Friday, April 22, 2011

Prevailing Wages

Fred Keller, the newly elected state Representative for the district that contains Susquehanna University, introduced a law almost all economists would support.

Prevailing wage laws are terrible for a couple reasons.  First, they force taxpayers to pay more for services than they would otherwise.  Given all the budget issues we are facing in this country, it is ridiculous to think that we would pay more for services than we have to, yet this is precisely the result you see when you enact prevailing wage laws.

Second, prevailing wage laws are bad for economic efficiency.  That is, the "wrong" person may end up winning the job.  In principles of microeconomics, we learn about how markets are efficient because at the market price, the people who most want to sell the product will sell the product and the people who most want to buy the product will buy the product.  When the government is involved, the way to ensure efficiency is to sell to the vendors who are willing to conduct a task for the lowest price.  When artificially high prices are involved, then it is easy for the job to go to the wrong person. 

For example, suppose 3 people of equal skill are willing to do a job.  They each have an alternative for the day that is worth:

Worker 1: $120
Worker 2: $90
Worker 3: $150

If the government sets the price between $90 and $119, we know the person with the lowest opportunity cost takes the job - worker 2.  This is good!  The other two have outside alternatives that are more valuable. 

However, suppose a prevailing wage law is in place and the government sets the wage at $160.  If this is the case, however, it would be just as likely that workers 1 or 3 would get the job.  This would cost society what is known as producer surplus and result in a "dead weight loss".  Compound that with the fact that taxpayers are paying more and you can see why prevailing wage laws are terrible.

It would be better if these laws were simply eliminated, but I suspect that's not politically feasible at the moment.  The current action, however, is a welcome change.

Kudos to Representative Keller for introducing a law that is good for taxpayers and is good for economic efficiency!

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