Best of intentions, worst of results - full report

BEST OF INTENTIONS, WORST OF RESULTS

A review of the New Zealand experience and international evidence on living wage policies

Your Money, Your Voice Promoting sensible restraint of government expenditure

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Contents About the Author 3 Abstract 4 1

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Introduction 5

1.1 Virtue signaling by the Wellington Regional Council on the living wage 5 1.2 Will Wellington bus fares go up? 5 1.3 What did the Wellington Regional Council know and when did it know it?

6 1.4 The Porirua City Council’s living wage compromise 6 1.5 The Porirua City Council put all its cards on the table for ratepayers to see 7 1.6 The Wellington City Council is a lapsed living wage employer 7 1.7 Repeat virtue signaling over adopting a living wage policy 8 1.8 The Wellington City Council is a living wage regifter 10 1.9 The Auckland Council is to vote again on a living wage policy 11 1.10 The Hutt City Council is considering a living wage policy 11 1.11 Purpose and scope of paper 11 1.12 Plan of the paper

Why a living wage? 13 2.1 Living wage campaigns have much to be modest about 13 2.2 40% of a living wage rise is lost to income tax and Working for Families 14 2.3 What inspires the living wage movement? 15 2.4 Who is responsible for social insurance? 16 2.5 A living wage is not about Working for Families being not enough 17

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Is the living wage just a question of morality?

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3.1 Positive economics or normative sociology? 18 3.2 The minimum wage and poverty in New Zealand 19 3.3 Does a council living wage policy uplift families from poverty?

19 3.4 Social reform without a safety harness 20 4

A living wage policy becomes an elevated hiring standard

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4.1 How big is a living wage increase? 22 4.2 How many workers earn less than the living wage?

22 4.3 Who gains from a living wage policy at one employer?

22 4.4 Minimum wage workers will not be shortlisted for living wage jobs 23 4.5 Wellington parking wardens lost their jobs because of the living wage policy 23 4.6 It became necessary to destroy a parking warden’s job to pay it a living wage 24 4.7 Wellington City Council contractors are also raising their hiring standards 26 4.8 The Wellington City Council does not know what is happening to its hiring 26 4.9 The Wellington Regional Council asked no questions 26 4.10 The living wage really is a question of morality 26 5

The efficiency wage offsets from living wage increases

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5.1 The job turnover and work intensity effects of living wage increases 28 5.2 Work intensity and equalising wage differentials 29 5.3 Employers already know that better quality employees are paid more 30 5.4 Workers too shop around for better job matches 30 5.5 We live in the age of strategic human resource management.

30 5.6 Why did performance pay emerge? 31 5.7 Employee effort elicitation is central to industrial organisation 31 5.8 Private sector wage policies must survive the test of competition 32 5.9 Fast-food franchises survive by motivating low-paid workers better 33

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5.10 Recruitment and managing turnover are routine entrepreneurial challenges 5.11 Paying for a living wage policy by cutting council executive pay 6

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The normative sociology of the living wage

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The tale of two city minimum wage laws in one mall

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6.1 6.2 6.3 6.4

The living wage movement are intellectually earnest social activists 36 The efficiency wage hypothesis is a theory of persistent mass unemployment 36 The fair-wage effort hypothesis is a theory of mass low-skilled unemployment 38 Precarious work as the flip side of efficiency wages 40

7.1 Adjacent local minimum wage laws 42 7.2 Two minimum wage laws inside one Californian mall 42 7.3 Two minimum wage economies inside one council 43 8

The living wage in labour markets with good and bad jobs

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8.1 Is the labour market as bleak as living wage activists portray?

44 8.2 Information costs grind in the wheels of the labour market 44 8.3 Are workers under the thumb or just in the dark about their best opportunities?

45 8.4 Looking for good jobs but ending up in bad jobs 46 8.5 A living wage as a backstop against landing in bad jobs?

46 8.6 The bargaining power of the low-paid 47 8.7 Who haggles over wage offers and why?

47 8.8 Does a living wage just even up the wage bargaining for the low-paid?

48 8.9 How much market power do employers have and over whom?

49 8.10 Are living wage increases paid out of excess profits?

50 8.11 How much is up for grabs in an employment relationship? 51 9

The living wage comes to San Francisco restaurants

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9.1 The living wage and the required level of applicant experience 52 9.2 No more entry-level jobs 53 9.3 Less employer funded training 54 9.4 What becomes of the not shortlisted? 55 9.5 No room at the council for the minimum waged 56 10

Baumol’s cost disease and bus driver productivity

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10.1 Some labour-intensive services sectors have stagnant labour productivity 57 10.2 The prominence of down-sizing in stagnant labour productivity sectors 57 10.3 Do bus drivers become more productive? 58 10.4 Managing staff turnover in stagnant labour productivity growth sectors 59 10.5 Many local government services are in the non-progressive sector 59 11

Why the futile crusade?

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11.1 A living wage policy has the best of intentions and worst of results 61 11.2 Picking up the pieces after social reform 61 11.3 Why no crisis of conscience after the 17 parking warden job losses?

62 11.4 Modern democracy is government subject to electoral checks 62 11.5 Do taxpayers and ratepayers get what they voted for “good and hard”?

63 11.6 The living wage and “the fury of democracy” 63 11.7 Why pick a harder fight to win? 64 11.8 Winning isn’t everything in the war on poverty 64 11.9 The duty of councils to be efficient and effective 65 11.10 But is a living wage policy still worth a try?

65 11.11 Should activists use minimum wage breadwinners for policy experiments?

66 11.12 The social justice of pricing minimum wage workers out of council jobs 67 11.13 Why not a 30% living wage increase for everyone?

67 11.14 Time to “pause for a cup of tea” 68

References

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About The Author Jim Rose is a Research Fellow at the New Zealand Taxpayers’ Union. He has masters degrees in economics from the Australian National University, Canberra and in public policy from the now National Graduate Institute for Policy Studies in Tokyo. Jim has worked at the Ministry of Business, Innovation and Employment, the Department of Labour, the Ministry of Social Development, and The Treasury. In Australia, Jim has worked in the Productivity Commission, the Department of the Prime Minister and Cabinet, and the Department of Finance.

In addition to papers for the Taxpayers’ Union Jim also writes op-eds for the National Business Review and the New Zealand Herald. His blog is at www.utopiayouarestandinginit.com

… the difference between those who favour and those who oppose minimum wage rates is not about the objective but about the effect. Both groups would like to see poverty reduced.

Those who, like myself, are opposed to minimum wage laws predict that the effect of the laws will be to render people unemployed and hence to increase poverty; those who favour them predict that the effect will be to reduce poverty. If they agreed on effects they would agree on policy. The difference is not a moral one but a scientific one, in principle capable of being resolved by empirical evidence. … The fact—or what I allege to be a fact—that differences about policy reflect mostly differences in predictions is concealed by the widespread tendency to attribute policy differences to differences in value judgments. This tendency arises because it is often so much easier to question a man’s motives than to meet his arguments or counter his evidence.

We can shortcut the hard process of analysis and collection of evidence, and at the same time bring the support of indignation and moral favour to our views, by regarding the man who differs with us as a “bad” man who wants to achieve “bad” objectives.

Milton Friedman (1967)

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Abstract Councils must still fill living wage vacancies on merit The Achilles heel of the living wage policies at the Wellington City, Wellington Regional and Porirua City councils is they still must hire on merit. Employees at the time of the living wage rise to $19.80 per hour gain, but their replacements will come from jobs on a similar pay rate to merit short-listing.

Only existing council employees will ever benefit from a living wage policy Ratepayers in Porirua and Wellington are paying above-market wages forever for a one-time poverty reduction for existing council employees. A living wage of $19.80 will not lift future recruits from poverty because they already will be earning a similar pay in their last job to warrant shortlisting.

A living wage policy becomes an elevated hiring standard The practical upshot of a living wage policy is a council is implicitly raising its hiring standards. The lower-paid breadwinners currently hired for these council jobs are shut out by the living wage policy.

The Wellington City Council living wage policy has already cost 17 workers their current jobs Seventeen out of 30 Wellington City parking wardens were not rehired when their service was brought back in house by the Wellington City Council as living wage jobs. Sixty-two Wellington City Council employees are still paid below the living wage because they are yet to upskill.

The Wellington City Council living wage is also lifting the hiring standards of its contractors. Existing cleaners and guards are expected to upgrade their qualifications before they are paid the living wage.

Living wage employers become pickier about who they shortlist The experience with large minimum wage increases in service jobs in American malls and restaurants is employers respond to the wage increase by being choosier in their hiring. Employers expect recruits to be much more experienced than before the minimum wage increase. Recruits are expected to arrive with the necessary skills rather than the employer train them.

Inexperienced and entry-level workers will not be short-listed for living wage jobs Living wage advocates happily concede that the quality of recruitment pools improves after a living wage policy is adopted. They call this professionalisation of entry-level jobs. They do not ask what happens to the workers who are no longer be shortlisted for living wage jobs. They should.

Income tax and Working for Families abatement undo 40% of a council living wage increase A living wage is linked to the sum of money needed to raise a family. Yet 40% of a living wage increase for workers with families will be lost to income tax and reductions in Working for Families. Taxpayers gain at the expense of ratepayers when they take up this slack with a living wage increase. Treasury estimates that 85% of those earning less than the living wage do not have dependents.

The very best of intentions cannot save a living wage policy from blowback The cruel reality is low income families are worse off, not better off, after the introduction of a living wage by their local council. Their breadwinners are no longer shortlisted for council jobs because of the raised hiring standard implicit in a living wage rise. While advocates of this futile policy may have the best of intentions, these results will hurt the very families they most earnestly want to help.

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1. Introduction 1.1 VIRTUE SIGNALING BY THE WELLINGTON REGIONAL COUNCIL ON THE LIVING WAGE The Wellington Regional Council is the second council to vote to adopt a living wage policy. In the dying days of the 2016 local elections, the Council agreed in principle to a living wage of $19.80 per hour for its employees and a phased introduction of the same for the employees of its contractors.

The first part of the living wage policy of the Wellington Regional Council was in fact cheap talk; five casual employees of the council were paid less than $19.80 per hour. The cost of paying the living wage to these five will be all of $5000 (Kedgley 2016). The sting for ratepayers (and for commuters) will come when a living wage is rolled-out for the Council’s contractors such as NZ Bus next year.

1.2 Will Wellington Bus Fares Go Up? This is the first application of a living wage policy by a council to a commercial service. It is not about services a council buys such as cleaning or security guard services. It is about a service ratepayers subsidise but with the buying public picking-up most of the tab. The Wellington Regional Council must decide whether ratepayers alone fund the living wage policy or that bus fares must go up too.

In addition to the NZ Bus contract, which expires next year, the living wage policy is to apply to Port Investments, Greater Wellington Rail and Wellington Water. There was no advice before council members on the cost of this extension to commercial services prior to their vote (Forbes 2016).

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1.3 What Did The Wellington Regional Council Know And When Did It Know It? Official information requests to the Wellington Regional Council reveal that the only information before it was a fourpage attachment to the motion proposed by Council member Kedgley. This attachment discussed the merits of living wage in general terms. There was reference to overseas research but only a passing mention that the Wellington City Council has a living wage policy.

No information was supplied on that council’s successes, if any, in reducing family poverty or lifting labour productivity as was promised when its living wage policy was adopted in 2014. Responses to official information requests also reveal that the Wellington Regional Council has not received any reports on a living wage in the past two years. There was no public consultation before the vote.

A union driver employed by NZ Bus in Wellington earns an average of $20.97 per hour, so this living wage policy by the Wellington Regional Council again may be virtue signaling. The salary range in the collective agreement starts at the minimum wage of $15.25 per hour but rises to over $22 per hour.

The twist is a prospective competing bus tenderer, Go Bus won over half the bus contracts in Auckland at the expense of NZ Bus by paying its drivers $18 per hour. In a further blow to value for rates for the ratepayer, the living wage policy of the Wellington Regional Council may weaken competitive tendering for bus contracts. Again, this information was not before the Council.

Financial decisions should not be made by a council without proper advice on how much ratepayers’ money is expected to be spent. Ratepayers deserve better than what the Dominion Post reported:

Hundreds of employees could be affected if Greater Wellington Regional Council decides to pay all staff a living wage, but the financial hit to regional ratepayers remains a mystery (Forbes 2016).

Revealing the cost for council employees after the vote on Kiwiblog (Kedgley 2016) is unsatisfactory. The out-going members of the Wellington Regional Council may not have known what a token initial gesture their living wage policy was when they voted for it on the eve of the 2016 local elections.

1.4 THE PORIRUA CITY COUNCIL’S LIVING WAGE COMPROMISE The Porirua City Council was the previous council to have voted on a living wage. In a compromise, $200,000 was allocated for one year to boost the pay of employees at or near the minimum wage.

… councillors decided not to introduce a living wage based on officers’ advice that it would be too expensive. Instead it narrowly voted 5-4 to accept Porirua mayor Nick Leggett’s Annual Plan amendment to create a $200,000 pool to help the salaries of full time permanent employees who currently earn “at a level around the minimum wage”. The details of what exactly what the money would be used for was not known (Dando 2016).

The Porirua City Council voted on the proposal for a living wage policy after seeking public submissions on its draft annual plan. This draft floated a living wage policy as an option for the coming financial year. This made that council a model in ratepayer accountability. The Porirua City Council gave the following rationale in its draft annual plan for a living wage policy:

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The ‘Living Wage’ is promoted as being the minimum amount needed so workers and their families can afford the basic necessities of life and allow them to live with dignity and participate in society. The current Living Wage hourly rate is $19.80 per hour. The current legal minimum wage is $15.25 per hour (Porirua City Council 2016, p. 11).

About 50 Porirua City Council employees will benefit from the compromise pay rise linked to being permanent and full-time. One hundred and twenty-nine employees of the Porirua City Council stood to benefit from the original living wage proposal; 60% of these employees were part-time. The cost to ratepayers of the original proposal was estimated at $860,000 per year, with a rate increase of 1.6 per cent. If this living wage policy were to be extended to contractors to the Council, the cost would have been twice that (Porirua City Council 2016). The Porirua City Council has about 340 employees.

1.5 The Porirua City Council Put All Its Cards On The Table For Ratepayers To See The Porirua City Council is an exemplar in terms of ratepayer accountability by including in its draft Annual Plan the 1.6% increase in rates necessary to fund a living wage for employees and the further rate increase of 1.6% to fund a living wage increase also for the employees of its contractors. The Wellington Regional Council adopted a living wage for the employees of its contractors including the buses without any information before it on by how much rates and bus fares must rise.

The rate increases required to fund a living wage policy were so large that the Porirua City Council balked and settled for a much more limited pay increase. The haste of the Wellington Regional Council in adopting its living wage policy denied itself this opportunity for mature reflection.

By funding the living wage increase for full-time employees for one year, the out-going council appears to have committed the incoming council to a living wage policy. Employment agreements usually rule out unilateral wage cuts so the incoming council will have a few options other than to fund these wage rises. That means higher rates or reduce services elsewhere in Porirua City. The Porirua City Council now had a minimum wage rate of $17.25 an hour (Garcia 2016).

1.6 The Wellington City Council Is A Lapsed Living Wage Employer The Wellington City Council adopted a living wage policy of $18.40 per hour in 2014. At the time, this was said to have be expected to benefit 500 low-paid employees and another 300 employees of council contractors. This policy was extended in 2016 to the employees of contractors working under joint service agreements with other councils. The extension of the living wage policy to contractors to the council increased the cost of those contracts by 19%.

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The Wellington City Council first floated the possibility of a living wage policy in its 2013-2014 draft Annual Plan. There was public consultation. The Wellington Regional Council skipped these steps.

The Wellington City Council later increased its living wage to $18.55 per hour (Devlin 2015) and then $18.63. It did not pass on the increases in the Living Wage Movement Aotearoa New Zealand’s living wage to $19.25 in 2015 and $19.80 in 2016. McIntyre (2016, p. 8) described the Mayor and Council members as “generally resistant to making the change”. This hesitation suggests to the Taxpayers’ Union that councils are unwilling to hand over its wage setting to an NGO. The living wage, initially $18.40 per hour in 2012 and now $19.80 per hour, is set by the New Zealand Family Centre Social Policy Unit for the Living Wage Movement Aotearoa New Zealand. It is set at a wage rate that provides the income necessary to meet a set of specified needs of a family of two adults and two children where one adult works 40 hours a week and the other works 20 hours.

1.7 Repeat Virtue Signaling Over Adopting A Living Wage Policy By not passing on subsequent living wage increases, local politicians can engage in repeat virtue signaling. In 2013 local elections, some Wellington City candidates promised a living wage policy to win votes. The Wellington City Council then approved a living wage policy in 2014 in its Annual Plan. As the then deputy mayor, Mr. Justin Lester said in September 2016:

I’m incredibly proud to be the first and only council in the entire country to implement a living wage for its employees (Garcia 2016).

The Taxpayers’ Union can reveal from responses to official information requests that 62 of the 238 Wellington City Council employees covered by their living wage policy are still paid below their living wage of $18.63 per hour because they are yet to “complete all competencies”. Wellington City Council officials call their Living Wage the Wellington Wage (McIntyre 2016, p. 13).

Rather than being disavowed by living wage activists, the Wellington City Council who failed to pass on two living wage rises instead won a new round of support from the same quarters for selling them the same living wage policy twice. The local paper let it slide that the Council had already reneged on the living wage policy whose extension it was praised editorially (see screenshot below). There are still 62 Wellington City Council employees paid less than their living wage rate of $18.63.

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Source: Living Wage Aotearoa New Zealand.

Several candidates in the 2016 local election promised to pay the 2016 living wage of $19.80 to the employees of the Wellington City Council and its contractors (Dominion Post 2016). The new mayor, Mr. Justin Lester, has a living wage of $19.80 as one of his top priorities (see screenshot below).

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1.8 THE WELLINGTON CITY COUNCIL IS A LIVING WAGE REGIFTER Wellington local politicians seem to be able to win the same voting bloc for a second time by hoping that these voters have let its slide that the Council quickly lapsed on its living wage policy. None of the 2016 Wellington City local election candidates dwelled on why the living wage policy lapsed and so quickly. Was it too costly to continue? The Wellington City Council has successfully combined virtue signaling with backsliding.

The Wellington Regional Council may have to copy this Sisyphean skill if a living wage for Go Bus drivers turns out to be too expensive for ratepayers and commuters.

