Market Wage vs. Living Wage
Wages are social conventions. There is no fundamental economic reason why any job has a particular wage, wages should rise with productivity, or the free market should produce enough living wage jobs for everyone.
This is my most important post to date for understanding how automation affects the labor market.
The post on what happened to horses in the face of automation presented an analogy for what will happen to humans. This one explains exactly how automation is impacting the labor market for humans in a unique way today.
Before getting to the implications of automation, it is important to understand in detail how wages are set in a free labor market.
How do employers think about wages?
A little background is necessary to understand the economics of wages. I pondered wages for 6 years while working at PayScale.com.
From an employer’s point of view, a wage can be:
- What the employee’s labor is worth to the employer
- What the employee’s labor would earn from similar employers
- What other employees doing similar jobs at the same company are paid
- What the employee is willing to accept
Except for the case of, e.g., employing one’s own children — I suspect Donald Trump has been overpaying his two sons — in a free market an employer will not pay more than what they estimate the labor is worth to the employer, 1.
The reason for this is clear. If an employer paid all employees more than it could sell the fruits of their labor for, which is how the worth of labor is measured by an employer, the employer would eventually go bankrupt.
PayScale focused on 2., which is the market wage for an employee. This represents what similar employers would pay the worker to do similar jobs, given the skills, abilities, and experiences the worker has.
Most employers consider the market wage a fair wage, because, if they pay substantially below it, their workers likely will leave for another company and higher pay.
The market wage is also the wage that represents the “supply and demand” free market aspect of wages. If a worker is of high worth to employers, 1. is high, and there is a shortage of that kind of worker, wages will be bid up, as different employers compete to hire the worker.
Conversely, if there are plenty of workers to do a job, even if the job is of high worth to the employers, there is no reason for the employers to pay more. The employers will simply take the difference between the low market wage and the high worth as profit.
Case 3, what other employees at the same company are paid, is often motivated by legal considerations. If a company employs 5 engineers doing basically the same job, and one is paid 20% less, and that employee also happens to be the only female engineer, that is a lawsuit waiting to happen.
Paying the similar employees similar wages can also be motivated by a desire to prevent dissatisfaction among employees, if they happen to share their salaries. Finally, paying all employees in similar jobs the same can be the result of a union negotiation.
Case 4, what the employee is willing to accept, is best understood as sometimes employees have reasons to work for an organization that are not financial. The employee is willing to accept wages that are below both the value of their labor to the company and the market wage.
Working at a non-profit is a great example of this. Workers may feel the mission of, e.g., the International Rescue Committee is so important, they will work for the IRC for half what they would earn at a for-profit employer.
In the other direction, some unions traditionally enforced a rigor in workers, sometimes with violence against “scabs”, where all workers in a market refused to accept wages much below what their work was worth to the employer. This increased the workers’ wages to where what the workers were willing to accept, the market wage, and the what the labor was worth to the employers were all about the same.
An example of this was the United Auto Workers union in the heyday of the Big Three auto manufacturers in America. Virtually everyone who could work in any auto manufacturing plant in America agreed not to take less than the high union negotiated wage. The workers captured a high fraction of what their work was worth to the employers as high wages.
Note that unsophisticated employees often think an argument for a raise is, e.g., “my rent has gone up. I can’t afford to pay my bills on these wages. I need a raise.” That reason simply is unimportant to an employer.
Employers generally will not pay an employee more than the market wage (2.) or what the employee is worth to the company (1.), even if that is not sufficient to cover the employee’s expenses.
The employee needs to find a cheaper place to live, or eat ramen noodles.
Living wages and undocumented immigrants
Because all humans doing any job have roughly the same basic needs — food, shelter, medical care, etc. — there is a lower limit on how little any employee is willing to accept. This lower limit is the minimum living wage.
What is that wage? It depends where you live and who you are.
American workers complain about undocumented immigrant workers, because those workers are willing to work for less. An illegal immigrant’s definition of a minimum living wage is simply lower.
