More on the General Effect of Welfare on Wages – Cafe Hayek

Source: More on the General Effect of Welfare on Wages – Cafe Hayek

An answer to the “Walmart Welfare Subsidy” argument.

Here’s a follow-up letter to a correspondent who continues to insist that welfare payments reduce the wages of low-income workers:

Mr. Chris Indovino

Mr. Indovino:

You’re unconvinced by the argument that government welfare payments generally reduce the supply of labor and, thus, cause the wages paid to low-income workers to rise. You write that “if taxpayers are footing a portion of the bill for poor workers to feed and clothe their families employers can get by by paying less to workers on welfare.”

Before I try again to convince you that you’re mistaken, let me acknowledge that there is one form of government welfare in the U.S. that does reduce poor-workers’ wages. That’s the Earned Income Tax Credit (EITC). Because one must work to be eligible to receive the EITC, this program increases the supply of labor and, thus, causes wages to fall. But the typical government welfare program, for which non-workers as well as workers are eligible, reduces the supply of labor and, thus, causes wages to rise.

Here’s why. Suppose you win a billion dollars in a lottery. What happens to your willingness to continue working at your current job? According to the logic expressed in your e-mail, you should now be willing to work for nothing, given that your lottery winnings are now sufficient to pay all of your expenses. But of course you will instead almost surely quit your current job. And if your employer wants to persuade you not to quit, he’ll have to offer you a much higher wage in order to make it worth your while to continue working. (Imagine how you’d react if your employer said to you “I want you to keep working and accept a pay cut to $0 per hour. I don’t have to pay you anything now because your lottery winnings cover all of your expenses.”) Winning the lottery, by reducing the supply of your labor, raises the wage that you must be paid in order to work.

Please don’t mistake me as equating government welfare payments for lottery winnings. They’re obviously different. But they both do reduce the supply of labor and, therefore, they both put upward pressure on the wages that employers must pay to recipient workers. The lottery example is a way of showing that workers do not reduce their wage demands simply because some of their expenses are covered out of non-wage income.

Sincerely,
Donald J. Boudreaux
Professor of Economics

This is a follow-up to a previous letter:

Mr. Chris Indovino

Mr. Indovino:

I did indeed read Scot Phelps’s Wall Street Journal letter in which he argues that government subsidization of low-skilled workers’ “housing, food, medical care, and transportation” enables employers of such workers to pay them less than their “true” value. I didn’t respond to it because I had nothing to say about such an economically unmoored argument that I’ve not said in the past. (See also this EconLog post by my colleague Bryan Caplan.) The central economic point is this: the welfare programs to which Mr. Phelps alludes (with the possible exception of transportation subsidies) reduce the supply of labor and, thus, push wages up. Far from employers being subsidized by such welfare programs, employers of workers who receive these government benefits are obliged, as a result, to pay wages that are made artificially high.

But to show just how deeply confused this Mr. Phelps is, let’s pretend that he’s correct to insist that welfare programs artificially reduce wages. Mr. Phelps then asserts that “Failure to pay a living wage gives consumers artificially low prices and increases corporate profits.” Because nearly all employers of low-skilled workers operate in intensely competitive industries such as retail and food service, workers’ artificially low wages would indeed result in artificially low prices for consumer goods, but not in increased corporate profits. The ability to hire workers at artificially low wages would attract new entrants into these markets, as well as cause existing firms to expand their outputs, until the rate of profit earned by employers of these workers is no higher than it would be if wages were higher. That Mr. Phelps is oblivious to this reality is sufficient reason to dismiss his economic analysis.

Sincerely,
Donald J. Boudreaux
Professor of Economics

As a commenter noted, welfare doesn’t subsidize work, it competes with it.

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