In the spirit of the famous Harvester case, ACTU secretary Sally McManus is proposing an overhaul of the national minimum wage to better account for the reasonable needs of an average sized family. The ACTU wants a “living wage” that takes into account the cost of renting a two-bedroom flat in a working-class suburb of Sydney or Melbourne, the cost of providing a balanced diet for a family of four, the cost of running a car, as well as electricity, gas, and childcare, with a little over to be able to take the family out for a meal or to a footy match. The aim is to fix the minimum wage at 60% of the median wage, bringing it up to $738 per week.
The ACTU’s proposal to replace the minimum wage with higher wages for all marginal workers is emotionally appealing but economically flawed. Moreover, the economics do not become correct just because similar policies have been introduced in Europe.
As Frederic Bastiat famously wrote, we need to consider that which is seen and that which is not seen. We need to consider not only the immediate beneficial effects on a few workers but also to foresee the long-term adverse effects on them and on many others.
To comprehend the economic error, we need to understand how prices work.
The miracle of the price mechanism is that it enables scarce economic resources to be allocated in a most efficient manner without planning or control.
In a free market, price rises transmit information about scarcity, and encourage positive economic reaction. The cause of the price rise is immaterial. Neither the buyer nor the seller needs to know why there are insufficient resources available. Prices efficiently transfer only the minimum information that the economic actors need to know.
Price rises create the incentive for buyers and sellers to use economic resources efficiently. When an item, or a component of manufacture, becomes scarce the parties will seek alternatives. In this way, maximum benefit is gained from the scarce resource and other resources are brought into play. Alternatively, production may be increased, but this will invariably require more investment and the use of costlier resources.
The third essential element in the mix is the principle of private property - that people own the results of their labour. Entrepreneurs must be confident that they can retain the rewards if they invest in new production. Otherwise there is no incentive for them to respond to the shortage.
The price mechanism enables society’s entire deposit of scarce physical and intellectual resources be assembled to:
make use of the talents of many individuals;
provide for the needs and tastes of every consumer;
encourage technical innovation, creativity and social development; and
do all this in a way that can be sustained.
But what happens when the government intervenes in the economy and controls prices?
The information transmitted is wrong and will lead to error. If the price of a commodity is set higher than the market, then more will be produced and less will be purchased; there will be inventories of unsold product. If the price is set lower than the market, then there will be insufficient produced and unrequited demand; there will be queues for, or rationing of, the limited quantities that are available.
Government price controls are implemented with the best intentions, but their results are counter-productive. Emotionally they appeal; economically they disadvantage those they are supposed to benefit.
Rent controls reduce the return for property owners and lead to less maintenance and fewer properties available for rent.
In the USA, during the Great Depression, government policies kept the recession going for a decade. The first thing was the maintenance of high wage rates. The Hoover administration believed that it was essential to maintain national purchasing power. In general, prices dropped, and profits were diminished, so the effect of maintaining high wage rates was unemployment. By 1932, twenty-five per cent of the workforce was unemployed. The second initiative was to provide low interest loans and guaranteed prices for agriculture. The result was a surplus of agricultural products. The government responded by providing incentives for farmers to reduce their acreages! The third policy was the Smoot-Hawley Tariff, which encouraged similar protection policies elsewhere and effectively crippled international trade.
Recently, in Venezuela, prices for essential items such as toilet paper, bottled water and condoms, were set so low that they could not be manufactured, delivered and retailed profitably. Consequently, none were available at the government price; limited quantities became available only on the black market.
The most insidious price control of all is the control of wages. Wages are a price like any other; if the price is too high, less labour will be bought.
If an employer is obliged to pay higher than the market rate, then the chances are the job will not exist. If it does, it will be in a marginal business at risk of going broke. Then the job will disappear. That is, fixing minimum wage rates leads to unemployment. The government that regulates wages must inevitably bear the burden of unemployment benefits created by its own policy. Minimum wage rates, whether enforced by government decree or by labour union pressure and compulsion, are useless if they fix wage rates at the market level. But if they try to raise wage rates above the level an unhampered labour market would have determined, they result in permanent unemployment of a greater part of the potential labour force.
Jessica Irvine, writing in The Age (2 Nov. 2017), claims there is no historic evidence for this. But you cannot measure what does not exist; you cannot measure the number of jobs that were not created.
The concept of the minimum wage grew out of the concern that wages needed to be sufficient for a man to provide for his family, in particular food, shelter, education and medical services. A wage needed to be sufficient for the dignity of man. In Australia, in 1907, The Conciliation and Arbitration Court brought down the famous Harvester Judgment, which established the basic wage. This became the foundation for controlled wages for decades. Justice Higgins concluded that a basic wage of 42 shillings ($4.20) per week, or seven shillings per day, for an unskilled man was the minimum amount that he and his family could live on. This was an increase of 6 shillings a week or 17 per cent. Unfortunately, this well-meaning decision misunderstands the interplay of prices in an economy and the consequences for job creation. It is all very well to have a higher wage, but that only applies if you have a job. Also, as wages are the major component of goods and services, higher wages lead to higher prices; a foolish and unending spiral.
Minimum wages and restrictions on the employer’s ability to fire poor performers favour those in work at the expense of those out of work. They dissuade entrepreneurs from creating jobs. They create unemployment and under-employment. They particularly disadvantage the young who miss out on the work experience and training that would qualify them for better jobs. In most Western countries, unemployment among the young is often two to four times the average level. There is substantial evidence that many low wage workers are in relatively high-income households and that poor households are usually poor because members of the households are out of work. Under this view, facilitating jobs growth should take precedence over raising wages of those in work. Minimum wage laws should not be seen as benign. They are a curse. They rob the young of self-esteem, of purpose and of life. They maintain households in poverty.
If we wish to increase wages, then we need a better mechanism. Henry Hazlitt, whose primer Economics in One Lesson is as relevant today as when he wrote it in 1946, explains:
"We cannot distribute more wealth than is created. We cannot in the long-run pay labour as a whole more than it produces. The best way to raise wages, therefore, is to raise marginal labour productivity. This can be done by many methods: by an increase in capital accumulation – i.e. by an increase in the machines with which the workers are aided; by new inventions and improvements; by more efficient management on the part of the employers; by more industriousness and efficiency on the part of workers; by better education and training. The more the individual worker produces, the more he increases the wealth of the whole community. The more he produces, the more his services are worth to consumers, and hence to employers. And the more he is worth to his employers, the more he will be paid. Real wages come out of production, not out of government decrees."
 P. Lewis, Minimum Wages and Employment, Centre for Labour Market Research, October 2006