Do Employers Exploit Workers with Low Wages?

It is a well-known “fact,” at least amongst my undergraduate students, that employers seek to exploit their workers by paying the lowest wage possible. This “fact” serves as the basis for much of the support for minimum wage policy; if businesses are trying to increase profit, they will obviously pay the lowest amount to their laborers and only government can step in to set a just wage.

The problem is that this reasoning does not hold up to scrutiny if one thinks about the opportunity costs available to labor and the actual fact that employers give their workers raises on a regular basis.

Allow me to explain with a simple example.

I Think I would Be a Great Bartender

As retirement nears, I have started contemplating what I would do with my free time. Sitting on the porch of a remote log cabin in the mountains sounds lovely, but I know this would lead to boredom. Interacting with people sounds more enticing and I’ve often thought that I would make a wonderful bartender. I’m gregarious, love meeting new people, and know my alcohol well.

Given that I have saved a solid nest egg, being paid for my bartending services would not be a high priority, but I wouldn’t mind earning a few extra dollars for the little pleasantries in life such as buying flowers for my wife. With that in mind, I told a recent group of seminar students that I would be happy to bartend at our local tavern for $5 per hour, well below the current minimum wage of $13.69 in Washington State. (Washington is one of the few states that does not have a sub-minimum wage for tipped employees.) Putting in a six-hour shift when the tavern is slow would net me $30, which would translate into a nice bouquet of roses.

I asked my students if the tavern owner would be willing to hire me for $5 per hour, assuming away the legal requirement that he would have to pay minimum wage. (I might agree to be paid in cash “under the table,” all the better for the owner because he wouldn’t have to pay FICA, health insurance, or other fees.) My students agreed that the owner would jump at this opportunity. Prof. Gill is gregarious and his willingness to work for low pay would make it easier for the employer to sideline a higher paid employee or negotiate their wages down.

Unfortunately, I had to tell them that they were wrong. The tavern owner probably wouldn’t hire me in lieu of a higher paid worker. The reason relates to opportunity costs.

Opportunity Costs Make Me a Potentially Horrible Bartender

If I were making $5 per hour for a six-hour shift on Monday night, I would earn $30. However, given that I have retirement income and that the $30 represents pocket change, any time that another opportunity worth more than $30 arises, I would have a strong incentive to skip work. If I needed to babysit my grandchildren on quick notice, or if my buddies asked me to join in a poker game, I might very well decide that I don’t need the $30 that night and would call in sick.

In other words, my relatively low opportunity costs – i.e., the value of my next best option – means that I may be a very unreliable employee. If I find it worth my time to skip work, I will impose a cost on the owner to find somebody to cover my shift at the last moment. If this is not possible, he may have to end up tending bar himself or even closing early for the evening, which could cost them dearly in lost business.

It would behoove the owner to pay me a higher wage so as to affect my decision to show up given my opportunity costs. If I were making $10 per hour (and hence $60 for a six-hour shift), I might hesitate a bit more before agreeing to babysit or join in the poker game.

Even at this higher rate, it might be more attractive to hire somebody in their mid-20s at $15 per hour because their opportunity costs of calling in sick are much higher than mine, and hence they are more likely to show up for work on a regular basis. Younger employees need the money more than I do; their opportunity costs for skipping work are significantly higher than mine. Not only does the money for that night matter, but younger employees will want to avoid being fired if they don’t show up. Thus, a higher-paid, younger employee in this situation would make a more reliable worker than I would, ceteris paribus. (Of course, other things influence reliability, hence the ceteris paribus clause.)

This, by the way, is why employers give reliable employees raises.

Raises Raise Your Opportunity Costs

That employers routinely give their low-wage employees regular raises is another fact that confounds my students’ belief that businesses are out to exploit their workers. I ask them, “How many of you have worked a low wage job and have received a raise after a few weeks or months?” Many hands go up. “And did you ask for that raise?” The response is usually that they did not ask for it, or they knew that after a certain amount of time on the job they would be rewarded with higher pay.

Then how is that exploitation? And how does this fit with the narrative that businesses always seek to keep wages low? Your employer is voluntarily increasing your income! At this point, I can see minds starting to change.

I further press this point by telling students that one of my favorite college jobs was working at a pizza joint for a starting wage of $3.25 per hour in the early 1980s. Admittedly, I was horrible my first month on the job. I constantly screwed up orders and burnt more than a few dozen pies. Indeed, for at least the first month on the job, I probably cost my employer more than my measly wage because of my initial incompetence. Nonetheless, I showed up on time and learned from my mistakes, something that my boss appreciated.

One day, my boss informed me that I would get 25 cents more per hour because he wanted me to stay on the job. Turnover in the restaurant industry is notoriously high as the work is often unpleasant and many see it as a quick stepping-stone to better employment. Plus, many teens would rather hang out with their friends, which is their opportunity cost.

Having to train new employees is costly. My boss realized that as I became more skilled, I had an incentive to move to another, higher-end restaurant that paid better. To prevent that, he needed to affect my opportunity costs by offering a higher wage. It worked, and I appreciated the signal that I was a valued employee. As I improved my pizza-making skills I received regular raises and was one of a group of employees that remained on staff for several years.

Minimum Wage, Raises, and Opportunity Costs

One of the problems with increasing the minimum wage is that it diminishes the ability to reward employees on a regular basis and keep them on staff. As noted above with my personal experience, new employees often cost more to the employer than the value they initially produce. This is because of the time it takes to hire and train a new employee combined with all the mistakes a newbie is likely to make.

Providing a raise to an employee not only changes the employee’s opportunity costs with respect to other job prospects, but it also provides encouragement to a worker for a job well done. While “encouragement” is a hard variable to measure in econometric analyses of employment, it nonetheless exists. There is value in working for an employer that routinely rewards improvement on the job. I could have left for a higher paying job (and did work for more cash unloading semis third shift prior to the pizza gig), but the continued recognition of my effort made me feel valuable. (By the way, I left the third-shift job because it affected my college grades, an opportunity cost that I could not afford.)

Unfortunately, higher minimum wages make it difficult for employers to offer such raises (and encouragement) early in the work tenure. A new employee who was hired at $10 per hour can more quickly get their marginal productivity to that wage rate than one who had to be hired at $15 per hour. The added time to improve one’s marginal productivity to make it to the higher level means a longer time to that first raise and, not surprisingly, greater frustration for not getting positive financial feedback to one’s efforts to improve. Moreover, if I know a wage increase is not forthcoming because I’m already paid a higher wage, I have less incentive to improve my skills in a timely manner. Government policy to set wages at some arbitrarily “just” level may only be making the employer-employee relationship worse in the long run and fueling the belief that wage labor is exploitative.

A Good Tip for Employers and Employees

The bottom line is that any business worth working for will be sensitive to the opportunity costs of their best employees and will reward them accordingly. Employers that consistently keep wages low for their best workers will see them abandon ship quickly. This will not only cost the business in terms of having to train new workers, but will also affect their ability to deliver quality customer service. Such businesses tend to get weeded out of the marketplace, as they should.

Maybe someday in retirement you will see me behind a bar. You can rest assured that I enjoy being there and am not being exploited. I might even be paid pretty well, all things considered.

Oh, and don’t forget to leave a gratuity for good service.

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