Two candidates for the Labour Party leadership have promised that they will require the payment of “living wages” for all government employees and for all government contractors. Matthew Hooton asked about the likely effects.
The proposal here isn’t for an $18.40 minimum wage but rather for a living wage mandate for government workers. The effects then are more minor. Imagine that we have rent control on a bunch of apartments but no rent control on new buildings. We’d then expect excess demand for the rent-controlled flats, but a clearing market elsewhere. Similarly, a living wage mandate in the government sector shouldn’t have huge equilibrium unemployment effects. Lots of people queue for jobs in the high-paying sector, but they take lower-paying jobs in the private sector.
The main effect will be an increase in the cost of providing some government services. At the margin, this should mean that we have a few fewer things done by government, albeit within the context of an expansion in the size of government under a future Labour government. There would also then need to be an increase in taxes to fund it, or reduced spending in other areas to compensate, or higher deficits. I suspect Labour would bridge the gap via tax.
There will be some transitional unemployment as marginal jobs undertaken by government get shifted away from the government sector. If some of these workers were earning substantial rents in the government sector and are not employable above the legal minimum wage in the private sector, there could be some increased longer-term unemployment from that. But that shouldn’t be any substantial part of the market. There will also be rather a few transitional costs where bureaus start renting fully serviced buildings with gardening and cleaning provided as part of the rent rather than either hiring those kinds of workers directly or through a contractor.
Note as well that government sector workers are already overpaid relative to their private sector counterparts
. While this may worsen the imbalance, it means that fewer government workers would be caught in the interval from the minimum to the proposed “living” wage than would be the case among private sector employees. The costs of a living wage mandate may be lower where imposed on the government sector than where imposed broadly. Imagine it in the limit: a $500/hour minimum wage in government. I expect that while government workers would earn a lot more, government would be a much smaller share of the economy. And think of the productivity gains in government: we’d only be choosing to use government rather than markets where we expected the social value of some government function were exceptionally high indeed.
So while I wouldn’t expect large disemployment effects from the policy, it’s hardly a great idea. If you want to increase the wages of the working poor, you hardly should be starting with government workers, who earn more on average than those in the private sector and who typically also enjoy greater job security and flexibility. And if you want to run transfers to the working poor, generalised wage subsidies are the least distortionary way of doing it. Labour’s proposed mechanism would be likely to reduce the efficiency of government services by pushing away from contracting out, and to skew the optimal balance between government services and other goods and services by increasing public sector costs.
Update: John Key also is no fan of Labour’s proposal. He suggests additional costs where aggregate wages are bid up, or at least that’s my interpretation of his argument that companies wind up having to pay more and that consumer costs then go up. That’s possible within particular labour markets but I have a hard time seeing big aggregate effects.
Let’s think of the market for service workers in restaurants. Suppose that the lowest-skilled workers work the cashier’s station at the cafeteria in some government office. And let’s suppose that this cafeteria continues to exist rather than the venue being leased out to a private sector firm, which it would under a $18.40 living wage mandate. The highest-skilled workers work at the fancy high-end restaurants, or work more complex jobs requiring a lot of balancing of tasks.
The living wage mandate then comes in. Currently employed cafeteria workers then are earning huge rents. Suppose we then have a lot of job applications from higher-skilled restaurant workers and, as consequence, job redefinitions to make better use of the more highly skilled staff. We then have more competition for more highly skilled restaurant staff and could see some bidding up of wages within that market. But there would still be low-skilled cafeterias in the private sector. With migration into that sector from former public sector workers who had been displaced, we could see some bidding down of wages in that part of the market. I can see mechanisms where there’s bidding up of private sector wages in some markets, but I’d also expect potential bidding down where lower-tier government workers move back into the private sector.