An undocumented worker will, e.g., live with five others in a two-bedroom apartment, not own a car, eat beans and rice for most meals, and get only limited health care. This in turn means the minimum living wage for an undocumented worker is lower than for a US citizen, who expects a car, his/her own bedroom, beef every night for dinner, and good healthcare.
Undocumented workers lower the market wage for a job requiring low skill labor, by accepting wages below what a citizen would consider a living wage, when there are plenty of workers willing to do a job.
While undocumented immigrant workers are a factor in suppressing wages for some jobs, they are still humans. They need to eat, be housed, get medical care, etc., like any other human. They need this 12 months a year, year in and year out.
A higher, enforced, minimum wage and legal status would likely be sufficient to stop immigrants from undercutting the wages of American-born citizens.
In any case, if an employer needs a human to do a job, the wage will be at least a minimum living wage. That may be as low as $4,000/year in a third world country, or as high as $20,000/year or more in America.
Simply put, a human could not survive to do the job if the wage were lower. Since this applies across all employers and employees, the market wage is at least a minimum living wage for nearly all workers and jobs.
Substitution and automation
Undocumented workers also do jobs that would not be done if the wages that needed to be paid were higher.
For example, many homeowners have a lawn service because it is cheap. If the workers mowing the lawns were paid $20/hour instead of $7/hour, the service would cost 3X more. Many homeowners would simply mow their own lawns rather than pay the higher price.
This is an example of substitution. At some point, when the cost of labor gets high enough, or an alternative cheap enough, an alternative may be substituted for hiring a worker to do a job.
For the lawn, the homeowner would mow it him/herself, instead of paying someone else to do it. Note that this still involves human labor. It is just no longer paid work, but the worker still needs to eat, have a place to live, etc.
Automation is a substitute for human work that does not have human needs. Let’s look into the lawn mowing example, and consider a robot substitute.
If it took three workers an hour to mow a lawn, the service provided by undocumented workers may charge $30 per week. The price is low, because the service is using undocumented workers. For citizen workers, the price would be more like $90 per week.
Alternatively, the homeowner could buy a robot lawn mower as a substitute for a lawn service. Could a robot be cheaper than a lawn service? Most of the components of a robot mower are about the same as for a non-robot mower: the blades, engine, frame, etc.
Some aspects of a robot mower are cheaper. For example, a large robot mower does not need to carry a human to steer it. Other aspects are more expensive. For example, a robot mower needs computers, sensors, and small motors to steer, adjust the throttle, and apply the brakes.
A good robot lawn mower now costs about $2,000. At $90 per mowing, the living wage for American workers, and $2000 for a robot, a robot lawn mower will pay for itself in about one year.
Given the continuously declining cost of computers and sensors, in a few years a self-driving mower will cost not much more than a self-propelled mower a human steers, or about $500. At this price point, a robot mower pays for itself in less than a year compared to even a lawn service that uses undocumented immigrants.
The robot mower likely will be better than the service. It can mow two or three time a week during the rapid growing season, and infrequently during slow growing season. A human service generally will already have a full schedule of work mowing once per week, so can’t have this flexibility.
There is still human work to be done with a robot lawn mower: setting it up initially at a house, giving it an annual tune up, fixing it when it breaks, etc.
However, most of this work is also present with the mowers the human lawn service uses, so those costs are not lower. These tasks also take far fewer hours of human effort than mowing the lawn takes every week.
There is no doubt that self-driving mowers will eventually become a cheaper option for homeowners than one’s steered by a human, even humans paid well below what most Americans would consider the minimum living wage. This is very close to being a reality in farming already.
The last wave of automation
Automation has been killing jobs, by providing a machine that will do the work for less cost than the minimum living wages for equivalent human workers, for at least 200 years. Shouldn’t we have seen before people who had a market wage for any job below a minimum living wage?
The last wave of automation, the automation that killed farm employment but created manufacturing and service jobs, did permanently create a subset of humans who now have a market wage below a living wage: children, senior citizens, and the mentally disabled.
In the 1800s, all these people, assuming they were physically fit, could earn a living wage working on farms. Even in third-world countries today, these groups are employed side-by-side with all other workers in agriculture.