Source: https://www.flickr.com/photos/fuzzy/4087788305 There is no judgement day at the local ballot box for lapsed living wage employers. Rather than the gift that keeps giving, the Wellington City Council’s living wage policy is the gift that is re-given (see screenshot below). The Taxpayers’ Union must ask whether the adoption of a living wage policy for yet a 3rd time by the Wellington City Council will be a major wedge issue in the 2019 local elections?

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1.9 The Auckland Council Is To Vote Again On A Living Wage Policy A living wage for the Auckland Council was floated by Mayor Brown in the 2013 local election and by Mr. Phil Goff, MP in the 2016 local election. In 2013, the Auckland Council voted down a living wage of $18.40 per hour by one vote (Radio New Zealand 2013). The Auckland Council later over-ruled a decision of its Albert-Eden Local Board to pay a living wage for its employees (Collins 2015).

In the 2016 mayoral election, winning candidate Mr. Phil Goff estimated that the current living wage of $19.80 per hour for Auckland Council staff could cost ratepayers $4 million; 1500 out of the 9000 Auckland Council employees would be in line for a pay rise (Furley 2016). Mr. Goff said after winning the Auckland mayoral election that a living wage was one of his top priorities.

The Auckland mayoral candidates in 2013 and 2016 were open about the cost to ratepayers of a living wage. The Auckland Council itself commissioned extensive research in 2013 (Maloney with Gilbertson 2013). The Wellington Regional Council defied this precedent in ratepayer accountability. The Wellington Regional Council appears to have neither known the trifling immediate cost of adopting a living wage policy nor the potentially large long-term costs to ratepayers and commuters.

The Auckland Council is followed the precedent of Wellington and Porirua cities and included a living wage policy in the Mayor’s Annual Budget for 2017. Implementing the living wage will be in a staged manner over three years. Mayor Goff said he could pay for the living wage increase by cutting costs elsewhere (Furley 2016). If these expenditures such as on better fleet management and group procurement are of low enough value to be reprioritised to fund a living wage policy for no loss of service, ratepayers are entitled to ask why the expenses were incurred in the first place.

1.10 The Hutt City Council Is Considering A Living Wage Policy The Chief Executive of the Hutt City Council will be reporting in March 2017 to that Council on the feasibility of a living wage policy for the employees and contractors to that Council. Most of the successful candidates at the 2016 Hutt City local elections supported a living wage policy. The Taxpayers’ Union hopes the Hutt City Council follows the gold standard set by the Porirua and Wellington city councils and invites public submissions on the living wage as part of its annual plan.

1.11 Purpose And Scope Of Paper The purpose of this paper by the Taxpayers’ Union is to review the case for a living wage policy at individual councils. The economics of a unilateral living wage policy by an individual employer is different to that of a minimum wage increase. It is outside the scope of this paper to review the case for a higher minimum wage (Krueger 2015). That is a different policy question.

1.12 Plan Of The Paper The next chapter will discuss the origins of the living wage movement. Chapter 3 is about the role of positive economics in public policy issues thought to be just a matter of morality. Chapter 4 will show how a living wage policy unintentionally raises hiring standards. Chapter 5 will examine the labour productivity offsets from a living wage policy.

Chapter 6 is about the misunderstandings within the living wage movement about the social problems that motivated the development of the efficiency wage hypothesis. Chapter 7 will explore the unintended consequences of having two minimum wage laws within one shopping mall in the USA with parallels to multiple living wage policies within one local council in New Zealand. Chapter 8 will discuss the operation of a living wage in real-world labour markets with good and bad jobs. Chapter9 will review the impact of a living wage rise on San Francisco restaurant workforce

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composition. Chapter 10 discusses the constraints that Baumol’s cost disease puts on the potential labour productivity offsets from a living wage policy for employers producing a labour-intensive service such as bus driving. Chapter 11 closes with a discussion of the motivational and institutional drivers behind the continued popularity of living wage policies despite their many unintended, often unwanted side effects.

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2. Why A Living Wage?

2.1 LIVING WAGE CAMPAIGNS HAVE MUCH TO BE MODEST ABOUT A living wage is not a New Zealand original. Baltimore was the first city to adopt a living wage for the employees of its contractors in 1994. Over 140 mostly successful living wage campaigns followed in the US for employees of city contractors and, in some cases, business subsidy recipients (Adams and Neumark 2003, 2005; Neumark, Thompson and Koyle 2012; Thompson and Chapman 2006). A few of these cities also started paying their own employees a living wage (Neumark 2002; Holzer 2008).

There is fair agreement on the effects of the adoption of these living wage policies by US local governments as summarised by Neumark, Thompson and Koyle (2012, p. 27)

… in our view this updated evidence is broadly consistent with the conclusions that Holzer’s (2008) review of the earlier evidence reached – that living wages have modest benefits for some workers and modest costs for others, and may also result in modest reductions in poverty.

These living wage ordinances were separate from the more recent campaigns to increase city minimum wages to as much as $15 per hour such as in Los Angeles, San Francisco and New York City.

Considerable political effort was required to enact living wage ordinances in American cities. But so few in the overall public and private labour forces were covered by them that Henry Holzer, who was Chief Economist of the Department of Labour in the Clinton Administration, exasperated that

… it is clear from all of these studies that any effects of living wage laws — both positive and negative—are extremely modest in magnitude, since very few low-wage workers are actually affected by these laws, and the impacts per worker are quite modest. The possibility that living wage ordinances on their own might help build a “middle class” is very remote. Indeed, one might apply a version of Henry Kissinger’s description of academic politics to the study of living wage laws —namely, that the politics are so fierce while (or maybe because) the stakes are so very small (Holzer 2008, pp. 20-21).

Modest reach to low-income families is an early hitch for New Zealand council living wages. Living wages are set at the rates that they are to uplift the pay of low-paid workers with families so that they earn enough in wages to afford the necessities of life. The Porirua City Council admitted in its draft Annual Plan that families will not be the largest beneficiaries of its proposed living wage:

While take-home pay would increase, those currently earning the minimum adult rate without family responsibilities in entry level roles would benefit the most (Porirua City Council 2016, p. 11).

The Treasury (2013) estimated that 79% of households earning pay below the living wage rate have no children; 6% are sole parents; the remaining 15% of households are couples with children (see graphic below). Almost all teenagers and majority of adults in their twenties earn below the living wage; 29% of low income workers live in families whose income exceeds $60,000 (Treasury 2013). Councils are likely to employ more adults than teenagers as compared to the general workforce but the general point about the porous targeting of the living wage towards family breadwinners holds.

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Source: Treasury (2013).

2.2 40% Of A Living Wage Rise Is Lost To Income Tax And Working For Families The living wage increase has a much smaller effect on the take-home pay of employees with families because of a reduced Working for Families tax credit. In its 2015 Minimum Wage Review, the Ministry of Business, Innovation and Employment (2015) calculated that a couple working 60 hours between them on the minimum wage lose over 40% of a living wage increase to reduced Working for Families and to tax – see table 1. Working for Families is abated at 22.5 cents on family income that exceeds $36,350. This income threshold can be a family with either one full-time worker earning more than $17.50 per hour or two minimum wage workers working more than 45 hours per week combined.

Table 1: interaction of a $19.25 living wage with Working for Families for a couple Weekly hours worked

Weekly earnings

Annual earnings

Income tax

ACC levy

Parent A

40

$770

$40,040

$6027

$580.58

Parent B

20

$385

$20,020

$2523.50

$290.29

Combined net earnings without other income support

Net earnings $33,432.22 $17,206.21 $50,638.43

Maximum In-Work Tax Credit

$3,120

Maximum Family Tax Credit

$8,173

Total abatement of family support due to income

$5,038.38

Total Working for Families assistance after abatement

$6,254.62

Effective annual earnings of household

$56,893.25

Percentage increase in minimum wage

30.5%

Percentage increase in take-home pay

17.3%

Source: Ministry of Business, Innovation and Employment (2015), table 10.

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For one parent on the minimum wage, the tax and abatement effect is a little less than that for 2 parents; a 30% wage rise turned into an 18% increase in take-home pay – see tables 1 and 2.

Table 2: interaction of a $19.25 living wage with Working for Families for a single parent Weekly hours worked Parent A

Weekly earnings

40

Annual earnings $770

Income tax

$40,040

$6027

ACC levy

Net earnings

$580.58

Combined net earnings without other income support

$33,432.22 $33,432.22

Maximum In-Work Tax Credit

$3,120

Maximum Family Tax Credit

$8,173

Total abatement of family support due to income

$784.13

Total Working for Families assistance after abatement

$10,508.87

Effective annual earnings of household

$43.941.29

Percentage increase in minimum wage

30.5%

Percentage increase in take-home pay

18.3%

Source: Ministry of Business, Innovation and Employment (2015), table 16

2.3 What Inspires The Living Wage Movement?

Economists and living wage advocates often talk past each other. Economists point out that a far more effective way of fighting poverty is to increase family tax credits such as Working for Families. George Stigler first suggested this in 1946 in an unsurpassed discussion of minimum wage laws:

There is great attractiveness in the proposal that we extend the personal income tax to the lowest income brackets with negative rates in these brackets... If the negative rates are appropriately graduated, we may still retain some measure of incentives for a family to increase its income. We should no doubt encounter many perplexing difficulties in carrying out this plan, but they are problems that cannot be avoided even though they might be ignored in less direct attacks on poverty (Stigler 1946, p.365).

Economists also point out that much of any living wage increases are lost to income taxes and reductions in family tax credits and other social assistance – see figure 1 and tables 1 and 2. Boston and Chapple challenge us to think more deeply on what works and what does not when they say

Some advocate raising the minimum wage significantly to reduce child poverty. Unfortunately, lifting minimum wages will do little for child poverty. This is because most of the extra wages received by parents on low incomes will be clawed back by the Government.

The most obvious losses are through income tax and ACC levies. Further, families partly reliant on welfare benefits and partly on paid employment may lose part of their benefit.

In addition, Working for Families payments and housing assistance are reduced as earnings rise. Consequently, net family income may grow only marginally for many families, even after a considerable rise in minimum wages (Boston and Chapple 2014).

This is before entering the fierce battle over the extent to which a minimum wage rise, small or large, puts a significant number of low-paid jobs at risk (Oi 1997, Manning 2016, Neumark 2014).

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Figure 1: New Zealand effective marginal tax rates by family type, March 2013, non-beneficiaries

Source: Inland Revenue Department (2015).

2.4 Who Is Responsible For Social Insurance?

Obviously, taxpayers could gain several hundred thousand dollars at the expense of Porirua City ratepayers from this winding back of Working for Families after a living wage increase. This transfer surfaces a fundamental question.

Who is responsible for social insurance? Taxpayers? Ratepayers? Private employers? Do the social responsibilities of businesses go beyond making a lawful profit (Friedman 1970)? Living Wage Aotearoa New Zealand want employers to share more of this burden

As Treasury’s report itself argues, “adopting a Living Wage would rebalance the role of the employer and the welfare system towards work being the primary mechanism for people to support themselves.” We agree with this proposition (Living Wage Wellington undated, p. 11) This is despite central government’s power to build a tax and welfare system with taxes collected on an ability to pay basis for social expenditures targeted to those most in need. Councils are limited to collecting rates. Private employers face competition that puts higher cost firms out of business.

We resolve our differences on the size and shape of the welfare state by normal democratic means; by trying to persuade each other and elections. The outcomes of these political contests are transparent in the laws then passed by parliament. As Landsburg explains in the U.S. context

Ordinarily, when we decide to transfer income to some group or another—whether it be the working poor, the unemployed, the victims of a flood, or the stockholders of American Airlines—we pay for the transfer out of general tax revenue. That has two advantages: It spreads the burden across all taxpayers, and it makes politicians accountable for their actions. It’s easy to look up exactly how much the government gave American, and it’s easy to look up exactly which senators voted for it. By contrast, the minimum wage places the entire burden on one small group: the employers of low-wage workers and, to some extent, their customers (Landsburg 2004).

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Not funding social insurance through the budget openly and transparently robs the winners of an honest victory and the losers of the peace that comes from a fair defeat on the floor of Parliament. The disappointed can try again by lobbying harder in the next budget or after the next election if they still want more generous social insurance or more redistribution of income and wealth.

2.5 A Living Wage Is Not About Working For Families Being Not Enough Paul Krugman (1998) was astute enough to point out what living wage movements are about dignity and independence; they are not about fixing an under-funding of social insurance. In a book review, Krugman (1998) first reminded that raising the minimum wage is a risky way of fighting poverty:

Why increase the cost of labor to employers so sharply, which--Card/Krueger notwithstanding--must pose a significant risk of pricing some workers out of the market, in order to give those workers so little extra income? Why not give them the money directly, say, via an increase in the tax credit? (Krugman 1998) Krugman acknowledges that living wage advocates know this but they see minimum wage increases as a way of moving the cost of fighting poverty off the budget and on to employers. As he explains:

What a shift from income supports to living wage legislation does is to move the costs of income redistribution off-budget. And this may be a smart move if you believe that America should do more for its working poor, but that if it comes down to spending money on-budget it won’t. Indeed, this is a popular view among economists who favor national minimum-wage increases: They will admit to their colleagues that such increases are not the best way to help the poor, but argue that it is the only politically feasible option (Krugman 1998).

Krugman then makes his most astute point when he said Machiavellian budget maneuvering was not the major motivator of the living wage movement. Living wage advocates believe families should earn enough in their jobs to support themselves at a decent level without relying on handouts:

… there is another, deeper issue here-namely, that even without political constraints, advocates of a living wage would not be satisfied with any plan that relies on after-market redistribution. They don’t want people to “have” a decent income, they want them to “earn” it, not be dependent on demeaning handouts (Krugman 1998).

Whether the provision of that social minimum is through the welfare state or is the responsibility of individual employers in setting wages divides the living wage movement and many of its critics. Krugman said insightfully that this disagreement is over whether morals or markets set wages:

In short, what the living wage is really about is not living standards, or even economics, but morality. Its advocates are basically opposed to the idea that wages are a market price--determined by supply and demand, the same as the price of apples or coal (Krugman 1998).

Workers should earn a decent income and the dignity that comes with doing that for themselves; they and their families should not have to rely on social insurance for the basic minimum. Wages at levels anything less than this basic minimum is not morally acceptable to the living wage movement; Working for Families is no substitute for earning enough in wages for your family to live on decently.

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3. Is The Living Wage Just A Question Of Morality?

3.1 Positive Economics Or Normative Sociology?

Resolving moral differences over a living wage is neither easy nor impossible as Friedman observed:

I venture the judgment, however, that … differences about economic policy among disinterested citizens derive predominantly from different predictions about the economic consequences of taking action - differences that in principle can be eliminated by the progress of positive economics - rather than from fundamental differences in basic values, differences about which men can ultimately only fight.

An obvious and not unimportant example is minimum-wage legislation. Underneath the welter of arguments offered for and against such legislation there is an underlying consensus on the objective of achieving a “living wage” for all, to use the ambiguous phrase so common in such discussions. The difference of opinion is largely grounded on an implicit or explicit difference in predictions about the efficacy of this particular means in furthering the agreed-on end (Friedman 1966, p. 5).

The great contribution economics can make to moral questions is its ability to trace out the likely effects of a policy option and compare them with their intended effects. As Friedman said:

Any policy conclusion necessarily rests on a prediction about the consequences of doing one thing rather than another, a prediction that must be based - implicitly or explicitly - on positive economics. There is not, of course, a one-to-one relation between policy conclusions and the conclusions of positive economics; if there were, there would be no separate normative science. Two individuals may agree on the consequences of a particular piece of legislation. One may regard them at desirable on balance and so favor the legislation; the other, as undesirable and so oppose the legislation (Friedman 1966, p. 5).

Positive economics is the opposite of what Robert Nozick dubbed normative sociology:

Normative sociology, the study of what the causes of problems ought to be, greatly fascinates us all (Nozick 1974, p. 247).

That said, positive economics will not resolve every moral dilemma in public policy as Robbins explained:

If we disagree about means, then scientific analysis can often help us resolve our differences {but] if we disagree about ends, it is a case of thy blood or mine … [for example] if we disagree about the morality of taking interest (and we understand what we are talking about) then there is no room for argument (cited in McCloskey 1986).

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An economic analysis of a living wage increase can enlighten its advocates on how well it will do in uplifting workers from poverty and what other effects it might have, intended or not, which they may or may not welcome. Such analysis throws light on the likely effects of a council living wage which can be compared to what the supporters of a living wage hope them to be. Tracing out the likely effects of a living wage policy in the labour market most helps those on the fence about it:

The price system lays the cards face up on the table. Every policy benefits some people and imposes costs upon others; the fencing of machines is a cost borne by consumers of the product of the machine and a benefit to manufacturers of fences. (Paradoxically, it would require a complex analysis to determine whether workers are benefited.) With direct regulation these costs and benefits are neither measured nor located, whereas a price system displays them openly. If you believe in full disclosure, as I do, this is a great merit (Stigler 1964a, p.18).

The 5-4 margin for the living wage compromise at the Porirua City Council suggests that there is an audience for a more detailed discussion of the pros and cons of a living wage policy such as here.

3.2 The Minimum Wage And Poverty In New Zealand The moral objective of a living wage is to reduce poverty. Its success must be measured in terms of poverty reduction and not be limited to the workers who still have jobs after the pay rise. The US evidence as summarised by Dube when debating doubling Seattle’s minimum wage to $15 an hour:

… we should acknowledge the limits of our knowledge about how local economies respond to a minimum wage. In my opinion, the best evidence suggests that state and federal minimum wage increases have had a very small impact on employment, while moderately reducing turnover, poverty and inequality. The limited evidence from other cities corroborates this. However, we cannot reliably apply those estimates to predict the effects of an increase the size of Seattle’s (Dube 2014).

Size matters when predicting the effects of large minimum wage increase using a literature based on small wage rises. Maloney and Pacheco (2012) found that fewer than 2% of workers were paid the minimum wage in New Zealand in 1999. The real minimum wage increased by 33% for adults and 123% for teenagers between 1999 and 2008. They found that more than 8% of adult workers and 60% of teenage workers were receiving hourly earnings close to the minimum wage by 2008. Maloney and Pacheco (2012) also found that these minimum wage workers were more likely to live in the poorest households, but were still relatively widely dispersed over the income distribution.

