The Upside Down Laffer Curve and the natural price of labor

I previously blogged about how there is a natural price of unskilled labor, which is the amount of money it costs to sustain the laborer and allow him to reproduce and raise children thus maintaining the labor pool. (This is also known as the Iron Law of Wages.)

It therefore follows that when the government gives out benefits to poor people, this means they require less additional money to sustain themselves, so as a result of government benefits wages will decrease.

But I also blogged about the idea of an inheritance dividend in which every adult citizen is given an equal share of government profits such that everyone would be able to sustain themselves without having to work at all. The inheritance dividend would lower that natural price of labor to zero. Does it follow that wages would be reduced to zero? This wouldn’t happen because no one would work for free. Most people assume that the inheritance dividend would raise wages because higher wages would be required to lure people away from enjoying life without work.

I therefore conclude that there is an Upside Down Laffer Curve for labor:

When government benefits increase, wages decline because this lowers the natural price of labor. However, there comes a point where wages reach their minimum level and after that point additional government benefits cause wages to rise because workers don’t see the point of working for such low wages when they’re getting such good benefits.

Examples of benefits on the right side of the Upside Down Laffer Curve are Aid to Families with Dependent Children and Unemployment Insurance. These benefits are so good that people can live off them. If the goal is to encourage people to work and contribute to the economy, than these premium-level benefits provide bad incentives.

On the other hand, benefits to the working poor such as Earned Income Tax Credits and Medicaid are on the left side of the Upside Down Laffer Curve. Government benefits for the working poor are bad policy because they lower the natural price of labor and cause lower wages. The end result is a taxpayer subsidy to employers. This distorts the free market by encouraging an economically inefficient over-reliance on unskilled labor.

Comments

[Brandon Berg]

Why is it inefficient to use all the unskilled labor we have? You seem to be suggesting that the value of unskilled labor is so low that we're better off paying some people to stay home and do nothing.

[michael vassar]

You should know that the "Iron Law of Wages" had long been considered to be economically discredited in the modern world of rapid capital accumulation. It theoretically holds only when the reproductive rate of labor exceeds that of capital. In practice, even then it is only as valid as the
Even in Adam Smith's time, Coal Miners and Coal Haulers were paid 3x-6x the prevailing wage for unskilled clerks and the like. The Iron Law of Wages is a special case of the economic dictum that in a perfect market a commodity is sold for its cost of production. Like all economic dictums, this one is only generally true, and is only true at all respecting the marginal cost of production, not the average cost of production. Also, while labor is fairly commodified, it is not a perfect commodity and the unskilled labor market is quite far from being a perfect market (trivially true from observation of differences in quality of unskilled service in different stores, also suggested by analogy with the skilled labor market and productivity)

[Austrian]

If government would just print enough money to hand out everyone 100K/year, just think how high wages would rise!

[Brandon Berg]

The Iron Law of Wages is a special case of the economic dictum that in a perfect market a commodity is sold for its cost of production.

The problem, of course, is that this is true in the general case only because producers will produce enough of the commodity to eliminate profits. But (modern) people don't decide to have children just because the child will eventually produce slightly more than it consumes. So the Iron Law of Wages specifies only a lower bound, not an upper bound.

[Luke Lea]

Sorry, Sigma, but the so-called "Iron Law of Labor" only applies where Malthus prediction of the pauperization of the laboring classes holds, in places like rural India for instance. In the West, mirable dictu, we accumulated capital which raises the price of labor far above the bare subsistence level. In developed countries wages are set by the average marginal utility of labor (a function of capital deepening) for the particular skill-market and geographical locale concerned, if I am not mistaken. See Samuelson's textbook Economics for the basics here.