Gary Galles – October 8, 2019
People frequently allege that, under capitalism, people aren’t paid what they are worth to employers. As a measure of how frequently that gets repeated, a Google search of “underpaid” I just did turned up 1,770,000 hits. And there is one sense in which that allegation may be true. But the commonly-drawn implication that state coercion will improve things is false.
The competitive market process does not guarantee that your payment equals your value to your employer. It guarantees you are paid at least as much (adjusted for a host of other circumstances and preferences) as your next-best known alternative.
Say Bob and Bill are your potential employers. Bob offers you $50,000. If Bill values your additional productivity at $70,000, what will he offer you? It is indeterminate. All we know is that it must be enough to outbid Bob, other things equal, to attract you. Bill need not pay you what you are worth to him. But even if you are paid less than your value to Bill, your supposed “underpayment” does not harm you. You are made better off than you would have been by any offer you accept from Bill.
If, however, Barbara joins those who seek your services, and offers you $60,000, Bill will have to beat that, rather than $50,000, to keep your services. If Betty then also joins the pursuit of your labor services at $69,000, that becomes the number that must be beaten. In other words, the more competitive the market for your labor becomes, the closer your pay approaches what you are worth to your employer, because the value of your alternatives approaches your value to your chosen employer. And only the free market guarantees that you will be paid that well.
Better Wages Come from More Competition Among Employers
This reveals why government coercion is not the path to increased worker well-being. Governments and their “big labor” progeny are constantly advancing mandates that impose barriers to entry and competition for their favored groups from other workers. When reduced barriers to entry and increased competition are the means by which workers become paid nearly what they are worth to employers, such coercive government “solutions” actually guarantee that many workers will be paid far less than they would otherwise have been.
Government is also a major source of other reasons why workers’ paychecks are less than their value to employers.
Government-mandated worker benefits provide one example. The costs of those benefits must ultimately come out of employees’ total compensation. So while government sponsors claim credit from recipients for mandated health coverage, worker training, family leave, workman’s compensation, etc., workers’ earnings are reduced to cover their added cost. But because these act as hidden taxes, employers get the blame for the lower wages that result.
Employer “contributions” for state unemployment and disability insurance, as well as their half of Social Security and Medicare taxes, are another source of such worker “underpayment.” Employers, knowing they will be on the hook for these bills, over and above wages paid, offer less in wages. Again, the money ultimately comes from employees’ pockets, but they blame their employers instead of the government for reducing what they take home as a result. When workers say “I was robbed,” they may be correct — but they finger the wrong suspect.
And these costs are substantial. An article in the September 29 Los Angeles Times noted that they can comprise 30% of employers’ labor costs.
Corporate taxes have similar effects. To the extent that such taxes’ effects reduce net-of-tax earnings, they reduce the value of workers to employers. Yet again, government gets the money and accolades from beneficiaries of added expenditures financed, while businesses are scapegoated as if they caused the underpayment. In fact, Stephen Entin summarized recent data-based studies on corporate tax incidence as showing that “labor bears between 50 percent and 100 percent of the burden of the corporate income tax, with 70 percent or higher the most likely outcome.”
The widespread assertion that people aren’t paid what they are worth to employers may be true in one sense, but not in the sense those making the assertion usually imply. “Greed” or some faulty “ism” is not to blame, and more government interferences provides no magic solution. The maximum such “underpayment” in a competitive labor market is the extent that your value to your highest valuing employer exceeds that of your second-highest valuing employer. And that difference gets smaller as labor markets get more competitive. On the other hand, there are many ways government’s coercive power reduces what workers take home well below their value to their employers (or how valuable they would be if they were freely allowed to compete for all jobs), in order to fill their treasuries and protect their “friends” from competition, while blaming others for what they have imposed. So, if being paid what someone is worth to an employer is the standard, government is the problem and competition is the answer.
Originally published at Mises.org. Gary M. Galles is a professor of economics at Pepperdine University.
Image source: Getty