Maloney and Pacheco (2012) estimated that a 10% increase in the minimum wage, even without any offsetting fall in earnings due to a loss of employment or fewer hours of work, lowers the poverty rate by less than one-tenth of a percentage point. This tiny poverty reduction disappears completely if a 10% increase in the minimum wage leads to a mere 3% reduction in hours worked. Pacheco (2011) reviewed the impact of rising minimum wages on employment in New Zealand from 1986–2004. She found significant negative employment effects of a higher minimum wage rate.

3.3 DOES A COUNCIL LIVING WAGE POLICY UPLIFT FAMILIES FROM POVERTY? This ability of economic analysis to compare the actual effects of living wage policies with their intended effects is particularly relevant to the living wage plans of local councils. They have a duty under the Local Government Act 2002 to operate in an efficient and an effective manner. Local government living wage policies to the USA and increases in the legal minimum wage both at home and abroad appear to be rather modest in their achievements as poverty reduction tools. The reduction of family poverty is the key rationale for championing living wage policies despite the risks of job losses. As the then Porirua Mayor said in his introduction to the draft annual plan

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… we want our employees to have the income to support their families and have money to invest in their lives in Porirua city (Porirua City Council 2016).

The risk is a small reduction in employment can cancel out any reduction in family poverty.

3.4 SOCIAL REFORM WITHOUT A SAFETY HARNESS Living wage activists must be extra vigilant when reviewing the success of a living wage. They do not expect the market to work around it through “the disposition to truck, barter, and exchange” if there are unintended consequences such as job losses. For them, there is no “marvel” in the market where people can make mistakes, learn from mistakes, and avoid repeating them (Hayek 1945). Living wage activists do not see the role of government as providing a rule book with the aim of “letting the players play” (Hayek 1960). Hayek (1973) equated this institutional enabling to a maintenance squad in a factory; its role is not to produce a product but to keep the (legal and tax) mechanisms that regulate production in a good working order. The specific products of the well-maintained machinery in each factory is decided by those who own it considering costs and anticipated demand.

Those that want to go beyond this role, and living wage activists do, must be alive to the hazards and difficulties that lie ahead for reform, which Adam Smith summarised in his ‘man of the system’ who:

seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder (The Wealth of Nations).

A policy must be judged by its likely results, not its good intentions, and this is doubly so if its proponents do not view the market as a fail-safe for when the reforms do not turn out as planned. Social reformers, by their calling, see a status quo in need of rapid improvement. Their low opinion of the institutions of the status quo limit the ability of many activists to fall back on markets chipping away at failed reforms in ways that regulatory and bureaucratic processes cannot replicate:

… the economic system corrects monopoly more readily than it corrects judicial errors.

There is no automatic way to expunge mistaken decisions of the Supreme Court.

A practice once condemned is likely to stay condemned, no matter its benefits. A monopolistic practice wrongly excused will eventually yield to competition, though, as the monopolist’s higher prices attract rivalry (Easterbrook 1984, p. 15).

Living wage activists, in common with many social reformers, do not share Adam Smith’s belief that ‘there is a great deal of ruin in a nation’; that prosperous nations are robust to a great many follies, private and public. Living wage activists, like many social reformers, believe that something must be done quickly for otherwise things will go further downhill rapidly. But their views as to the limited robustness of the market economy shapes the scope for reform as James Buchanan explained:

We start from here, from where we are, and not from some idealized world peopled by beings with a different history and with utopian institutions. Some appreciation of the status quo is essential before discussion can begin about prospects for improvement (Buchanan 1975).

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The rest of this paper is about the extent to which a living wage delivers on uplifting council employees to a wage sufficient to support their families to a minimum acceptable level. Living wage activists promise this despite the perceived fragileness of the status quo they seek to reform and, by extension, that must be an unstable cornerstone on which to build a bridge spanning far enough to reach their El Dorado. We start from here; living wage activists must explain how we get from here to their journey’s end without too many bumps and false starts. They should hold themselves to a higher standard about downside risks because they do not expect the market to fill any gaps. Even if wrong in their pessimism, they must live by it when defining when to pullback at the bridge too far. Activists cannot leave anything to chance because they do not expect the market to pick up the load.

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4. A Living Wage Policy Becomes An Elevated Hiring Standard 4.1 How Big Is A Living Wage Increase?

A living wage of $19.80 per hour is a 30% increase on the current minimum wage of $15.25 per hour. A living wage for all employees would increase the current minimum wage from a little less than two-thirds of the median wage to about 85% of the median wage (see screen snapshot below).

Source: Treasury (2013).

4.2 How Many Workers Earn Less Than The Living Wage?

A minimum wage equal to the living wage rate would increase the wages of 555,000 workers (Ministry of Business, Innovation and Employment 2015). This extensive coverage of an increase to the living wage rate compares to the 155,000 workers covered by the most recent minimum wage increase of 50 cents to-$15.25 per hour (Ministry of Business, Innovation and Employment 2015).

4.3 Who Gains From A Living Wage Policy At One Employer?

A living wage of $19.80 would have lifted the pay of the 129 current employees of the Porirua City Council. The 2013 proposals for a living wage at the Auckland Council would have benefited 1500 of its employees. Up to 238 employees of the Wellington City Council currently benefit from its living wage policy along with 38 cleaners and 22 guards employed by its contractors according to responses to official information requests to the Wellington City Council.

This is far less than the original forecast of 500 to 800. The focus of this chapter and much of the rest of this paper is whether any future council employees benefit from the adoption of a living wage policy.

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Any employer who unilaterally introduces a living wage is simply raising their hiring standards. The workers who previously won the jobs covered by the living wage increase will not be shortlisted because the quality of the recruitment pool will increase. The Council must by law hire on merit so only those who currently earn $18- $20 in other jobs will be shortlisted for living wage vacancies. These recruits are on about the living wage now so they do not benefit from the living wage policy.

4.4 Minimum Wage Workers Will Not Be Shortlisted For Living Wage Jobs Workers who would not have previously applied for council jobs because they can earn more elsewhere will now apply because of the higher pay. These better paid applicants will crowd out the applicants of the minimum wage workers who currently win these jobs. Living wage advocates do not discuss what becomes of these low-paid workers who are no longer shortlisted. They should.

4.5 Wellington Parking Wardens Lost Their Jobs Because Of The Living Wage Policy The Wellington City Council should be perfectly aware that a living wage policy is an elevated hiring standard that toughens up shortlisted because that is exactly how its own managers interpreted that policy when 30 parking wardens were bought back in-house. The Taxpayers’ Union can reveal that:

Between January and July 2104 WCC began moving nearly 500 directly employed staff to the Living Wage (2013/2014 rate of $18.40). Soon after around 50 very low-paid parking wardens were taken in-house and lifted to the Living Wage, receiving a $4 an hour pay increase.

This process was fraught because the WCC HR staff mismanaged the recruitment process resulting in some parking attendants deemed to be below the skills required for the new role, losing their jobs (McIntyre 2016, p. 8).

It is futile to deny that a living wage prices the minimum waged out of council jobs because 17 parking wardens already have lost their jobs. A response to an official information request to the Wellington City Council revealed that only 13 of the existing 30 parking wardens were rehired. It was known as early as 2013 that these parking wardens would have to reapply with no guarantees:

Service and Food Workers Union national secretary John Ryall said raising the pay of wardens - at present about $14.10 an hour - to the $18.40 living wage was great news, provided existing wardens were able to shift to working for the council … The council said … it would provide opportunities for their staff to apply (Chapman 2013).

The Taxpayers’ Union is not aware of any street or other protests by living wage activists against these 17 redundancies. The Taxpayers’ Union is also unaware of any assistance offered by the living wage movement to these first casualties of a Wellington campaign they describe as “in good heart”.

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4.6 IT BECAME NECESSARY TO DESTROY A PARKING WARDEN’S JOB TO PAY IT A LIVING WAGE Living Wage Wellington knew of the lost parking warden jobs (McIntyre 2016) but is as enthusiastic as ever. How many more minimum wage workers must be made redundant by living wage activists to save these workers from family poverty? Social justice activists should learn and adapt when things do not work out as planned. How many more repeats of the Wellington City parking warden redundancies before living wage activists call it quits?

Source: Living Wage Aotearoa New Zealand (undated).

The living wage movement pressed its case by asking minimum wage parking wardens to tell their stories in print afterward (see screenshot above) and as guest speakers at their first forum in 2013 for the Wellington living wage campaign (McIntyre 2016, p. 7). The Taxpayers’ Union challenges Living Wage Wellington to invite a parking warden who lost their job because of the Wellington City Council’s living wage policy to tell their story to their next gathering.

Activists should be willing to bear witness to the human cost of the living wage policy that they support with such feistiness.

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These job losses were not mentioned by then deputy mayor Mr. Justin Lester in a recent interview. He held out the extension of the living wage policy to parking wardens as an unqualified success:

What’s your living wage policy?

Well it’s largely been implemented. So that’s for all council employees and for all council controlled organisation employees like museums, and the zoo …

A good example is parking wardens, they were contracted out, we brought them back in, and we’re saving money, paying a living wage, and getting a better service. It just makes sense (Hurley and Mulligan 2016).

Minimum wage workers lost steady jobs (see snapshot below) in the name of a living wage that is boasted about in the media. Workers laid-off in a downsizing take longer to find a job than after a plant closure (Gibbons and Katz 1991).

Employers will take it as a signal that if a parking warden is selectively made redundant, they were not the most productive of employee. Plant closures do not reveal the same information about the relative quality of laid off workers (Gibbons and Katz 1991).

Source: Careers New Zealand.

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4.7 Wellington City Council Contractors Are Also Raising Their Hiring Standards The Wellington City Council is negotiating with its contractors about which employees will receive a living wage.

CrestClean is unwilling to pay unless its employees obtain another certificate (Dominion Post 2016a). Spotless plans to pay more in only three of 18 council sites; Recon Security expects its guards to obtain another qualification before receiving the living wage (Dominion Post 2016b). Council contractors share the Council’s unwillingness to pay more unless matched by up-skilling.

These negotiations over the new qualifications employees must now have is another vindication of the prediction by the Taxpayers’ Union that a living wage increase raises hiring standards. An applicant for future vacancies will not be shortlisted unless they have these additional qualifications.

These additional qualifications are no small ask as a hiring standard. If it were easy to obtain these additional qualifications, many existing council employees would have already acquired them.

4.8 The Wellington City Council Does Not Know What Is Happening To Its Hiring In response to an official information request, the Wellington City Council said that it held no information about any improvement in the quality of job applicants because of its living wage and it had not done any research on this specific matter. The Wellington City Council should do that research because of the troubling developments in hiring standards for living wage jobs in-house and among its contractors. It is basic policy analysis to check if a policy delivered on its promises.

Council managers may be responding to the improvement in the quality of recruitment pools by not short-listing the low-paid breadwinners they did in the past. Ratepayers need to know if this is so. If it is, the living wage policy is a futile gesture that should not be imitated by other councils. The Wellington Regional Council has ample time to reconsider before extending its policy to contractors.

4.9 The Wellington Regional Council Asked No Questions The Wellington Regional Council did not take in account these disturbing trends in hiring standards at the Wellington City Council when it so hastily adopted a living wage policy. If there had been public consultation, which was the case in Wellington City and Porirua City, the Taxpayers’ Union would have drawn this to the attention of the Council and its ratepayers. A well-run council would have made inquiries of its own with the Wellington City Council about the reports in the Dominion Post of elevated hiring standards before voting to spend ratepayers’ money on a living wage policy.

4.10 The Living Wage Really Is A Question Of Morality Living wage activists support a living wage because they believe workers deserve to earn enough wages on their own to buy the necessities of life and not depend on handouts such as Working for Families. This moral journey falls at the first turn if there are job losses. A living wage cannot deliver on its high bar of no more child poverty (see snapshot below) if there are job losses and there were.

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This early fall is even harder because living wage activists do not anticipate the labour market will quickly supply new jobs to the 17 unemployed parking wardens. They are the victim of their own pessimism when their policies do not work out as planned. Activists cannot decry the violence inherent in the capitalist system but then add so hap hazardously to the ranks of the unemployed.

This chapter illustrated the contribution positive economics makes to reform with “the development of a “theory” or, “hypothesis” that yields valid and meaningful … predictions about phenomena not yet observed” (Friedman 1966, p.

7). This chapter predicting elevated hiring standards was drafted months before the 17 parking warden redundancies were uncovered. As Mises said

Scarcely anyone interests himself in social problems without being led to do so by the desire to see reforms enacted. In almost all cases, before anyone begins to study the science, he has already decided on definite reforms that he wants to put through. Only a few have the strength to accept the knowledge that these reforms are impracticable and to draw all the inferences from it (Mises 1981, p. 214).

Living wage activists are yet to have their Road to Damascus despite knowing what they do.

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5. The Efficiency Wage Offsets From Living Wage Increases 5.1 The Job Turnover And Work Intensity Effects Of Living Wage Increases It is standard to make an efficiency wage argument for a living wage (Maloney with Gilbertson 2013; PSA 2014; CTU 2013, 2014; Living Wage Wellington, undated; Waldegrave 2014). Workers on an efficiency wage are paid more than the going rate for their skills and experience. This higher wage than elsewhere motivates them to work harder because they have more to lose if fired. The link between higher wages and greater employee self-motivation is as old as Adam Smith:

‌ the wages of labor are the encouragement of labor which like every other human quality improves in proportion to the encouragement it receives: Where wages are high accordingly we shall always find the workmen more active, diligent and expeditious than when they are low (The Wealth of Nations).

The living wage movement asserts that a living wage is a win-win for everyone (see snapshot). This greater effort and motivation of an efficiency wage, of the above market rate of pay, will reduce the costs of supervising employees and increase output per worker through higher staff morale (Katz 1986). This, together with reduced job turnover because employees on more than the going rate will stay longer, offsets some of the costs to the firm of a living wage increase (Manning 2014, 2016).

Estimates of the saving from reduced job turnover after a living wage rise are about 10% of wages (Reich, Hall and Jacobs 2005; Fairris 2005). A more recent estimate suggests the reduction in job turnover can offset one-fifth of the cost increase from modest minimum wage rises (Dube 2015). If there are productivity gains after a living wage rise, does this not imply that a smaller workforce will be required to do the same amount of work in at least some of the work areas of local councils?

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5.2 Work Intensity And Equalising Wage Differentials The PSA extolled the job turnover and absenteeism reductions and the morale improvements that follow a living wage increase when the Wellington City Council adopted a living wage policy in 2014:

… the Council has rightly looked to overseas evidence which shows that where the living wage has been introduced there have been marked reductions in staff turnover and absenteeism and it has also helped to foster more positive workplace cultures (PSA 2014).

That workers are motivated by a living wage rise to push their own noses even harder against the grindstone is always presented as an advantage of a living wage. McCloskey has misgivings:

The argument one hears from, say, Paul Krugman – that raising wages is good for the company because workers will work harder as a result – seems implausible, considering that the company in such a case would already have raised wages, for its own good. And working harder worsens the conditions of work (McCloskey 2016).

A living wage rise can upset the deal with employers over work intensity. As Alchian and Allen say:

Full wages, like full prices, contain more than money payments. Partially offsetting the employment effects of minimum-wage laws are adjustments in work conditions not controlled by the law: for example, the extent of health care and on-the-job training, length of vacation, number of sick days, tolerance of tardiness and use of company mail or telephones, number of coffee breaks, length of lunches, cleanliness of restrooms, provision of parking space, safety precautions, and air conditioning. Employees will accept jobs with less of these nonmonetary features to reduce the employer’s full costs of hiring them (Alchian and Allen 1967, p. 335).

Reich, Hall and Jacobs (2005) found that workers report a faster pace of work and more stress after a living wage rise. Adam Smith pioneered labour economics by noticing that workers in the 1700s were already alive to what was expected in return for their wages and job and occupational choices:

First, the wages of labour vary with the ease or hardship, the cleanliness or dirtiness, the honourableness or dishonourableness of the employment. Thus, in most places, take the year round, a journeyman tailor earns less than a journeyman weaver. His work is much easier. A journeyman weaver earns less than a journeyman smith. His work is not always easier, but it is much cleanlier. A journeyman blacksmith, though an artificer, seldom earns so much in twelve hours as a collier, who is only a labourer, does in eight. His work is not quite so dirty, is less dangerous, and is carried on in daylight, and above ground.

Honour makes a great part of the reward of all honourable professions. In point of pecuniary gain, all things considered, they are generally under-recompensed... Disgrace has the contrary effect. The trade of a butcher is a brutal and an odious business; but it is in most places more profitable than the greater part of common trades (Wealth of Nations).

Wage differentials arise to equalise the net monetary and non-monetary advantages and disadvantages of jobs from

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such things as onerous work conditions, location, risks to life and health, shift-work and inflexible schedules and chances of a layoff (Rosen 1986; Roback 1982; Kahn 2008).

5.3 Employers Already Know That Better Quality Employees Are Paid More At bottom, this efficiency wage hypothesis is entrepreneurs are ill-informed of the higher quality and greater self-motivation of better paid recruits. Bureaucrats, unions, activists and politicians notice these gaps in the market faster than those who profit directly from superior alertness to hitherto untapped entrepreneurial opportunities. Entrepreneurs instead leave this money on the table. This is despite performance pay quickly spreading to one-third of UK workers (Manning and Farzad 2010), and most New Zealand firms, which lowered job turnover rates (Fabling and Grimes 2009).

Persistent, known but unexploited opportunities for entrepreneurial profit are not left on the table for long in markets that are competitive and open to new entry (Kirzner 1997; Alchian 1950; Stigler 1963, 1987). The art of business is identifying assets that are currently in low-value uses and devising ways to profitably move them into higher value uses before others do (Froeb and McCann 2008). There are vast economic and industrial psychology literatures on better motivating workers and armies of consultants to advise employers (Lazear 1998; Brickley, Smith and Zimmerman 2004).

5.4 Workers Too Shop Around For Better Job Matches Implicit in the efficiency wage hypothesis of the living wage movement is workers too have failed to notice they are willing to work harder if they are paid more in wages per hour. This revelation comes only after a living wage rise at the behest of their employer or activists. These workers have not discovered their own willingness to work harder if paid more per hour despite spending the first 10 to 15 years of their working lives job shopping. The first six to 10 job changes of younger workers are known as job shopping; searching for the jobs, employers, industries and occupations that are more to their liking (Manning 2005; Neal 1999; Topel and Ward 1992). Many prime age and older workers, in time through job shopping, find the jobs, employers, industries and occupations that are good matches for their skills, experience and preferences for such things as work intensity so they stop job shopping and stay for longer in these jobs (Johnson 1978; Rosen 2002).

