces a graph (see below) showing a close relationship between wages per hour and output (GDP) per hour, expressed in constant dollars, between 1910 and 1960.
Harper’s theory of wages is not new—it is the classical theory of labor taught in college economics. John B. Taylor, economics professor at Stanford, produces graphs that show a similar relationship in his latest textbook (see the next page for a graph showing the rise in hourly compensation since 1955). Even Wallace Peterson, an economist who favors increasing the minimum wage and other forms of government intervention in the labor market, supports the view that, in the long run, productivity gains are the ultimate source of . . . increases in real living standards.
Two Benefits of Higher Profits
How is it that workers tend to receive higher wages as output increases? The key is profitability. When firms increase their profits, there are dual benefits to workers: (1) more and better products and services are sold to consumers, and (2) more funds are made available from retained earnings to pay workers and to improve tools, equipment, and training. When firms are successful, company officers aren’t the only ones who benefit. Workers also receive higher wages and more services, including training, better equipment, and fringe benefits. The advantages of giving higher compensation are: (1) less job turnover, (2) better workers, and (3) higher incentives to work more productively.
The Ford $5-a-Day Story
The Henry Ford $5-a-day story is a classic example. As a result of the huge success of the Model T, in 1913 the Ford Motor Co. doubled its profits from $13.5 million to $27 million. With these profits, Ford decided to share the wealth with his employees and overnight doubled the minimum wage at his Detroit plant from $2.50 to $5 a day. It made Henry Ford an industrial messiah.
The effect of the instant pay raise was dramatic: a tremendous surge in output and skyrocketing morale among Ford workers. Thousands of potential employees moved to Detroit in hopes of getting a job. Ford argued that the higher wage had two great benefits, increased efficiency at the automobile plant, and increased buying power of his workers. Importantly, the $5 wage permitted Ford workers to buy their own cars for the first time. Indeed, sales of Model T’s continued to soar as wages went up and prices declined. By 1916, over half a million cars were sold.
Ludwig von Mises adds the following point to Harper’s original argument: it is marginal productivity, not just total productivity, that has raised average wages over the past hundred years. He points out that many jobs have not changed over the years (barbers, butlers, etc.), yet they benefit from higher wages due to labor competition. It is not any merit on the part of the butler that causes this rise in his wages, but the fact that the increase in capital invested surpasses the increase in the number of hands. Mises concludes, there is only one means to raise wage rates permanently . . . namely, to accelerate the increase in capital available as against population.
Do’s and Don’ts
Harper, Mises, and other free-market economists warn politicians not to seek artificial ways to increase income, such as:
—labor union power, and
All of these measures either cause unemployment or economic inefficiency.
On the other hand, there are a few policies the government can undertake to encourage productivity and higher wages, such as tax cuts on business and investment. Reducing corporate income taxes will increase net income and thereby increase the capability to pay workers more and provide greater benefits. Cutting capital gains taxes will encourage private savings, reduce interest rates, and stimulate capital formation.
But the most dramatic improvement in the lives of the working poor could be achieved by converting Social Security into a genuine private pension system. Privatizing Social Security would increase the nation’s saving rate and, most importantly, provide a high retirement income for all American workers. Even minimum-wage earners could have over $1 million in pension assets under a privately funded Social Security at retirement.
These measures are far superior to raising the minimum wage and other counterfeit proposals to help the working poor.
5. Sam Beard calculates that Social Security contributions of minimum-wage earners ($1,240 a year) would make them millionaires in 45 years if their Social Security contributions earned 8 percent a year. See his book Restoring Hope in America (ICS Press, 1996). Also, see my column $4,000 A Month From Social Security?, The Freeman, June, 1994.