Why were these people put out of work by automation? They were not capable of doing the jobs the last wave of automation left for humans. They lacked the required cognitive skills.
That wave of automation took nearly all repetitive, low-skilled, cognitive tasks, like milking a cow or pulling seeds from cotton, and did them for lower cost than paying a human a minimum living wage.
This collapse of jobs for these people wasn’t instantaneous. For a while, e.g., children could get jobs in textile mills fixing threads on machines. However, even those simple tasks were eventually automated away.
To get a living wage by the 1940s, a worker needed to read, following instructions, understand relatively complex machines and have the visual and manual acuity to control them. Generally, children, seniors, and the mentally disabled cannot do this.
Of course, there will always be a few simple, repetitive, tasks that need to be done, just as there are still jobs for a few horses to provide power and transportation.
However, whenever a simple, repetitive, task demands large numbers of workers, a machine will be created to automate away the task. The days of there being enough minimum living wage jobs for most children, seniors, and mentally disabled people in America, let alone all, are over.
Fortunately, the greater wealth that came with automation allowed us as a society to create “retirement” for the seniors — they now receive pay without working — and free education through high school for children.
Education both occupied the children’s days and taught them the skills to be “better” than a machine. Parents were also rich enough that they could afford to feed their children, even if their children did no useful work.
John Henry was still screwed, but the kids learned the skills needed to run the steam drill when they became adults.
Why is this time different?
Until about the last 35 years, automation had physical capabilities that far surpassed anything a human could do, but the machines were fundamentally stupid, deaf and blind.
Automation today has cognitive and sensory capabilities that far surpass the most able human for even complex tasks.
With the current wave of automation, like the self-driving mower, many healthy adults with less than a high school degree now have, or soon will have, a market wage below a minimum living wage.
The explosion of men without a high school degree 25–54 who are now not in the workforce — 21% vs. 6% for college grads (Table 2)— is a sign there are not enough living wage jobs these men can do.
In 1955, the percentage of working age men without a high school degree not in the workforce was the same, or slightly lower, than that of college grads. There were living wage jobs for everyone.
The fact automation today is eliminating jobs for low education workers can be fixed by more education, for a while.
Only 30% of Americans have a college degree. Given the graduate rate of some subgroups, like Asian men, it is plausible the college graduation rate could be raised to 60% or so, with sufficient government spending.
There are limits to education.
In the 1820s, no education was required for young adults to get living wage farm jobs. In the 1920s, finishing 8th grade was plenty to get living wage jobs at Ford. By the 1980s, high school was needed for most living wage jobs. Young adults today are beginning to need college degrees to get living wage jobs.
When jobs with skills at the level of a graduate from an average law school can be done by machines, like software that creates a will, a lot of people will find no amount of education will bring them to the point where their market wage is a living wage when they compete against machines.
It has always been the case that automation destroyed jobs. That did not make humans no longer useful, because pretty much every machine needed a human to be its eyes, ears, and brain.
The problem is the latest generation of automation couples the fantastic physical capabilities of machines with an ability to sense and comprehend the environment. Most humans no longer have an unique work skills which are beyond the capabilities of automation.
Even where some jobs remain for humans, if the supply of workers able to do these jobs outstrips the demand, those workers will be forced to live on the minimum living wage, unless there is non-market, government, intervention to pay them more.
Eventually, automation will be a substitute for all of us that is cheaper and better at whatever work we do. If you are a scientist, composer, novelist, artist, or inventor, that time will be a little further in the future for you.
Our growing crisis of declining real wages for many workers is not about illegal immigrants or NAFTA or China. It is about the robots.
This is not about a lack of goods and services. America produces more in total, per person, and per worker, that it ever has in the past, even with the declining workforce participation of men. No one need starve or suffer.
The era in America when the free labor market creates enough good paying, living wage, jobs for everyone who wants one is ending. Machines are substitutes who will work for far less than any human. We need a new mechanism to ensure all Americans participate in the bounty we produce.
Copyright © 2017 by Al Lee. All rights reserved.