5.5 We Live In The Age Of Strategic Human Resource Management.

Times have changed since a 1930s Philadelphia dockyard foreman hired day labour by throwing apples over the front gate (Jacoby 1985, p. 13). Whoever waiting outside caught them passed the physical and the initiative test too. In the 1960s, Ford had a waiting lounge at its factory gate:

“If we had a vacancy, we would look outside in the plant waiting room to see if there were any warm bodies standing there. If someone was there and they looked physically OK and weren’t an obvious alcoholic, they were hired� (Murnane and Levy 1996, p. 19).

These rather casual approaches to the screening of applicant quality and job fit are well behind us.

There has been a revolution in how private and public employers husband employees at all pay grades. Human resource management gained ground in the 1980s at the expense of old style personnel management (Acemoglu

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2002). Strategic human resource management stresses rigorous selection and recruitment, more training at induction and on the job, more teamwork and multi-skilling, better management-worker communication, the encouragement of employee suggestions and innovation, and common canteens and uniforms as unifying status symbols (Lazear 1998).

Modern human resource management strives for a single unified organisational culture made up of highly committed, capable workers who pull together at their own initiative (Baron and Kreps 1999). This pays because, for example, the share prices of firms rise on the announcement of family-friendly policies and the winning of good employer awards (Arthur and Cook, 2004, 2009).

5.6 Why Did Performance Pay Emerge?

There is no cheaper way for more ambitious employees to signal their willingness to work harder if paid more than a wage rise for all employees no matter their prior efforts. No prior training is necessary; a trial period is not required; no screening is needed to verify employee potential to produce more. A general pay rise is superior to bonuses and promotions in enlivening effort. These are the claims of the living wage movement about the incentive architecture of the workplace. The Wellington City Council’s decision not to hire 17 of the 30 existing parking wardens for the new living wage vacancies suggests that it does not share this view of how to enhance worker productivity.

Living wages aim to reduce family poverty. The mothers and fathers in these poor families are adults with enough experience of different jobs to know how hard they are willing to work for what pay. The intensity of work in different jobs is part of the information that job shopping uncovers. Work intensity is a leading factor in lateness, absenteeism and job quits (Fairris 2004).

A general pay rise under the auspices of a living wage policy is the opposite of the modern trend towards incentive pay schemes which are carefully embedded into the wider organisational architecture of modern firms (Brickley, Smith and Zimmerman 2004; Bloom, Sadun and Van Reenen 2012). This organisational architecture encompasses the assignment of decision rights in the firm, the methods of rewarding individual employees, and the systems that evaluate the performance of both individual employees and business units (Brickley, Smith and Zimmerman 2004).

5.7 Employee Effort Elicitation Is Central To Industrial Organisation Modern theories of the firm focus on enhancing the value of employment relationships through the better motivation and direction of employee effort. Living wage activists are not onto something new with their efficiency wage arguments about labour productivity and employee morale.

The cost of discovering prices, the quality of what is to be exchanged and making and enforcing contracts are central to Coase’s (1937) and Barzel’s (1982) theories of the firm. The supplier is hired as an employee because this is cheaper than continually negotiating in the market. Transactions that normally take place in the market with independent suppliers are taken inside the firm by hiring the supplier as an employee to save on these costs of repeated haggling (Coase 1937; Cheung 1983).

Alchian and Demsetz’s (1972) theory of the firm focused on metering employee effort in team production – on how owners and managers ensure that everyone on the team pulls their weight:

Two key demands are placed on an economic organization-metering input productivity and metering rewards.

Every economic definition of a firm is about managing a group of people. There is team production or some sort of nexus of long-term contracts or mutually dependent assets. As Barzel and Kochin (1993) said when contrasting Coase’s (1937) theory of the firm with Alchian and Demsetz’s (1972):

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Even though they offer an alternative to Coase’s theory of the firm, their firm, nevertheless, is fundamentally a transaction cost phenomenon - it arises in response to the costs associated with measuring and policing various inputs and outputs.

Allen (1991) and Fama and Jensen (1983a, 1983b) all argue that the economic organisations that survive are those that maximise the gains from trade net of transaction costs. As Fama (1980) said

The striking insight of Alchian and Demsetz (1972) and Jensen and Meckling (1976) is in viewing the firm as a set of contracts among factors of production. In effect, the firm is viewed as a team whose members act from self-interest but realize that their destinies depend to some extent on the survival of the team in its competition with other teams (Fama 1980).

Much of the organisation of the firm, including its size and degree of vertical and horizontal integration and many different forms of contracting are driven by ensuring that the owners get what they pay for and the participants tied together by this long-term relationship, including employees, maximise their joint wealth (Barzel 1982, 1987; Klein, Crawford and Alchian 1978; Klein 1998).

5.8 Private Sector Wage Policies Must Survive The Test Of Competition Living Wage Movement Aotearoa New Zealand (2016) want all employers to adopt a living wage. Councils expect ratepayers to pick up the tab for this. This is not so easy for private employers.

The firms that survive and grow in market competition with rival ways of doing business are the more efficient simply because they survived (Stigler 1958, 1987). The firms that survive are organised in a way that delivered the products that customers want at the lowest price while covering costs (Alchian 1950; Fama and Jensen 1983a, 1983b). The results of the competitive market process that continually weeds out the less efficient firms are known at the end of this race, not at the start (Alchian 1950). Which firms survive will not be known in advance to politicians nor activists when they decide to make one specific input more expensive such as under a living wage policy.

The entrepreneur is the residual claimant to the revenues of the firm. The entrepreneur’s profit is what is left after employees and everyone else is paid (Alchian and Demsetz 1972). Entrepreneurs do not need living wage activists to remind them that their profits flow from their relative success in policing the efforts of employees and contractors to perform to their best, and ensuring that individual rewards match individual contributions to the firm (Alchian and Demsetz 1972; Barzel 1982, 1987). Entrepreneurs must police the contributions of employees and contractors if they are to survive in competition; the better they do this, the more they profit (Barzel 1987).

Every firm already knows that they must provide incentives embedded into job and team designs so that employees act the way the employer wishes, giving the agreed level of effort and correctly allocating their efforts across multiple tasks as the employer would want them to do in the presence of uncertainty, incomplete and dispersed information and costly observation and measurement (Alchian and Demsetz 1972; Barzel 1982, 1987; Holmstrom and Milgrom 1991; Lazear 1998). Owners and managers do not need living wage activists to remind them of this daily challenge. The personnel economics rationales for everything from employer funded pensions to the structure of promotion ladders and executive pay including stock options is reducing the costs of monitoring employee effort by better rewarding more self-motivated employees (Lazear and Gibbs 2009).

Efficiency wages were pioneered by Henry Ford in 1914 when he doubled wages to $5 a day; this reduced job turnover from 370% to 20% and lifted productivity by 40-70% (Summers and Raff 1987). Ford’s losing out in competition for skilled labour was undermining the pricing of his Model-T:

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At the time, workers could count on about $2.25 per day, for which they worked nine-hour shifts.

It was pretty good money in those days, but the toll was too much for many to bear. Ford’s turnover rate was very high. In 1913, Ford hired more than 52,000 men to keep a workforce of only 14,000. New workers required a costly break-in period, making matters worse for the company.

Also, some men simply walked away from the line to quit and look for a job elsewhere. Then the line stopped and production of cars halted. The increased cost and delayed production kept Ford from selling his cars at the low price he wanted. Drastic measures were necessary if he was to keep up this production (cited in Worstall 2012).

Both sides of employment relationships are alert to the power of incentives when they hire, apply and quit. Lazear (2000) found that productivity at Safelite Glass rose by 44% after moving to piece rates. The firm retained and recruited more-able workers. Half this increase was from employees quitting when piece rates were introduced with their replacements applying with the eye to earn more by working harder. Average pay rose by 10% after the switch. These gains were from closer alignment of pay with individual job performance. Performance pay also improves job sorting; the firm recruits and retains a workforce that is more willing to work harder if they know they will be individually rewarded for doing more. A council living wage policy does the opposite to this.

5.9 Fast-Food Franchises Survive By Motivating Low-Paid Workers Better Fast food restaurants are targets of choice of living wage advocates and their efficiency wage arguments. Yet they are an obvious example of modern human resource management spreading to low-wage jobs. Employer-employee unity and empowerment replaced olden days’ detachment and formality with the bosses directing and controlling workers from above. Teenagers seek out these minimum wage entry-level jobs with franchises because a successful stint in their high energy working environments are excellent credentials for further advancement up the job ladder. Teenagers understand some jobs are better than others and offer a leg up on the job ladder.

Franchises, despite their reputation for offering low quality jobs, have sophisticated management practices and make greater investments in their employees than non-franchise competitors (Cappelli and Hamori 2008). Franchises may hire less educated workers and use more part-time roles, but they offer them more training, and they are more likely to have employee involvement work systems than do non-franchise establishments (Cappelli and Hamori 2008). Despite spending more to train and motivate low-paid employees than non-franchise operations, franchising has thrived which suggests they can offset this cost disadvantage in profitable ways (Cappelli and Hamori 2008).

Pay rates at fast food restaurants are higher when not owner operated. Krueger (1991) found that fast food franchise workers are paid more in company-owned stores to make-up for the absence of an owner-manager having a large personal stake in daily operations and employee effort:

The earnings gap is 9 percent for assistant and shift managers and 2 percent for full-time crew workers. Furthermore. the tenure-earnings profile is steeper at company-owned restaurants. These findings suggest that monitoring difficulties influence the timing and generosity of compensation (Krueger 1991, p. 75).

The cost of monitoring managers is why these higher paying company-owned restaurants are nearer corporate headquarters and in cities more often (Rubin 1978; Brinkley and Dark 1986).

A living wage policy is no more than a large pay rise that hopes for the best in terms of morale and job turnover. It is not a suite of organisational improvements like franchising. Inchniowski, Shaw and Prennushi (1997) and Inchniowski and Shaw (2003) both found much larger productivity increases when human resource management practices were changed as an interdependent package crafted to reinforce and complement each other. Performance pay worked better with flexible job design, joint problem solving, more training, better communication and multi-skilling. Fabling and Grimes (2009) found that New Zealand firms that introduced a broad suite of human resource management prac-

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tices significantly improved performance and shared these as wage rises.

The living wage movement hypothesis is that franchising, despite the global revolution it wrought in retailing, is leaving money on the table in terms of the best ways to motivate and reward employees.

5.10 Recruitment And Managing Turnover Are Routine Entrepreneurial Challenges Every profit minded entrepreneur seeks to hire and retain the group of workers with the lowest cost per unit of output produced by the firm. Firms that do not do this will not survive in competition with more alert rivals. The trade-off between worker quality and wages in setting hiring standards is a routine entrepreneurial decision in every firm when recruiting as Lazear and Gibbs (2009) explain:

Managers often say that their goal in hiring is to obtain the best quality workers. It sounds like a good idea, but is it? The most productive workers are also likely to be the most expensive. Should the goal instead be to hire the least expensive workers? ‌ The best worker is not the cheapest, nor the most productive, but the one with the highest ratio of productivity to cost. We should hire as long as the marginal productivity of the last worker hired is greater than or equal to the cost of the worker The notions of cheap and expensive are in fact imprecise. As McCloskey (1985) noted, no matter how cheap or expensive something might be, we buy until the cost of one more unit is more than its benefit. No matter how low-priced or dear, buying any more is a deal not worth doing. Councils hire workers at less than the living wage because these recruits are best value for money. A council could pay more but the extra output does not cover the cost of the higher wages to ratepayers.

Private employers have good incentives to discover the wage rates that balance higher turnover and less successful recruitment with the cost of a higher wage offer. As George Stigler (2000) explains:

The competitive industry is not one for lazy or confused or inefficient men: they will watch their customers vanish, their best employees migrate, their assets dissipate. It is a splendid place for men of force: it rewards both hard work and genius, and it rewards on a fine generous scale.

The success of a competitive enterprise is not the least uncertain if its employees are able and diligent and its leadership sane and courageous (Stigler 2000).

To survive in market competition, entrepreneurs must rise above all of problems the firm faces such as employee relations, innovation, changing regulations, unstable markets, access to finance and new entry. This is the decisive (and Darwinian) meaning of efficiency from the standpoint of the individual firm (Stigler 1958). The firms which quickly imitate the more successful firms are more likely to survive and grow. The firms that fail to adapt or are slow in doing so are more likely to shrink and fail. The relatively fastest in this evolutionary process of discovery, learning, adaptation and imitation will be the profit maximising firms; market competition, in time, will lead to the survival only of these profit maximising firms (Alchian 1950; Stigler 1958, 1987; Becker 1962). Councils solve too many of their management problems by putting up rates.

Private employers are free to experiment with higher wages and a living wage accreditation. These pioneering firms are chancing their arm because only time will tell if this new cost configuration will survive in market competition. Busi-

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ness vitality and capacity for growth and innovation are only weakly related to cost conditions and they often depend on many subtle factors that are difficult to observe and comprehend (Stigler 1958, 1987). One method of industrial organisation supplants another when it can supply the market at a lower price (Marshall 1920, Stigler 1958; Demsetz 1973). Councils face no similar market test on the wisdom of their adoption of a living wage policy.

5.11 Paying For A Living Wage Policy By Cutting Council Executive Pay The living wage movement often change the subject from productivity by suggesting that the cost to ratepayers of adopting a living wage can be offset by cutting the salaries of top council executives:

The proposed cost of introducing a living wage for direct employed staff at Auckland Council was $3.5m, or 0.5% of the total salary budget. A reduction of the total amount paid to those on salaries above $120,000 by 3% would, on its own, more than meet that living wage cost (Living Wage Wellington, undated).

Not paying bonuses or reviewing pay annually against market benchmarks as previously promised runs against the duty to be a good employer and the duty of good faith in all aspects of the employment relationship. There is no such thing in contract law as a unilateral variation of an employment agreement. The living wage movement, through its close affiliations with unions, should know of these contractual and statutory constraints on employers unilaterally cutting the pay of any employee. Their union allies vigorously oppose any employment law amendments to allow high-paid employees to contract-out of any of the protections of the Employment Relations Act. Paying future council executives below the going rate would make council vacancies less competitive in the managerial labour market. Any council that pays uncompetitive salary packages will not recruit and retain the same quality of executive and managerial leadership that it did in the past. This will compromise the quality of council administration, and in a blow to ratepayer accountability, obscure how the living wage policy is funded and its true cost in terms of reduced council services.

Grass-roots activists committed to local democracy such as the living wage movement should not circumvent transparency about the full cost of a living wage policy. Councils should pay no more nor no less than what is required to recruit and retain managerial employees of the requisite quality.

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6. The Normative Sociology Of The Living Wage 6.1 The Living Wage Movement Are Intellectually Earnest Social Activists The living wage movement is an unusually research-intensive manifestation of social activism. At its founding, it convened a two-day conference of local and international experts and retained consultants to calculate the first living wage launched on 14 February 2013 (see screenshot below).

Living wage activists embraced the efficiency wage argument without doing adequate background checks on its intellectual pedigree as to what problems it was causing and solving. The efficiency wage hypothesis was not developed by time and motion consultants seeking to improve labour productivity through higher morale. Efficiency wages were the problem, not the solution. Living wage activists see the efficiency wage as part of the solution rather than as the source of job loss.

6.2 THE EFFICIENCY WAGE HYPOTHESIS IS A THEORY OF PERSISTENT MASS UNEMPLOYMENT Shapiro and Stiglitz (1984) first put forward their theory of an efficiency wage to explain large-scale involuntary unemployment. It was the very real threat of a prolonged spell of unemployment (rather than a morale boosting pay rise) that motivated employees to put in more effort to keep their jobs:

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To induce the worker not too shirk, the firm attempts to pay more the “going rate”; then, if the worker is caught shirking and is fired, he will pay a penalty. If it pays one firm to raise its wage, it pays all firms to raise their wages. When they all raise their wages, the incentive to shirk again disappears. But as all firms raise their wages, the demand for labour decreases, and unemployment results. With unemployment, even if all firms pay the same wage, a worker has an incentive not to shirk. For, if he is fired, an individual will not immediately obtain another job. The equilibrium unemployment rate must be sufficiently large that it pays the workers to work rather than take the risk of being caught shirking (Shapiro and Stiglitz 1984, p. 435).

The unemployed offer to work for less pay than existing employees but they are not hired because their labour productivity is not assured at this lower pay (Akerlof 1982, 1984; Katz 1986, 1988; Yellen 1984). There is involuntary mass unemployment because of the prevalence of efficiency wages:

If there is involuntary unemployment in an equilibrium situation, it must be that firms, for some reason or other, wish to pay more than the market-clearing wage. And that is the heart of any efficiency-wage theory (Akerlof 1984, p. 79).

Direct parallels were quickly drawn between the efficiency wage hypothesis as a worker discipline device eliciting greater effort and the old Marxist concept of the reserve army of the unemployed:

… it pays each firm to increase its wage to eliminate shirking. When all firms do this, the average wage rises and employment is reduced. In equilibrium, all firms pay a wage above the market clearing level, creating unemployment. Since jobs are scarce and rationed, the loss of a job can involve a lengthy spell of unemployment. The reserve army of the unemployed acts as a discipline device making shirking costly (Katz 1986, pp. 240-41).

It is misconceived for living wage activists to use a theory of lengthy unemployment to justify a large living wage rise but argue that there will be little unemployment because of the efficiency wage effects. This is the exact opposite of what the efficiency wage hypothesis is about. The leading Keynesian macroeconomists of their generation were striving to explain mass unemployment:

… the economists who developed the theory of efficiency wages (including Shapiro and Stiglitz, Akerlof and Yellen and Yellen) had no illusions that they were helping business firms to discover a new way to increase profits. The economists who developed efficiency wage theory were trying to explain persistent unemployment. Hence the title of Janet Yellen’s famous survey, Efficiency Wage Models of Unemployment.

