The Just Price Fallacy


Courtesy of the New York Times, we learn that Obama is planning on using Federal contracts to engineer the “appropriate” wage levels for unskilled workers:

The Obama administration is planning to use the government’s enormous buying power to prod private companies to improve wages and benefits for millions of workers, according to White House officials and several interest groups briefed on the plan.

By altering how it awards $500 billion in contracts each year, the government would disqualify more companies with labor, environmental or other violations and give an edge to companies that offer better levels of pay, health coverage, pensions and other benefits, the officials said.

I want to comment on what Republicans have been saying about this, for example:

They see it as a gift to organized labor and say it would drive up costs for the government in the face of a $1.3 trillion budget deficit.

Now, it is hard to argue that this isn’t a gift to organized labor, but that is beside the point. Big government is in the business of giving gifts, and competition is fierce. No, the problem is the argument that this will drive up costs. Will it drive up costs for the government? Well, no. The demand is fixed at a nominal price of $500 billion. What Obama is doing is increasing the price of labor, which will cause the quantity of labor demanded to fall. This can be a good thing, as it can represent an increase in productivity — which it will have to, unless we want to spend $500 billion and only get half of a lawn mowed. I don’t think that will look very good, aesthetically, or politically. The result is that fewer workers will be employed.

Republicans have nothing to fear, though…costs are still fixed!

However, Obama seems to believe that on net, he is doing some good for the working poor. Of course, he is doing nothing of the sort. There is a tendency among the left to think that the “laws” of supply and demand don’t exist when convenient, much like Ray LaHood thinks the laws of physics don’t exist. By raising the price of labor, you also increase the quantity of labor supplied. Since demand is fixed, that means people go unemployed. Who goes unemployed? The least productive. Who are the least productive? The most poor. So if the government has the market power that is intimated in the article, then you will see this chart persist (for the “Less than High School” and “High School” categories) well into the future.

This tendency is called the “just price fallacy“, and it is very popular in politics…and unfortunately, seems to be human nature to decry prices we don’t deem to be “just”. Going all the way back to Diocletian, we can find examples of people verily condemning “price gouging” or “profiteering”. Of course, as we know from economic theory (and experience) setting price floors causes unemployment, and setting price ceilings causes shortages.

In (nearly?) all cases, simply giving poor people money is much better anti-poverty measure. Ironically, Milton Friedman, widely regarded as a “conservative economist” was one of the strongest backers of the negative income tax — a policy deemed “too liberal”! Why the tepid response to things like the Earned Income Tax Credit from the non-economist left (we know the right do it to simply score political points with constituents)? Well, it seems that it stems from what I like to call the “Barbara Ehrenreich theory of value[1]“. For those of you who do not know who Ehrenreich is, she pretty much built the industry of authors working undercover doing low-paying jobs, with the intent on writing a normative essay about the experience. Of course, the common conclusions are that we should treat these people nicer (which is fairly uncontroversial), and we should pay them more based on the humility that they face. By giving money directly to the poor, it seems that we are “justifying” employers that profit from “slave labor”. Of course, this is wrong and wrong-headed, but the view persists.

That’s about as far into psychology as I care to go…the bottom line is, if Barack Obama wants to help poor people, cut the contracts and give money directly too poor people. If all $500 billion were cut (hypothetically), it would afford the government a $6,000 subsidy for every household under $25,000. You could avoid the poverty trap by phasing the benefit out over the next quintile of income, and you would have a very effective anti-poverty program.

____
[1]Not to be confused with the “labor theory of value“.

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9 thoughts on “The Just Price Fallacy

  1. One solution to the problem, in my mind is a 20-25% flat tax starting at $45k with a $11,250 transfer payment at the beginning of each year. Basically a negative income tax plus flat tax.

    I don’t believe the left rejects negative income taxes out of altruism, but rather not understanding labor economics. Ostensibly their solution amounts trying to subsidize the poor by making their employment less attractive and more costly to an employer. I’d much rather disperse the costs among a wider base than concentrate it on small businesses (let’s be honest it is small businesses that are hiring at min wage levels). I’m not sure if Joe Democrat would agree to this or not, but oddly, Joe Democrat does seem to support dispersing costs when it comes to insurance.

      1. “The lefty non-economists I’ve talked to” is not exactly a representative sample. However, it is instructive as to thought patterns (even if simply among those people).

        Ask a leftist-liberal non-economist that you know if they would advocate eliminating the minimum wage in favor of wage subsidy. I’m betting you would get a firm “no”.

      2. That’s probably because minimum wages stick regardless of the problem of employing the same number of people with higher wages–whereas a one-time wage subsidy or even a permanent, annual subsidy will not scale without further legislation to keep it going.

      3. I’m confused about what you said here.

        A wage subsidy is not only easier to target (at say, an age group…one of the arguments against minimum wage), you can index it to really any variable you find appropriate, and it’s easy to phase out over the span of the second quintile of the income distribution.

        It’s vastly superior policy.

      4. You’re probably correct. I’m just not confident our government can make it any more reasonably efficient than the inefficiency of increasing the minimum wage.

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