The question that motivated efficiency wage theory was not why firms should raise wages but why firms don’t cut wages when they should. The answer they gave was that firms don’t cut wages despite unemployment because they fear that workers will respond to lower wages with reduced productivity …

In the original efficiency wage literature, there is no wishful thinking–no idea that we can have more of everything that we want without trade-offs. Instead of being desirable, the efficiency wage is a problem because lower wages would reduce unemployment and be

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better for the economy … the efficiency wage theorists took it for granted that to the extent that firms can increase profits by raising wages they have already done so (hence the persistent unemployment) (Tabarrok 2015).

Gordon was blunt about why efficiency wage arguments were popular and with whom

If any development in the microeconomics of labor markets could be called the “rage of the 80s,” it is efficiency wage theory, based on the hypothesis that worker productivity depends on the level of the real wage. When there is such a link between the wage rate and worker efficiency, firms may rationally pay a real wage rate that exceeds the market-clearing level. Firms may refuse to reduce the wage to hire members of a pool of unemployed workers who may be available at a lower wage, fearful that a reduction in real wages for existing workers may reduce productivity by more than the gain in lower wages (Gordon 1990, p. 1157).

Living wage activists have it the wrong way around about the social benefits of paying an efficiency wage. The efficiency wage hypothesis is a theory of why wages are too high and employment is too low (Akerlof 1982, 1984, 2002; Yellen 1984; Katz 1986, 1988; Stiglitz 2002). Living wage activists are using a well-respected theory of why wages are too high to argue that wages are too low.

6.3 The Fair-Wage Effort Hypothesis Is A Theory Of Mass Low-Skilled Unemployment Living wage advocates make much of the demoralising effects of pay inequality on workplace productivity. In common with the efficiency wage hypothesis, this is another example of what Nozick (1974) called normative sociology; the study of what the causes of social problems ought to be. Again, living wage activists misconstrue what the fair-wage effort hypothesis was seeking to explain .

The fair-wage effort hypothesis aimed to fill gaps in the efficiency wage hypothesis by explaining why unemployment is so much higher among the lower skilled (Akerlof and Yellen 1988, 1990). Under the fair-wage effort hypothesis, workers slack off if paid less than they think they deserve:

The motivation for the fair wage-effort hypothesis is a simple observation concerning human behavior: when people do not get what they deserve, they try to get even (Akerlof and Yellen 1990, p. 256).

Lazear (1989, 1991) contends that employers too may want greater pay equity to temper over-competitiveness in teams. If pay and promotions in a team are linked to the relative performance of its members, large pay differentials may undermine co-operation and might encourage sabotage:

Very large pay spreads induce high effort, but they also create a work environment in the firm that is not very pleasant… individuals who are competing with one another can either seek to outperform others, or they can contribute to the failure of others. Such incentives can result in collusion (Dye, 1984) or in sabotage (Lazear, 1989). Thus, pay structure must strike a balance between providing incentives for effort and reducing the adverse consequences associated with this kind of industrial politics (Lazear and Shaw 2007, p. 95).

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Lazear’s (1989, 1991) theory about the industrial politics arising from pay inequality stressed how sizable rewards to individual members of a team could lead to a lack of team play and lower team output. If the prizes were smaller for superior relative performance, the pay rise after a promotion or the annual performance bonus, there may be more teamwork (Lazear 1989, 1991). Akerlof and Yellen (1990) were correct in their insight that their hypothesis about fairwage effort applies more to workers on lower wages with fewer chances of moving up promotion ladders and pay scales.

The fair-wage effort hypothesis is but another Keynesian macroeconomic theory of unemployment:

The hypothesis explains the existence of unemployment. Unemployment occurs when the fair wage w* exceeds the market-clearing wage. With natural specifications of the determination of w*, this hypothesis may explain why skill and unemployment are negatively correlated. In addition, it potentially explains wage differentials and labor market segmentation (Akerlof and Yellen 1990, p. 256).

The fair-wage effort hypothesis was developed as a descendant of the efficiency wage hypothesis because the latter cannot explain why wages are high for everyone working in high-paid industries:

All workers in better-paid industries tend to receive positive wage premia. That is, the wages of secretaries and engineers are highly correlated across industries. Ease of supervision and the magnitude of turnover costs might well be correlated across industries for a given occupation explaining, for example, why, say, skilled machinery operators receive positive wage premia in most industries. But there is no obvious reason why, say, secretaries, should be harder to supervise in the chemical industry where pay is high, than in the apparel industry where pay is low (Akerlof and Yellen 1988, p. 44).

The efficiency wage hypothesis also offered “no natural explanation” for why unemployment rates are much higher among the lower-skilled (Akerlof and Yellen 1990). Skilled workers are probably more difficult to monitor than the unskilled so their unemployment rates should be higher than for the low-skilled as a worker discipline device but the contrary is the case (Akerlof and Yellen 1990).

The fair-wage effort hypothesis aimed to fill gaps in the efficiency wage theory of unemployment by explaining why low skilled unemployment is much higher both in recessions and in better times. Living wage activists must accept that their demands for workplace pay equity increase low-skilled unemployment under a Keynesian theory which they embrace with considerable enthusiasm.

If high wages are paid to the more skilled to attract the best applicants, demands for pay equity by their less skilled co-workers could price some of them out of the market leading to unemployment (Akerlof and Yellen 1988, 1990). In addition, pay equity norms are unlikely to respond quickly enough to fluctuations in aggregate demand so wages can be too high in recessions causing mass unemployment of the low skilled (Akerlof and Yellen 1988, 1990; Summers 1988). The unemployed cannot successfully offer to work for less than existing workers do in a recession because they cannot make a credible commitment to eschew fairness considerations once hired (Akerlof 2002).

An important premise of New Keynesian macroeconomics is demands for pay equity come at a price. At a price that is high enough for the efficiency wage and fair-wage effort hypotheses to be put as a comprehensive New Keynesian explanations of involuntary mass unemployment (Gordon 1990).

Both the efficiency wage hypothesis and the fair-wage effort hypothesis are attempts to flesh out a theory of extensive labour market dysfunction leading to mass unemployment. Living wage activists are using Keynesian theories of why wages are too high to argue for even higher wages.

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6.4 Precarious Work As The Flip Side Of Efficiency Wages To make things even more untenable for the living wage movement, efficiency wages were put forward as a cause of what is now called precarious work. The efficiency wage hypothesis breathed considerable new life into the old theory of dual labour markets (Katz 1986; Dickens and Lang 1985).

The notion of a segmented labour market, of a primary and a secondary labour market, each with distinctly different wage setting mechanisms, was very much a fringe idea prior to the 1980s:

Efficiency wage theory provides a rare common meeting ground for mainstream and radical economists, because the far left in U.S. economics has taken the lead in developing theories of dual labor markets and for setting-out policy proposals for higher minimum wages based on the assumed validity of the efficiency wage approach (Gordon 1990, p.

1157).

The workers privileged enough to hired by firms paying an efficiency wage would enjoy job security, low job quit rates, good working conditions, career advancement, training and higher pay (Akerlof 1982, 1984; Bulow and Summers 1986; Dickens and Lang 1993). The remaining equally productive workers who were unlucky enough to be priced out of these good jobs by the job rationing implicit in an efficiency wage must fend for themselves in a secondary labour market; in precarious work with high quit rates, harsh workplace discipline, few promotions, little training and poor pay (Akerlof 1982, 1984; Katz 1986; Dickens and Lang 1985). Efficiency wages do not motivate greater employee effort unless the prospect of precarious work in this secondary labour market looms large in the back of their minds as their main alternative source of employment for those lucky enough to be employed in the good jobs in the primary labour market (Katz 1986; Bulow and Summers 1986).

Those workers crowded into these bad jobs in the secondary labour market find it to be a slow and difficult process to break into these better paying good jobs in the primary labour market. There are queues for the good jobs because they are paying above-market wages; many of those crowded into the bad jobs are women and minorities (Bulow and Summers 1986; Dickens and Lang 1985, 1993).

Akerlof, in his Nobel Prize lecture on behavioural macroeconomics, contended that the good and bad jobs caused by paying efficiency wages is central to explaining involuntary mass unemployment:

The existence of good jobs and bad jobs makes the concept of involuntary unemployment meaningful: unemployed workers are willing to accept, but cannot obtain, jobs identical to those currently held by workers with identical ability. At the same time, involuntarily unemployed workers may eschew the lower-paying or lower-skilled jobs that are available. The definition of involuntary unemployment implicit in efficiency wage theory accords with the facts and agrees with commonly held perceptions. A meaningful concept of involuntary unemployment constitutes an important first step forward in rebuilding the foundations of Keynesian economics (Akerlof 2002, p. 415).

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Living wage activists already doubt that the market can provide steady wages growth and stable employment. Efficiency wages are a leading New Keynesian macroeconomic explanation for that. The living wage movement cannot pick and choose from what the efficiency wage hypothesis says about how well the labour market functions for those who are and are not in efficiency wage jobs.

Living wage activists are unwittingly following a course of action that leads to more job rationing, more precarious work and more unemployment. Those priced out of council jobs by a living wage such as the 17 parking wardens are left to take their chances in the rest of the local labour market. These workers must take bad jobs while queueing for the good jobs in the primary labour market. Instead of being sources of opportunity in their communities, councils through a living wage policy risk becoming drivers of labour market segmentation and the fostering of a precariat.  

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7. The Tale Of Two City Minimum Wage Laws In One Mall 7.1 Adjacent Local Minimum Wage Laws Many cities in the USA have the power to impose a minimum wage at a higher rate than the federal and state minimum wages. Neighbouring cities can have different minimum wages. The higher minimum wage can apply to mobile workers who spend only a short time in that city. This overlap is a laboratory to explore what happens when a living wage policy applies to only part of a region. Neighboring councils in the Wellington region will be in the same position as these U.S. city minimum wage laws; offering or not offering living wages for otherwise identical nearby jobs.

7.2 Two Minimum Wage Laws Inside One Californian Mall The Westfield Valley Fair Mall is half in San Jose city and half in Santa Clara city – see figure 2. In 2012, San Jose raised its minimum wage from $8 to $10 per hour. Employees doing the same work in the same building often steps away from each other had to be paid different wages (National Public Radio 2014). The Californian state minimum wage of $8 per hour applied in the city of Santa Clara.

Figure 2: The city boundary for San Jose and Santa Clara runs through the Westfield Valley Fair Mall

Source: National Public Radio (2014).

On the $8 minimum wage side of the Mall, employers quickly noticed that many employees quit to jobs on the $10 side. Minimum wage workers do keep an eye on competing opportunities and take them up when they arise. As information about jobs opportunities is costly, some minimum wage employees did not know that other shops nearby in the Mall paid more (National Public Radio 2014).

Employers on the $8 side of the Mall found that the quality of their job applicants also fell away; there were noticeable differences in the personality traits and dress standards presented by the $8 an hour job applicants and $10 an hour job applicants (National Public Radio 2014).

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A pretzel store owner on the $10 side of the Mall said that the question she asked herself every time she bought anything was how many pretzels she had to sell to cover the cost. She quickly concluded that she could not sell enough pretzels to cover the wage rise (National Public Radio 2014). There was another pretzel store around the corner from her’s but in the other city so she could not raise her prices by too much. She took a cut in her profit. This flowed on to her employees because they received a bonus based on 15% of her annual profits (National Public Radio 2014).

In a delicious irony that applies to councils in the Wellington region, this pretzel store owner also owned another store in the same mall but in the other city and therefore covered by that city’s $10 per hour minimum wage law. She solved the problem of staff morale by rotating them one week, one week off in each of her stores in the different cities but same mall (National Public Radio 2014).

A Gap Store straddled the two city boundaries – see figure 2. Gap could have kept a record of how much time employees spent in each of the two cities within its store and paid them accordingly. They instead raised everybody’s pay to the $10 per hour minimum (National Public Radio 2014) .

7.3 Two Minimum Wage Economies Inside One Council Contractors to different councils in the Wellington region that require a living wage to be paid to employees of council contractors face this same problem of staff morale as well as record-keeping as at the San Jose mall store owners.

Wellington City Council has already decided that contractors to joint agreements with other councils must pay the living wage when supplying in Wellington City.

Wellington City Council tonight voted 9–6 to extend an $18.55-per-hour wage to contractors working under a proposed new contract to supply security services to the Council…

The proposed security contract will cover Wellington City Council, Porirua City Council and Kapiti Coast District Council. The preferred supplier will not have to apply a living wage rate for work done for the Porirua and Kapiti councils (WCC 2015).

Auckland Council headed off this administrative chaos when it stopped a local board paying its pool attendants a living wage, which was above that paid at other Auckland Council pools (Collins 2015).

The Porirua and Wellington councils share ownership of the Titahi Bay sewage treatment plant and the Spicer landfill.

The Titahi Bay sewage treatment plant staff are employed by a council controlled organisation Wellington Water. This is a joint venture of the Porirua, Wellington, and Hutt councils and the Wellington Regional Council. The Spicer landfill is run by private contractors.

It is costly to pay different wages depending on which council contract and where the employee is working each day or part of the day. A guard service to several councils and to private properties faces an even more complicated administrative compliance challenge. Wellington City Council contractors are side-stepping these costs by refusing to pay the living wage until the employees concerned obtain qualifications that merit the pay rise (Dominion Post 2016a, 2016b).

The Porirua City Council has sown the seeds of dissension by paying its low-paid staff more but only if they are fulltime and permanent. The $200,000 allocated for one year in a compromise will see employees in identical jobs sideby-side on significantly different pay rates. Part-timers are 60% of the 129 council employees that would have benefited from a living wage. Unlike the pretzels store owner in the San Jose mall, the council cannot rotate employers in and out of the higher paying jobs once a week to preserve staff morale. A policy initially designed to improve morale will undermine it.

The Wellington Regional Council faces the same dilemmas with joint facilities and joint contracts with other councils who do not have a living wage policy. Wellington Water is jointly owned by the Wellington Regional Council and Hutt, the Porirua, Upper Hutt and Wellington city councils. Centreport is owned by Wellington Regional Council and the Manawatu-Wanganui Regional Council.

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8. The Living Wage In Labour Markets With Good And Bad Jobs 8.1 Is The Labour Market As Bleak As Living Wage Activists Portray?

Living wage activists see the labour market as a dystopia ripe for extensive government intervention. They certainly do not share Sir Arthur Slater’s view of the competitive market process where

The normal economic system works itself. For its current operation it is under no central control, it needs no central survey. Over the whole range of human activity and human need, supply is adjusted to demand, and production to consumption, by a process that is automatic, elastic and responsive (Coase 1937, p. 387).

The living wage is rooted in the conception of an inherent inequality of bargaining power between workers and employers in the labour market. The case for outside intervention in wage setting and a living wage weaken if the labour market is a less troubled than in this Dickensian view.

8.2 INFORMATION COSTS GRIND IN THE WHEELS OF THE LABOUR MARKET What happened in the two minimum wage economies inside one city mall discussed in the prior chapter vindicates the standard economics of low-wage job markets. The low-paid are alert to their opportunities and take the best jobs that come to their notice but gaps in their information is the sand in the wheels of this search. As Manning (2005) observed in his superb Monopsony in Motion:

That important frictions exist in the labor market seems undeniable: people go to the pub to celebrate when they get a job rather than greeting the news with the shrug of the shoulders that we might expect if labor markets were frictionless. And people go to the pub to drown their sorrows when they lose their job rather than picking up another one straight away. The importance of frictions has been recognized since at least the work of Stigler (1961, 1962) (Manning 2005, p. 4).

The living wage movement has a dystopian view of how the labour market works and how to best move workers into better paying jobs. Standing against this are arguments that a want of information rather than weak bargaining power is what slows workers down from moving to a better job. As Stigler (1961, 1962) argued, information is costly to obtain in the labour market:

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No worker, unless his degree of specialization is pathological, will ever be able to become informed on the prospective earnings which would be obtained from every one of these potential employers at any given time, let alone keep this information up to date. He faces the problem of how to acquire information on the wage rates, stability of employment, conditions of employment, and other determinants of job choice, and how to keep this information current (Stigler 1962, p. 94).

The living wage movement accepts that low-paid workers respond actively to news of better paying job opportunities.

They do this by arguing that a living wage improves the quality of recruitment pools. More workers apply for the living wage vacancies on the news of a living wage policy. Fewer employees quit and they work harder in response to a living wage policy. Living wage activists should mind how they go by stressing an inequality of bargaining power but also letting through the door even one market discipline such as a sensitivity of wage offers and profits to job turnover rates:

Let us consider the extreme case of highly specialized, non-versatile labor. If we consider (a) the continuous replacement of personnel who gradually leave through competing employment openings, retirement and death, and (b) (in an expanding industry) the recruitment needed for expansion, we must recognize that the probability of the workers’ exploitation is remote. The observable labor turnover between firms suggests indeed that collusive action to reduce the price of labor has virtually never been regarded as profitable (Hutt 1973, p. 4).

But, as illustrated at the Californian mall discussed in the previous chapter, not every worker knows there are better paying options which may be even just a few steps away from their current job. A living wage policy could make up for these gaps in the information of low-paid job seekers.

8.3 Are Workers Under The Thumb Or Just In The Dark About Their Best Opportunities?

Information costs are a better explanation than pinning everything on an inequality in bargaining power. This is because information costs have a profound impact on labour market workings (Stigler 1962; Alchian 1969; Alchian and Allen 1967, 1983). For unequal bargaining power to keep the wages of the low-paid down, collusion must succeed between a great many employers recruiting across many industry and occupational labour markets (Hutt 1973, Alchian and Allen 1983).

More insight is gleaned from the fact that job seekers do not initially know the location of suitable vacancies, the wages for various skills, differences in job security and other factors. They must find this knowledge, keep it current and forecast whether better vacancies may open soon. Employers must learn the location, availability and asking wages of suitable applicants. Long-term contracts arise to share risks and curb opportunism over sunken investments in specialised human capital. These factors lead to queues, unemployment, spare capacity, layoffs, shortages, inventories and non-price rationing in conjunction with wage rigidity (Alchian 1969; Alchian and Allen 1967, 1983).

The rest of this chapter casts the living wage argument in the best possible light from the modern labour economics of job search and job matching but still stays with McCloskey’s maxim that

Every piece of economic analysis is not complete until everyone is earning only normal profits, or at least the analyst can identify a reason why not (McCloskey 1985).

The arguments to come on the labour market will be based on the good and bad jobs, the jobs that can pay more than or less than the going rate, resulting from the costs of job search and matching. These good and bad jobs arise from the element of chance in every job search and job match rather than betting it all on an enduring employer conspiracy to keep wages down. Some workers are paid less than the going rate because they are down on their

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luck rather than under the thumb.

8.4 Looking For Good Jobs But Ending Up In Bad Jobs Some low-paid workers would be paid more if they knew of better opportunities, which can be just over the way such as in the mall divided by $8 and $10 minimum wages. It is ignorance, the costs of commuting or moving elsewhere and personal preferences for certain locales and types of work that leads workers to settle for less rather than employers purely having the upper hand in bargaining:

there may be a certain number of workers in the immediate neighbourhood and to attract those from further afield it may be necessary to pay a wage equal to what they can earn near home plus their fares to and fro; or there may be workers attached to the firm by preference or custom and to attract others it may be necessary to pay a higher wage.

Or ignorance may prevent workers from moving from one to another in response to differences in the wages offered by the different firms (Robinson 1933, p. 296).

Wage dispersion results; a job seeker may take a wage below the going rate and employers may pay above it if finding a better deal is not worth the cost of looking for it (Stigler 1962, Alchian 1969; Mortensen 2003). The extent of job search depends on the costs of acquiring information, the income available while searching and the costs of relocation and retraining; The more varied are the potential job opportunities, the greater the gains from continued search (Alchian and Allen 1967).

It takes time to find good vacancies and employers time to find well-suited recruits. Some well-suited applicants and hiring employers may not be lucky enough to meet and so must settle for less. Further search for a possibly better deal leaves the job seeker in their current job or unemployed and the vacancy unfilled (Moscarini 2008; Mortenson 2003, 2008; Boeri and van Ours 2013).

8.5 A Living Wage As A Backstop Against Landing In Bad Jobs?

The extent of wage dispersion is based on the cost of searching for information on these better jobs and recruits (Stigler 1962, Alchian 1969, Mortensen 2003, 2010). This wage dispersion leads to good jobs and bad jobs in the same industry or occupation. The good jobs may pay above the going rate while a bad job pays less than it. A minimum wage can top up the wages of the less well-informed job seekers unlucky enough to land in these less wellpaid bad jobs (Dube 2013; Acemoglu 2001).

The cost to workers of finding and employers filling vacancies and, importantly, how the gains are split from good job matches is central to understanding labour markets including the effects of wage floors (Alchian and Allen 1967, 1983; Manning 2005, 2011; Mortensen 2008; Cahuc 2014). Wrangling over the value of a good match is not just at hiring.

The success of new job matches depends on many factors not known until later. The suitability of recruit may slowly emerge on the job and result in a long-term match or an early parting of ways (Moscarini 2008; Jovanovic 1979).

Recruits accumulate human capital specific to the firm as time passes (Oi 1987; Moscarini 2008). Hiring and training costs depend on how long the recruit plans to stay (Oi 1962, 1983a, 1987; Becker 1993). Employees and employers both suffer a capital loss if a good job match ends prematurely because of the cost of replicating it (Oi 1983a). This joint capital loss disciplines both sides against breaking-up before their time and bargaining too hard at recruitment and pay reviews (Lazear 1998). Their best alternative to no agreement can be sufficiently unattractive to keep both sides at the table.

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8.6 The Bargaining Power Of The Low-Paid The strength of alternatives to no agreement drives wage bargaining as Alchian and Allen explain:

An important truth is that employers compete against other employers, and employees against other employees-not employees against employers, as folklore says. It is the availability of higher-valued alternatives, not the ability to bargain collectively, that increases bargaining power (Alchian and Allen 1967, p. 328).

The side with more outside options and a stronger ability to credibly commit to a specific wage offer wins the larger share of the split (Manning 2005; Cahuc and Zylberberg 2004; Lazear 1998). Those searching for new jobs while onthe-job play a better hand than the unemployed (Manning 2005).

Concerns about workers not holding their own in wage bargaining date back to Adam Smith:

… in the long run the workman may be as necessary to his master as his master is to him; but the necessity is not so immediate (The Wealth of Nations).

Calls for a minimum wage arise partly out of concerns over who has the upper hand in bargaining:

… labour is often sold under special disadvantages arising from the closely connected group of facts that labour power is ‘perishable’, that the sellers of it are commonly poor and have no reserve fund… The want of reserve funds and of the power of long withholding their labour from the market is common to nearly all grades of those whose work is chiefly with their hands. But it is especially true of unskilled labourers, partly because their wages leave very little margin for saving, partly because when any group of them suspends work, there are large numbers who are capable of filling their places (Marshall 1920).

Take-it-or-leave-it wage offers are more common for lower paid vacancies (Cahuc, Postel-Vinay and Robin 2006).

Employers who post the going rate for lower-paid vacancies saves transaction costs for both sides of a more routine job match (Alchian and Allen 1967; Boeri and van Ours 2013). The take-it-or-leave-it offer for a standard vacancy to be filled by similarly qualified job applicants may reflect where bargaining would have gone in any case and so saves that predictable journey. The market discipline on employers is posting an offer below the going rate attracts an inferior job applicant pool (Mortenson 2003; Boeri and van Ours 2013; Cahuc, Postel-Vinay and Robin 2006).

8.7 Who Haggles Over Wage Offers And Why? A well-matched recruit is a valuable find and the better paid is the job, the more it is worth haggling over the spilt (Alchian 1969; Lazear 1998). One-third of workers bargain over the wage paid in a new job; only about 5% for blue collar workers haggle but 86% for knowledge workers make counter-offers (Krueger and Hall 2012; Brenzel, Gartner and Schnabel 2014; Brenčič 2012). The less skilled job seeker finds new jobs faster because they have less specialised human capital to match up with prospective vacancies than say a knowledge worker (Alchian 1969; Oi 1983, 1987: Lazear 1998).

Lower paid jobs entail less search and bargaining because there is less to haggle over; there is more variance in applicant quality and goodness of fit for higher paid vacancies so both sides search for longer and haggle more (Lazear 1998; Alchian 1969; Oi 1987). The going rate for low skilled vacancies is common knowledge. Employers that post an inferior offer risks lowering the quality of their recruitment pools. It saves search costs for both sides to post the going rate (Alchian and Allen 1967; Lazear 1998). The rub is less skilled employees are laid-off sooner in downturns because less firm-specific human capital is lost for both sides of the job match (Oi 1962, 1983; Becker 1993).

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8.8 Does A Living Wage Just Even Up The Wage Bargaining For The Low-Paid?

Manning (2005, 2006, 2011) argues that employers still have some discretion over what wages they pay because of the time, effort and costs to workers in finding the better jobs. He also argues that employees will not quit immediately if paid slightly less than the going rate in their industry and occupation because of the time and cost of finding a better job. As Boeri and van Ours explain

Even labour markets in which each individual employer is infinitesimally small relative to the market as a whole, however, may confer on employers some degree of monopsony power. This happens when there are search frictions and mobility costs, making it costly for workers to change jobs. These costs prevent the labour market from arbitraging away any difference in the way in which different employers pay for (homogeneous) labour services. Job creation and hiring costs also attribute to employers some degree of monopsony power. When it is costly to establish a new job or hiring is highly regulated, there are fewer vacancies, and hence for workers it is harder to find openings to apply for (Boeri and van Ours 2013, pp. 36-7).

A rationale for a minimum wage is restoring the going rate in low-paid jobs where employers have more bargaining power. It evens up the split (Manning 2005; Dube 2013; Boeri and van Ours 2013). Manning gets to the nub of the link between employer’s power over wages and the minimum wage:

Employers will use this monopsony power to pay workers less than their marginal product. This gap between marginal product and wage offers policy an opportunity to raise the wage of workers without necessarily jeopardizing their employment (Manning 2008).

An Infometrics report to the living wage movement could not be more concise on this wage top-up:

When someone has limited labour market experience or education, and also has very little in the way of savings or community support, they may be desperate to work just to survive. In this case, the bargaining power in the labour market falls strongly in the favour of potential employers, and the employee might get paid very little for doing a task.

This imbalance of power in wage negotiation can undermine the whole wage negotiation system. Even job applicants who recognise the value of their output will be undercut by those who are willing to accept a lower wage for the same value of work. As a result, putting a floor under the price of labour both limits the extent that prospective employees can under-sell their effort and restricts the extent that applicants can be undercut by others competing for the position. In this case, if an employer puts a higher value on the work than they actually pay, all a minimum wage does is take some of the difference (gained by the employer due to their strong bargaining position) and gives it back to the employee (Welvaert 2014).

The concerns of living wage activists about bargaining power can be theoretically and empirically grounded in job search and matching. Market structure and the strength of competition are not “assumed but is something to be deduced� from these transaction costs (Stigler 1964b). Chance plays a role in when and where vacancies open and how mobile human capital is to new jobs.

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Nonetheless, the living wage increase of 30% proposed to offset any power of employers have over wages is larger than any reasonable estimate of the gains to be split in employment relationships because of the costs of job search, recruitment and training that create a good job match. Manning (2011) estimated that about 5% of the value of the employment relationship is subject to bargaining:

Hiring costs play an important role in macroeconomic models based on imperfect competition in the labour market deriving from search.… the original Oi (1962) estimates seem in the right ballpark – with hiring costs a bit below 5% of the total labour costs.

The bulk of these costs are the costs associated with training newly-hired workers and raising them to the productivity of an experience worker. The costs of recruiting activity are much smaller. We also have evidence of heterogeneity in hiring costs, both across worker characteristics (the hiring costs of more skilled workers typically being higher), and employer characteristics (the hiring costs of large employers typically being higher) (Manning 2011).

There are other estimates of the split from a good job match (Manning 2011) but none are as large as the proposed living wage increases at home (30%) nor abroad (100%). The surplus from a good job match “while not trivial” are “not enormous” so even the most “artfully chosen” minimum wage rise to even up the split still must be modest (Manning 2011). To quote Manning yet again:

There are rents in the typical job. This should not be a controversial claim – workers care when they lose or get jobs, employers care when workers leave. There is more doubt about the size and distribution of those rents. A very rough benchmark might put them in the region 15-30% of the wage, with a best guess being that most of them go to the worker (Manning 2011).

Experienced workers earn 15-30% less in their next job if unexpectedly laid off because their firm-specific and industry-specific human capital can be lost (Topel 1990; Manning 2011). Profits and rates of return on all capital invested in firms are never near these magnitudes (Stigler 1963, 1976). If the deal was lopsided instead in favour of employers, firms would invest heavily in recruitment because hiring another worker is so profitable, but they do not; hiring costs are about 5% of wages, and recruitment efforts and costs are keep to a minimum for the lowest-paid (Manning 2011).

8.9 How Much Market Power Do Employers Have And Over Whom?

The only labour markets with any significant evidence of a power of employers to keep wages down by the more than even a few percentage points are professional sports and professors (Boal and Ransom 1997, 2002; Ashenfelter, Farber and Ransom 2010; Hirsch 2008; Hirsch and Schumacher 2005). These professionals have few alternatives for their specialised skills. They invest up-front in skills demanded by one sport or one or two universities per city. It is in higher skilled markets where employers might take advantage of the more limited mobility of specialised human capital.

By contrast, the low-paid search in thick job markets because they can apply for most any unskilled vacancy in any industry that is albeit within their commuting radius (Hutt 1973; Alchian and Allen 1967, 1983; Manning and Petrongolo 2011). The higher skilled search in markets much thinner in near-by vacancies that open regularly which are wellmatched to their idiosyncratic backgrounds (Lazear 2009; Fishback 1998; Manning 2006, 2011). The main hiring criteria for low-skilled vacancies is that the successful recruits be friendly and reliable (Osterman 2001). Little of their human capital is specialised and whose value depends on staying with one employer for a length of time.

Activists do not give employers their due for seeing entrepreneurial gain in tying their own hands to prevent opportunistic behaviour towards employees of all pay grades. Employers and the employee to accumulate

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specialised skills or experience have an incentive to share the costs and returns of that human capital to bind themselves to each other (Oi 1962, 1983a; Becker 1993). The employer pays for part of costs of specific human capital while the worker’s trainee wage pays for the rest. Employers then pay a premium over the wages the up-skilled worker could earn elsewhere to induce them to stay long enough to recoup their joint training investment (Leuven 2005; Becker 1993).

Many contractual and other arrangements emerge to reduce mischief in long-term relationships where one party depends on the other to stay in the relationship long enough for their specialised investment to be recouped (Alchian and Woodward 1987, 1988). Without long-term safeguards against opportunism after specialised assets have been sunk, many valuable relationships rich in specialised human capital might not be formed (Klein 1984, 1998; Klein, Crawford and Alchian 1978).

There is evidence that workers with similar skills in similarly attractive jobs, occupations and locations earn similar pay (Hirsch 2008). There can be unexpected shifts in the supply or demand for skills but these imbalances even themselves out once people have time to learn, update their expectations and adapt to the new market conditions (Ryoo and Rosen 2004; Bettinger 2010; Zafar 2011; Arcidiacono, Hotz and Kang 2012; Webbink and Hartog 2004).

Skills supply and student enrolments can be ‘remarkably sensitive’ to changing career prospects (Ryoo and Rosen 2004).

Activists underrate the hand that the low-paid play. Employers are more likely to have power over the wages of higher skilled workers because of the more limited mobility of their human capital.

Despite these concerns about employer power over the wages of the more skilled, there is good evidence that the demand and supply of human capital responds to wage changes. Over- or under-supplied human capital leaves and enters in response to changes in wages until the returns from education and training even out with time (Ryoo and Rosen 2004; Arcidiacono, Hotz and Kang 2012; Ehrenberg 2004). As evidence of this equalisation of the returns on human capital across labour markets, the returns to post-school investments in human capital are similar - 9 to 10 percent - across alternative occupations, and in occupations requiring low and high levels of training, low and high aptitude and for workers with more and less education (Freeman and Hirsch 2001, 2008). Activists are proposing a living wage increase far larger than any upper-hand employers might play.

8.10 Are Living Wage Increases Paid Out Of Excess Profits?

Living wage advocates suggest that employers earn high profits, some of which they can do without. Despite this focus of living wage activists on business profits, especially those of large employers and franchises, there are no above-normal profits from an ability to set wages below the going rate.

There are plenty of employers in most occupational or industry labour markets. Any power they have over wages comes not from their fewness in number in a local labour market such as in a company town but from the time and cost to workers of searching for suitable vacancies in their commuting radius (Manning 2005, 2011). The profits from this market power over wage setting will be fleeting; if a firm earns above-normal profits from power over wages, entry by new firms will erode these profits away (Manning 2005, 2011; Stigler 1963, 1976). A living wage cannot be safely paid out of above-normal profits as asserted by living wage activists because there are none.

This is despite presenting a narrative of the labour market process that is the most favourable in modern labour economics to the living wage movement in terms of employer’s power to set wages:

Traditional monopsony is clearly unrealistic, since employers obviously compete with one another to some extent. But there are a range of choices between perfect competition and monopsony where a degree of market power coexists with competition between employers.

It is best to think in terms of “oligopsony” or “monopsonistic competition” as the most accurate descriptions of the labor market we envisage. Oligopsony describes a situation where employer market power persists despite competition with other employers—the number of employers does not need to be small. Monopsonistic competition is oligopsony with free entry, so that employer profits are driven to zero (Bhaskar, Manning and To 2002, p. 156).

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A minimum wage increase therefore still threatens the profitability and the survival of businesses despite any power an employer might have over wages because of the costs of job search and job matching. As Bhaskar, Manning and To (2002) say in their fine survey of employer market power:

Notice also that because a binding minimum wage reduces employers’ profits when there is free entry into and exit out of the labor market, some employers will be forced to exit. Employer exit has a negative effect on total employment through the loss of exiting employer payrolls. That is, although establishments that remain after the imposition of a minimum wage increase their employment, some employers are forced out of business. Thus, minimum wages have two opposing effects: the employment-increasing “oligopsony” effect and the employment-reducing “exit” effect. The overall effect of a minimum wage depends on which effect dominates (Bhaskar, Manning and To 2002, pp.

168-169).

Councils cannot go out of business as the pretzels store owner at the California Mall would if she cannot boost her sales by enough to cover a living wage increase, but ratepayers are out of pocket if their council adopts a living wage policy. The Porirua City Council (2016, p. 11) floated a 1.6% rate rise to pay for it. The Council flinched at this and compromised on a more limited pay rise. A living wage policy in the public sector is funded from higher rates or taxes.

In the private sector, there will be a combination of higher prices, lower profits, layoffs and some business failures (Oi 1997).

8.11 How Much Is Up For Grabs In An Employment Relationship?

Much more of the labour market is explained by a theory of information costs than by a theory based on an inherent inequality of bargaining power. Much more importantly for our purposes at hand, the information cost based theories of the labour market clearly identify why there might be bargaining in specific jobs and how much might be up for wage bargaining. The idea behind the living wage is to even up this wage bargaining. Whatever bargaining stakes that are up for grabs in any employment relationship, the available evidence suggests that what can be split up in this wage bargaining is far smaller than the proposed living wage increase of 30%. Rather than being about fairer shares, the living wage rise of 30% is far larger than what is available to share.

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9. The Living Wage Comes To San Francisco Restaurants 9.1 The Living Wage And The Required Level Of Applicant Experience Living wage advocates are so committed to their cause that many of their own arguments for a living wage seriously undermine the case for a living wage increase. Recent research by Lester (2016a, 2016b) on the impact of a large minimum wage increase on San Francisco restaurants, a study designed to advance the case for a living wage, instead showed how deeply exclusionary it was.

The biggest change, greatly praised in the adjacent tweet by a business reporter at the Washington Post, was that low-skilled workers were no longer hired at San Francisco restaurants. As the adjacent tweet acknowledges while misconstruing out of misplaced enthusiasm its social costs, San Francisco restaurateurs became pickier about who they recruited after a large minimum wage rise. Living wage activists look on this greater pickiness in hiring as a good thing. The Taxpayers’ Union does not. Social progress is not about putting more and more jobs out of the reach of low-paid breadwinners.

Lester (2016b) wrote a briefing for the Washington Centre for Equitable Growth that all but destroys the case for a living wage. He did not intend this but he documented in detail the exclusion of inexperienced workers from the restaurant industry in San Francisco after a large minimum wage rise. He compared San Francisco’s minimum wage of $12 per hour with North Carolina which only had the federal minimum wage of $7.25 per hour. The Taxpayers’ Union argues that this study of hiring standards illustrates what will happen to recruitment if councils adopt a living wage policy.

As figure 3 shows, Lester (2016b) found that the higher minimum wage in San Francisco of $12 all but eliminated the hiring of inexperienced workers. Thirty-five percent of North Carolina restaurant recruits had no previous experience but only 2% in San Francisco. Two to three times as many San Francisco restaurant workers have several years of experience as compared to North Carolina. The Taxpayers’ Union expects the same after the adoption of a living wage policy by a local council. Young or inexperienced workers need not apply for council jobs. They will not be short-listed.

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Figure 3: Experience standards for San Francisco and North Carolina restaurant workers, 2014

Source: Lester (2016b).

9.2 No More Entry-Level Jobs The most fundamental criticism of living wage increases is they exclude workers who do not meet the new labour productivity level required to make it profitable for employers to hire them. UK Living Wage Foundation commissioned research found this was so. There was an increase in hiring standards and tougher shortlisting after the adoption of a living wage (Coulson and Bonner 2015). The Living Wage Movement Aotearoa New Zealand (undated) frequently cites this UK research showing elevated hiring standards after living wage rises with approval rather than with concern.

Lester (2016b) welcomed the transition of minimum wage jobs in the restaurant industry in San Francisco into a career for professionals. As he says in his briefing paper:

Concurrent with this wage compression was a rise in professional standards as employers sought to hire and keep already well-trained workers at higher wages and with expanded benefits. Both developments reduced turnover and attracted more professional employees who maintain a high level of customer service (Lester 2016b, p. 2).

As with all minimum wage and living wage advocates, Lester is incurious as to what happens to those low skilled, inexperienced workers and new workforce entrants who no longer meet the hiring standards of San Francisco restaurants because of the much higher minimum wage.

As Lester concedes in his conclusions about what will happen if the San Francisco minimum wage of $12 an hour, the highest in the country, is extended to other cities and states

Higher professional standards may limit entry-level opportunities within the industry, while lower standards may result in more employer-provided training for new workers (2016b, p.3).

Lester sees this loss of entry-level jobs for the low-paid as a positive. The Taxpayers’ Union does not. A living wage is supposed to raise the pay of minimum wage workers. The actual effect of a living wage is to increase the number of vacancies pitched at more skilled, already better paid workers.

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9.3 Less Employer Funded Training The San Francisco restaurant industry was not the only Californian industry where the introduction of a living wage raised the hiring standards of employers and reduced the incentive to train recruits. Fairris and Bujanda (2008) found that Los Angeles county’s living wage policy lead its contractors to hire workers with more experience, training and education. Fairris and Bujanda (2008) estimated that 40% of the wage gain from the living wage policy was lost through the hiring of more experienced workers who were already paid a living wage or thereabouts in their previous jobs.

Reich, Hall and Jacobs (2005) found that a living wage policy applied to all employers at San Francisco International Airport not only reduced the hiring of lower-skilled workers, employers started hiring more males in low-wage occupations which called for strength and physical capability

The QSP [Quality Standards Program] led firms to hire more men in a small number of ‘masculine’ low-wage occupations. Among all ground based non-supervisory workers (the survey population), the overall proportion of women hired did not change (32.3 versus 31.8 percent). However, among low-wage occupations (customer service, ramp, cabin cleaners, screeners, wheelchair attendants and skycaps only), the proportion of women hires fell from 33.4 to 30.3 percent (Reich, Hall and Jacobs 2005).

Employer funded on-the-job training is often a major part of a job package. It is well-known in labour economics since the time of Adam Smith that any job is a package of wages and other attributes including learning opportunities (Rosen 1986). Workers sell services and buy learning opportunities; firms buy labour services and sell jobs with differing learning possibilities (Rosen 1972, 1976).

If the training provided by an employer is useful elsewhere, the trainee funds it by trading-off lower starting wages for training (Becker 1993). A classic example of this is an apprenticeship. Once trained, the employee can command a higher pay because other employers will pay them more now they are trained. Again, this is a standard result in the human capital literature. Where the human capital is more specialised to one firm or job, the employer and trainee share its cost (Becker 1993).

In San Francisco, restaurants expect recruits to arrive fully trained and experienced. They provide little in the way of on-the-job training. Their recruits must have been able to afford to fund this in their previous jobs by trading off wages for training as Lester notes in his working paper:

…San Francisco employers were less likely to report lengthy formal training periods for either front-of-house or back-of-house workers. Instead, there is an overall higher level of skill expectation and—as is the case for many professions—workers are expected to acquire and exhibit industry specific knowledge on their own (Lester 2016a, p. 19).

In North Carolina, as Lester notes, the restaurant industry hires younger workers with much less formal education and offers them intensive on-the-job training:

The restaurant industry in the Research Triangle region tends to hire younger workers with a lower level of formal education. Specifically, 49.5 percent of workers in there are under age 24 or have less than a high school education, compared to 38.9 percent in San Francisco. Conversely, 40.6 percent of workers in San Francisco have some college or a bachelor’s degree or higher, compared to 29.7 percent in the Research Triangle Region (Lester 2016a, pp 15-16).

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North Carolina restaurants sought unskilled workers who were friendly and reliable as Lester notes:

One manager of a neighbourhood bistro in Raleigh explained what he looks for in a new front-of-house worker: “Basically, we require [that a server] can work a four-shift minimum per week and go an entire shift, an entire eight-hour shift without smoking a cigarette and [without] any facial piercings or anything. Beyond that, just come in with a smile on your face” (Lester 2016a, pp. 16-17).

The restaurant industry in North Carolina is willing to give the low skilled, poorly educated and the inexperienced a chance to work if they are willing to work. Lester reports this when quoting an upscale bar-and-grill manager on his hiring standards:

We look for at least one year’s experience, but the biggest thing we look for is we look for the person. We don’t look for the skill. I could teach anybody how [to] wait tables [and] pour drinks. I can teach anybody how to cook steaks. What I can’t teach is how to be a good person (Lester 2016a, p. 17).

Lester then discusses with approval the much higher San Francisco hiring standards:

Rather than viewing servers as essentially interchangeable labourers who can be trained quickly and easily if they possess a modicum of personal hygiene and a friendly personality, employers in San Francisco exhibited a clear description of what a “professional server” was. One mid-scale restaurant employer said of her front-of-house staff: “We have a lot of people who have made it a career and they’re investing in the knowledge of the product and learning their trade or already know their trade because they’ve done it for years” (Lester 2016a, p. 17).

Lester (2016a) paints a picture of a San Francisco restaurant industry that expects workers to fund their own training.

In North Carolina, employers fund much of these training opportunities to low-paid workers despite this making these up-skilled employees an attractive proposition for rival firms to then poach. By depriving low skilled workers of this opportunity of on-the-job employer-funded training, a higher minimum wage made San Francisco’s low skilled workers worse off. A living wage denied low-skilled workers both a job and a step up in the job ladder, all for their own good.

9.4 What Becomes Of The Not Shortlisted?

Councils want to go down the same path. Deprive low-skilled workers of the opportunity of winning a job at a council as a step up in their careers. That is unavoidable if they adopt a living wage. A living wage will change council jobs into vacancies that minimum wage workers do not fill. The Wellington City parking warden layoffs are a telling example how the living wage excludes the lowest-paid.

The refusal of contractors to the Wellington City Council to pay the living wage to guards and cleaners unless they obtain additional qualifications is evidence of this raising of the bar. The existing employees of those contractors are no longer qualified for their own job if it is a living wage job. Twelve of the 30 parking warden know this raised bar at great personal cost. They were not shortlisted for their own jobs when their service was taken in-house by the Wellington City Council and paid a living wage. Another 5 of these parking wardens were shortlisted but were not hired.

Advocates of a living wage policy for councils want to have it both ways. They want to raise the wages earnt by workers on or near the minimum wage. But they also want to spin the living wage rise as benefiting employers by raising the quality of their recruitment pools because they now pay more. Living wage advocates welcome this as a professionalisation of low-paid and entry-level jobs.

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NZ Bus starts its trainee drivers on the minimum wage. The living wage policy of the Wellington Regional Council would give NZ Bus a strong incentive to hire experienced drivers rather than train raw recruits. The experience with living wage policies in the US shopping malls and restaurants and already at the Wellington City Council suggests that this is very much the most likely outcome.

9.5 No Room At The Council For The Minimum Waged Councils see themselves as integral to their local communities. Such councils would never adopt a policy of not short-listing minimum waged breadwinners from their communities from council jobs. The Wellington City Council did so in 2014 and the Porirua City Council and the Wellington Regional Council are following suit. This is not their intention, but is a predictable consequence of a living wage policy. The door is already shut at the Wellington City Council.

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10. Baumol’s Cost Disease And Bus Driver Productivity 10.1 Some Labour-Intensive Services Sectors Have Stagnant Labour Productivity Most council living wage jobs will be service jobs. Living wage activists make much of the large potential productivity gains from paying a living wage to the low-paid such as these service workers.

Baumol (2012) identified a cost disease in the services sector, initially in the performing arts (Baumol and Bowen 1966) and then in government services such as schools and urban transit (Baumol 1967). Baumol first noted that the number of musicians required to perform Beethoven’s string quartet in the 19th century and now were the same. There has been no labour productivity improvements. Four musicians play four instruments for a certain time and that is it. They can play in larger and larger theatres, make records and CDs, and perform on radio and TV. But this scaling-up only mean fewer musicians are required to serve what could now be a global audience rather than a local market; and these lucky few are more and more handsomely paid superstars (Marshall 1920, Rosen 1982).

Baumol’s (1967, 2012) key point was wages growth in a stagnant labour productivity sector is not driven by the extent of labour productivity growth, if any, in that sector. The Economist explains

Employers in such sectors face a problem: they also need to increase their wages so workers don’t defect. The result is that, although output per worker rises only slowly or not at all, wages go up as fast as they do in the rest of the economy. As the costs of production in stagnant sectors rise, firms are forced to raise prices. These increases are faster than those in sectors where productivity is improving, and faster than inflation (which blends together all the prices in the economy). So, prices of goods from stagnant sectors must rise in real terms. Hence “cost disease” (Economist 2012).

Firms operating in stagnant labour productivity sectors must match the wages paid in competing occupational and industry labour markets or they will not recruit and workers will not train. Wages increase in jobs with growing labour productivity, so wages in jobs with stagnant productivity must also increase at the same pace if all jobs are to attract applicants. Wages growth therefore tends to equalise across industries despite uneven growth rates in labour productivity. Of course, consumers must be willing to pick up the tab for the rising cost of the services with stagnant labour productivity.

10.2 The Prominence Of Down-Sizing In Stagnant Labour Productivity Sectors One hypothesis explaining the decline of big bands in the 1930s and 1940s and the rise of rock ‘n’ roll in the 1950s is rock ‘n’ roll bands have a smaller payroll (DeBoer 1985). Baumol’s cost disease made a smaller band an unavoidable cost-cutting measure especially when starting out but it was cultural forces that determined musical content (DeBoar 1985). As Schultz said

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In 1983 it took General Motors about 135 man hours to produce a car. Twenty-five years later, that number had fallen to 32.29 hours per vehicle, marking fifteen consecutive years of improvement in productivity. By contrast, it took the band Lynyrd Skynyrd 1.07 man hours to produce a performance of the song Freebird in 1977. Today, a band duplicating the performance would still take 1.07 man hours (Schultz 2009).

Since the 1980s, music has focused on individual performers, who become superstars, not bands. The top 1% of artists doubled their share of concert revenues from 26% in 1982 to 52% in 2003 (Connolly and Krueger 2006). Ticket prices increased greatly too. A point to remember for buses.

10.3 Do Bus Drivers Become More Productive?

The stagnant sectors involve large amounts of labour and personal interaction and include healthcare, education, and the performing arts (Baumol 2012). Bus drivers are an excellent example of a labour intensive service where labour productivity will be stagnant. Elkins observed that

It took one driver to operate a 40-passenger bus back when public transportation was profitable in, say, 1930, and it still requires one driver to operate a 40-passenger bus today.

From the perspective of labour productivity alone, bus drivers are no more productive today than they were 80 years ago (Elkins 2016).

Sarriera and Salvucci (2016) found that for US public transit, labour productivity growth between 1997 and 2013 was 0% per year for buses and 0.7% per year for rail. They also found that labour was on average 64% of total costs (operating and capital) for buses and 40% for rail.

Baumol’s cost disease means the price of manufacturing goods and of services which are not labour-intensive may drop by 50-90% or more compared to 20 years ago, such as in the US but rises in the prices of labour-intensive services run well ahead of the CPI inflation rate (see Carpe Diem graphic).

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10.4 Managing Staff Turnover In Stagnant Labour Productivity Growth Sectors NZ Bus, as the contractor to the Wellington Regional Council, can do little to lift productivity of its drivers. Much is made of the living wage as a motivating force for higher morale and lower job turnover. A driver drives along fixed routes for the duration of his or her shift. They cannot speed but they can be late. There are no conductors and passengers tag on electronically. Tagging on with makes polite customer interaction with drivers motivated by higher pay less important than before.

Provided drivers do not crash the bus or run late, there is little in the way the labour productivity of drivers can improve beyond the minimum expected of a competent bus driver. Larger buses and dedicated bus lanes save on driver numbers and help schedules stay on time but these one-time innovations have their limits as sources of on-going labour productivity growth. Even Uber has been unable to get around one driver must drive one car safely from A to B within the speed limit.

The wages of drivers are set by what they can command in alternative employment. Competition motivates employers to set wages at a level that retains trained and experienced employees at the rate that best serves the business. That higher wages reduces staff turnover is not news to them.

The productivity gains championed by living wage advocates is already factored into wage settings in stagnant productivity sectors such as bus driving. The Collective Agreement for NZ Bus already has a strong gradient to retain experienced drivers; wages start at $15.25 per hour for trainees and rise to over $22 per hour for the most experienced drivers to keep them on the payroll.

The Wellington Regional Council extended a living wage to its contractors including bus drivers on the basis that there will be productivity offsets from greater morale and reduced staff turnover. That there is little scope for productivity gains in bus driving was not put to them. Wages are already set to recruit and retain bus drivers with the experience or that NZ Bus can afford within the cost parameters of its contract to that Council. Indeed, a living wage rise would undermine graduated pay rises with seniority that NZ Bus currently uses to retain drivers as they gain more experience.

A living wage will not make the Wellington buses more efficient. The interaction between wages, morale and job turnover is very much in the mind of NZ Bus because matching the outside job options of drivers is the principal driver in its wage bargaining, recruitment and staff retention policies. None of this information was before the Wellington Regional Council when it voted for a living wage in the hope of productivity gains in a sector notorious for stagnant labour productivity.

10.5 Many Local Government Services Are In The Non-Progressive Sector Baumol (1967) divided the economy into progressive and non-progressive sectors. The progressive sector experienced regular productivity growth such as manufacturing or ICT; labour productivity in the non-progressive sector is static because of his cost disease. This non-progressive sector was made up of labour-intensive services. Local councils provide many such labour-intensive services.

Baumol (1967), whose paper was titled “Macroeconomics of Unbalanced Growth: The Anatomy of Urban Crisis� was pessimist about labour productivity growth for most local government services

The bulk of municipal services is, in fact you will be low of this general stamp [non-progressive] and our model tells us clearly what can only be expected ‌ inexorably and

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cumulatively, whether or not there is inflation, administrative mismanagement or malfeasance, municipal budgets will almost certainly continue to mount in the future, just as they have been doing in the past. This is a trend for which no man and no group should be blamed, for there is nothing than can be done to stop it (Baumol 1967, p.423).

Baumol’s cost disease puts a dark cloud over the entire living wage movement for local councils. There will be few productivity offsets from a living wage policy in Baumol’s non-progressive sectors.

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11. Why The Futile Crusade?

11.1 A Living Wage Policy Has The Best Of Intentions And Worst Of Results Seventeen parking wardens lost their jobs because of the elevated hiring standard; the productivity offsets are suspect at best and trivial for services such as bus driving; and the living wage increase is far larger than any bargaining power employers might have to keep wages down. Coase warned that implementing reforms in real life is far different to theorising in the classroom (or at an activist rally):

The policy under consideration is one which is implemented on the blackboard. All the information needed is assumed to be available and the teacher plays all the parts. He fixes prices, imposes taxes, and distributes subsidies (on the blackboard) to promote the general welfare. But there is no counterpart to the teacher within the real economic system (Coase 1988, p. 19).

The living wage unintentionally harmed the minimum wage workers the policy was intended to benefit because reformers cannot control all the moving parts of an economic system.

11.2 Picking Up The Pieces After Social Reform As nay-sayers about the resilience of capitalism, it is out of bounds for living wage activists to expect the labour market to jump in to quickly supply new jobs to the 17 unemployed parking wardens. The convener of the Living Wage Movement, Ms Annie Newman, summarised the strength of their piety:

There are hundreds of thousands of New Zealanders who are not earning a living wage, they are earning what the market dictates, and invariably those are poverty wages, so it doesn’t surprise us that there are people that don’t have houses, they don’t have heat, they don’t have proper fuel, and yet they work for what is a so-called living (Pryor 2015).

Activists should pause sooner than most when their reforms trip-up, as they have, because they see the market as a dystopia, not a ‘marvel’ that spontaneously picks up the pieces as Hayek explained:

… they lack the faith in the spontaneous forces of adjustment which makes the liberal accept changes without apprehension, even though he does not know how the necessary adaptations will be brought about. It is, indeed, part of the liberal attitude to assume that, especially in the economic field, the self-regulating forces of the market will somehow bring about the required adjustments to new conditions, although no one can foretell how they will do this in a particular instance. There is perhaps no single factor contributing so much to people’s frequent reluctance to let the market work as their inability to conceive how some necessary balance, between demand and supply, between exports and imports, or the like, will be brought about without deliberate control. The conservative feels safe and content only if he is assured that some higher wisdom watches and supervises change, only if he knows that some authority is charged with keeping the change “orderly” (Hayek 1960).

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11.3 Why No Crisis Of Conscience After The 17 Parking Warden Job Losses?

It must be asked why living wage policies have grown in popularity among the councils elected at the 2016 local elections despite being so counter-productive? Of equal importance is living wage activists should be the last to risk adding to the reserve army of the unemployed, but they did. The living wage movement had no moments of reflection or self-doubt about the truth of their mission after the 17 parking warden redundancies became known to them (McIntyre 2016).

11.4 Modern Democracy Is Government Subject To Electoral Checks Voters can replace politicians who disappointed them such as a policy to reduce family poverty with a council living wage that instead backfires. Schumpeter’s (1942) theory of democratic participation is voters have enough knowledge and sophistication to vote out leaders who performed poorly or contrary to their wishes. This power to throw the rascals out at the next election gives politicians an incentive to adopt policies that do not outrage public opinion and to administer policies with some degree of honesty and competence (Posner 2005). But voters through their ignorance and superficiality still can be manipulated (Schumpeter 1942; Peltzman 1976, 1989, Somin 2013).

Retrospective voting – voting failing governments out, rather than voting better ones in – punishes serious misalignments between governments and public opinion (Posner 2005). Throwing the rascals out works if their replacements at the next election are minimally competent (Posner 2006). But low voter turnout and a lack of strong party politics at local elections makes it harder for voters to punish under-performing political brands by voting them out and replacing them with a new administration.

Nonetheless, the incentives for political leaders to listen to and heed voters is robust. Peltzman (1980) and Caplan (2007) point out that the near doubling in public spending between 1950 and 1980 was at the behest of the median voter – the ‘swinging’ voter. Most of this growth was in health, education, old-age pensions and social insurance, which grew because of support from the average voter (their main beneficiary). The question arises as to whether that is good enough:

Hundreds of millions of people under democratic rule enjoy standards of living that are, by historic standards, amazingly good. The shortcomings of the worst democracies pale in comparison with those of totalitarian regimes. Nevertheless, now that democracy is a typical form of government, there is no reason to dwell on the truisms that it is “better than communism” or “beats life during the Middle Ages.” Such comparisons set the bar too low (Caplan 2007, p. 3).

George Stigler was an optimist about good policies surviving and winning in democratic politics including those involving extensive redistribution either broadly in society or to specific groups:

In policy analysis, one may legitimately employ an alternative definition of efficiency that rests on the goals adopted by the society through its government. When a society wishes, for example, to give more income to a group than the market provides, we may surely analyze the efficiency with which this is done…

In this latter view, every durable social institution or practice is efficient, or it would not persist over time. New and experimental institutions or practices will rise to challenge the existing systems. Often the new challenges will prove to be inefficient or counterproductive but occasionally they will succeed in replacing the older system. Tested

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institutions and practices found wanting will not survive in a world of rational people.

To believe the opposite is to assume that the goals are not desirable: who would defend a costly practice that produces nothing (Stigler 1992, pp. 458-59).

Furthermore, Stigler argued that public policy in democracies is well informed by economics:

… the truly established findings of economists are incorporated into all public policies. No one disputes the fundamental law of demand, that buyers will seek to purchase more of a thing if its price is reduced. When a government introduces effective price ceilings without formal rationing, it does not disregard the law of demand: it simply decides that it prefers the pattern of purchases that will result from queueing (Stigler 1986, p. 9).

Stigler was not naive about who are more successful in political competition:

I do not conceal my lack of admiration for a painfully long list of redistributive measures undertaken by modern governments. Many serve no ethically accepted purpose such as compassion for the needy; indeed, they serve only as recognition of which groups possess or lack political influence (Stigler 1988).

Democracy is efficient in that the least-worst modes for taxing, regulating and redistributing income between winning and losing pressure groups are adopted (Becker 1983). A living wage policy, for all its faults, might be better than the alternatives that lost in political competition. That things could have been worse defines political efficiency as Churchill did where “democracy is the worst form of government, except for all the others”. A leading rationale for letting local councilors strut their small stages is more centralised and bureaucratic alternatives for local service delivery are worse.

11.5 Do Taxpayers And Ratepayers Get What They Voted For “Good And Hard”?

A less optimistic line of thought about public choice and voting is rational irrationality (Caplan 2007). Voters in elections have no incentive to inform themselves properly about the actual consequences of policies and keep voting vote for policies that do not work, such as a living wage policy. An informed vote is just as decisive as an ignorant vote because each vote is just one of very many.

Because of the insignificance of a single vote in deciding elections, it is not rational for voters to invest in correcting erroneous beliefs about the effectiveness of policies (Caplan 2007). This is not the case of the ill-informed beliefs of voters cancelling each other out at the ballot box. Voters as a group have systematically biased beliefs about such things as the effectiveness of the market, the value of interactions with foreigners, and whether living standards are improving (Caplan 2007).

Rationally irrational voters believe the policies they support work but have next to no private incentive to check if this is so (Caplan 2007). Elections and public policy are repeatedly shaped by systematic biases that most voters have little incentive to correct. The incentive to be tolerably well-informed about local government policies is weaker and many more do not bother to vote. Low voter turnout together with little incentive to be informed is a heady brew in local elections.

The ability of the Wellington City Council to adopt a living wage policy in 2014 to popular acclaim, renege on further rises in the living wage but successfully campaign at the next local election on adopting a living wage suggests that ratepayers have a limited incentive to hold them to account.

11.6 The Living Wage And “The Fury Of Democracy” An even gloomier view of political decision-making is expressive voting (Brennan and Buchanan 1984; Brennan and

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Lomasky 1993). As the vote of one individual is rarely, if ever, decisive, voters see politics as a theatre made up of symbols for which they boo and cheer (Brennan and Hamlin 1998).

Voters gain pleasure, excitement and a sense of identity from support for a political party and worthy causes in the same way as they cheer and boo sports teams (Brennan and Buchanan 1984; Brennan and Lomasky 1993). Voters vote against their self-interest because their vote is not decisive; voting for good causes adds to their sense of selfworth (Hillman 2011; Brennan and Lomasky 1993). Voting can also be influenced by the desire to anger or please others (Glazer 2008).

Expressive voters can be rather casual about whether policies they are supporting at the ballot box such as whether a council living wage works if they feel good cheering them on says Caplan:

In expressive voting theory, voters know that feel-good policies are ineffective. Expressive voters do not embrace dubious or absurd beliefs about the world. They simply care more about how policies sound than how they work. The expressive protectionist thinks: “Sure, protectionism makes America poorer. But who cares, as long as I can wave the flag and chant ‘USA!’ ‘USA!’” Rationally irrational voters believe that feel-good policies work (Caplan 2007, pp. 138-139).

Symbols are so important to expressive voters that they can be deeply hostile to effective solutions to the leading problems that trouble them (Hamlin and Jennings 2011; Fry 1999). Environmentalists were long opposed pollution taxes including carbon pricing because they were “a license to pollute” (Stavins and Whitehead 1992). This was despite the effectiveness of the polluter pays in lowering the economic costs of environmental clean-ups to industry and consumers and, in turn, the level of political resistance environmentalists would have to overcome (Blinder 1987; Caplan 2007).

11.7 Why Pick A Harder Fight To Win? A living wage is a type of public policy particularly at risk to expressive voting as Lomasky explains:

It is not the depths of ignorance but rather heights of emotion that generate unfortunate electoral outcomes. Because much voting is expressive, analysts need to attend with special care to those issues concerning which voters are most strongly inclined to “send a message” (Lomasky 2008, p. 481).

Raising Working for Families is a far more effective solution and an easier political fight. But earning a living wage is so important a symbol to activists that they prefer a long march. This agitating one employer at a time delays poverty reduction for a long time compared to compromising on a higher Working for Families or a small minimum wage increase to the benefit all workers still in their job.

11.8 Winning Isn’t Everything In The War On Poverty Children must wait in poverty while their champions fight over the messaging of how they are to be helped. The struggle is more important than the prize; reducing family poverty as swiftly as possible.

Be they driven by rational irrationality or expressive voting, living wage policies by councils do send that all important message about poverty but a living wage reduces the job opportunities of the very low-income families the policy aims to benefit. The 17 laid-off Wellington parking wardens and their families know this downside all too well. A living wade policy is a cost with no family poverty reduction benefit other than to those council employees employed at the time of the initial pay rise.

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11.9 The Duty Of Councils To Be Efficient And Effective As a guard against these paradoxes of voting arising from rational irrationality and expressive voting, councils have a statutory duty to operate in an efficient and effective manner. They are not sovereign like Parliament. Councils must by law stay their hand and not adopt ineffective policies. Constitutional design is about slowing the impassioned majority down with the constitutional entrenchment of rights, judicial review, separation of powers, upper houses and other checks and balances (Elster 1992; Buchanan 1994). The Local Government Act 2002 attempts to stop council members from acting before they have reflected on considered advice on the effectiveness of what they plan to do.

Unlike MPs, council members are personally liable if they act outside their powers.

The Wellington City Council’s own legal advice said “the Council is at risk of being found to have acted outside of the purpose of local government as set out by sections 10 and 11 of Local Government Act” and that the changes would be unlawful because “the increased cost that arises as a consequence of the living wage should allow for a corresponding increase in the quality or effectiveness of the particular service being provided” (Business NZ, no date).

The Council’s briefing papers on its living wage policy anticipated a 19% cost increase for the one security contract alone.

When the Wellington City Council extended its living wage policy to the employees of contractors under joint service contracts with neighbouring councils, it decided that the Council itself shall vote on each living wage contract variation. This was to avoid putting its Chief Executive and his managers in the position of breaking their own employment agreements regarding their duty to act lawfully.

After the Wellington Chamber of Commerce sought a judicial review, the Wellington City Council agreed to consult with the Wellington Chamber of Commerce on any further extensions of its living wage policy to new contracts and to seek a legal judgement to clarify any disagreements that might arise in the consultation process, if necessary (Devlin 2016).

11.10 But Is A Living Wage Policy Still Worth A Try? Demands for massive pay rises for the low-paid are not just confined to New Zealand. The US debate is worth reviewing because their living wage advocates are so upfront about the job losses. US living wage activists such as Fight for $15 want to double their federal minimum wage from $7.25 per hour to $15 per hour. California, New York, San Francisco and Seattle are among the states and cities increasing their local minimum wages, currently of up to $12, to $15 by 2021 or 2022.

Some such as Arindrajit Dube say that these very large wage increases by cities and states in their federal system are experiments “worth running and monitoring” (Lane 2016). As Dube said recently:

“… 30 to 40 percent of the California workforce will get a raise … This will be a big experiment. It’s far outside of our evidence base… If you’re risk-averse, this would not be the scale at which to try things. On the other hand, if you think that wages are really low and they’ve been low for a really long time and we can afford to take some risks, doing things at this scale will get us more evidence” (Lee 2016).

Noah Smith (2016) concluded that the empirical literature on minimum wages suggests that a 10% minimum wage increase would reduce employment by about 2% so doubling the federal minimum wage would see the employment of young people go down by one-fifth. Smith (2016) said this is a “small but real effect -- a $15 federal minimum wage might throw a million kids out of work”.

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11.11 Should Activists Use Minimum Wage Breadwinners For Policy Experiments?

Smith (2016) considers balancing the one million unemployed teenagers against the wage gains for adults as “necessary for a decision”. He suggests that the large minimum wage increases in some US states and cities will tell us how big this welfare trade-off between jobs and wage rises is:

We don’t really know what happens when you raise the minimum wage to $15 — but soon, we will know. We will be able to see whether employment rates fall in L.A., Seattle, and San Francisco. We will be able to see whether people who can’t get work migrate from these cities to cities with lower minimum wages. We will be able to see if employment growth suddenly slows after the enactment of the policy. In other words, federalism will do its job, by allowing cities to act as policy laboratories for the rest of the country (Smith 2015).

“Big experiments” involving large minimum wage increases to “provide clear evidence” to quote Dube’s words (Scheiber and Lovett 2016) are wrongheaded as Robert Lucas has explained:

I want to understand the connection between in the money supply and economic depressions. One way to demonstrate that I understand this connection–I think the only really convincing way–would be for me to engineer a depression in the United States by manipulating the U.S. money supply. I think I know how to do this, though I’m not absolutely sure, but a real virtue of the democratic system is that we do not look kindly on people who want to use our lives as a laboratory. So I will try to make my depression somewhere else (Lucas 1988).

Leading reasons for economic theory, empirical research and the study of economic history are to warn the present against repeating past errors and not try experiments that are folly (Rosen 1993). There is too much group think and not enough courage of your vocation (see snapshot below).

Australian-born economist Justin Wolfers is frank about the wishful thinking in the US debate:

But if you are interested in what level to set the minimum wage, the existing literature is nearly hopeless. Plausible reforms lie far outside the bounds of historical experience. We don’t have useful estimates of the extent to which employment effects vary with the minimum wage. Since policymakers tend to implement short-run fixes, we know a lot about the effects of temporary reforms, but very little about the consequences of lasting reform (Wolfers 2016).

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Most of the empirical studies are of the jobs lost over the next few years. When estimates have a 10 to 15-year horizon with time enough for entry, exit and technological adaptation and automation, a “long-run disemployment effect that is five times larger than the short-run effect” is in evidence (Aaronson, French, Sorkin 2016; Aaronson, French, Sorkin and To forthcoming; Sorkin 2015).

11.12 The Social Justice Of Pricing Minimum Wage Workers Out Of Council Jobs Living wages and minimum wages are political bargains that price some out of jobs but others will earn more. Seventeen parking wardens are all too aware of this as they were thrown to the wind. John Rawls famously complained that utilitarian trade-offs “adopt[s] for society as a whole the principle of choice for one man” and in so doing these trade-offs fail to “take seriously the distinction between persons”. In a key passage of his A Theory of Justice, Rawls said that:

Each person possesses an inviolability founded on justice that even the welfare of society as a whole cannot override. For this reason, justice denies that the loss of freedom for some is made right by a greater good shared by others. It does not allow that the sacrifices imposed on a few are outweighed by the larger sum of advantages enjoyed by many… [T]he rights secured by justice are not subject to political bargaining or to the calculus of social interests (Rawls 1971, pp. 3-4).

The living wage is a policy experiment that prices the lowest-paid out of council jobs. This social exclusion grates against Rawls’ (2001) liberal notion of each of us as the author of our lives through social institutions that give “a sense of self-worth and the confidence to carry out our plans”.

Pricing workers out of jobs clashes with the central concern of living wage activists, which is workers should earn for themselves a wage decent enough to live on; they should not rely on handouts for this. The 17 unemployed Wellington City parking wardens are in direr straits than this because of the living wage movement. They were left to fall back on unemployment benefits. Over 500,000 workers paid less than the living wage are at risk of being been priced out of council jobs. Over 150,000 of these earn the minimum wage and have no chance of being shortlisting for a living wage job.

11.13 Why Not A 30% Living Wage Increase For Everyone?

The productivity offsets from a living wage rise are not limited to the low-paid. The greater morale, lower turnover and improved recruitment pool arguments apply more to better paid, more skilled jobs than to low-paid jobs where monitoring employee effort is easier. Pushing for a 30% pay raise for all workers, which would close the Trans-Tasman wage gap, is a reasonable extension of the productivity arguments for a living wage at a council but no one cheers on this logical next step.

A living wage rise of 30% in New Zealand (and a 100% on the USA) are still on the table because of inner contradictions in the expressive politics of sending a message. Brennan (2009) argued that there are many expressive voter concerns that politicians must balance to be re-elected. Once an individual policy popular with expressive voters starts to be seriously costly to the swinging voter, expressive voter support for that policy falls away. Brennan (2009) argued that the nature of expressive concerns of voters is such that significant reductions in their incomes is not politically sustainable in the longer term. This suggested to Brennan him that policies for which the expressive voter cheer often will be limited to those modest in cost and often largely token in character.

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Low-paid workers are not necessarily swinging voters. The middle class is the dominant voting bloc in democracies (Stigler 1971; Peltzman 1980). If a living wage increase reached into the middle-class to jeopardise their jobs, expressive voter support for the policy would fade. Recall Holzer’s (2008, p. 21) remark that the politics of the living wage “are so fierce while (or maybe because) the stakes are so very small”. The small-scale of council living wages may be why they win support. As Stigler said

we live in a world that is full of mistaken policies, but they are not mistaken for their supporters (Stigler 1982, p.10).

Living wage policies at councils do not do much good but they also do little harm because so few jobs are covered by them. There is not much to lose from cheering for a living wage on unless you were a laid-off parking warden or are a minimum wage worker applying a council job in the future.

11.14 Time To “Pause For A Cup Of Tea” It is all going too fast. Living wage advocates fail to take seriously that the 17 Wellington parking warden jobs that have already lost jobs and the tougher short-listing after a living wage increase at other councils are the jobs of real living people who suffer when their interests are traded-off for the greater good of others, some of whom are from wealthier households. Councils may promise no layoffs but the Porirua City Council struggled to finance a partial living wage to beyond the 2016 local elections. Future councils have a duty to reconsider the size of payrolls if their finances tighten.

Karl Popper (1945) preferred piecemeal social engineering where we proceed step-by-step based on trial and error, learning from mistakes. Results achieved are checked with what results were promised, and we should watch closely for unintended consequences. Popper also cautioned against large-scale reforms whose complexity and scope make it hard to disentangle cause from effect to work out what specifically happened because of the reforms, and then learn and correct errors:

… we make progress if, and only if, we are prepared to learn from our mistakes: to recognize our errors and to utilize them critically instead of persevering in them dogmatically (Popper 1957).

Living wage rises that overreach the mark to result in many job losses that are hard to undo. The 17 redundant Wellington City parking wardens cannot be rehired by sacking those that replaced them. The duty to hire on merit would still preclude their short-listing. Alternative social policy tools to reduce family poverty such as Working for Families can be easily refined on a piecemeal basis with experience so to target them better at those most in need. Popper again

The piecemeal engineer will, accordingly, adopt the method of searching for, and fighting against, the greatest and most urgent evils of society, rather than searching for, and fighting for, its greatest ultimate good (Popper 1945).

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Munger (2014) argues for filtering our ambitions through the test of whether the “politicians I actually know, running in electoral systems with voters and interest groups that actually exist� can deliver. Every hour spent lobbying a council for a living wage policy is an hour not spent lobbying members of parliament about the generosity of Working for Families and social welfare benefits. That delivers better against John Rawls’ conception of how to promote equality of opportunity:

government guarantees a social minimum either by family allowances and special payments for sickness and unemployment, or more systematically by such devices as a graded income supplement (a so-called negative income tax) (Rawls 1971).

The Government is planning a tax and families package in the next budget. Living wage activists might better direct their energies towards the size and shape of that rather than local council pay. In the longer term, the living wage movement could put forward proposals that might raise the economic growth rate which in turn will lead to higher incomes and faster wages growth for all.

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