Garrett M. Petersen

My Get-Rich-Slow Scheme

Today I will be dispensing life advice. There’s a certain type of person who will tell you that you should follow your passion regardless of money concerns; to do otherwise would be “selling out.” This is pretty terrible advice. If eating, sleeping, and going to the bathroom are not my passions, should I never do these things? What is it about money (or rather, all the things that exchange for money) that makes it unacceptable to include among one’s goals?

The big problem with this advice is that it is often given to young people. Young people have passions, but they can only be passionate about the things they have experienced at their young age. When I was young, I was passionate about painting. Now I am passionate about economics. If I had taken the oft-repeated advice to “follow my passion,” I would be struggling to make a living as an oil painter. Only by not following my passion was I able to discover a different (and much more remunerative) passion.

Compensating differentials are key. The standard, textbook definition of a compensating differential is a difference in compensation that emerges because of the pleasantness or unpleasantness of a job. People who drain septic tanks earn more than people of similar skill levels because draining septic tanks is unpleasant. People who play in symphony orchestras earn less than people of similar skill levels because playing in an orchestra is neat.

However, the compensating differential as described above presumes that people know how pleasant or unpleasant the jobs are. What would be the compensating differential for a job that everyone thought was unpleasant but that was really quite pleasant? The answer is that the perceived unpleasantness would prevent most people from entering that job, so the people who did enter the job could get both a positive compensating differential and a pleasant work experience. There’s a significant benefit to seeking out such a career!

Here is my advice: Learn what you can about the careers that both pay well and sound unpleasant to most teenagers (hint: many of these careers involve doing math). Discover the one that you find most pleasant. Make that your career.

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How Do We Know (That The Minimum Wage Hurts Workers)?

Airplane Takeoff — One thousand internet points to the commenter who can correctly identify this image!

Here’s a conversation between a reporter and one of the alleged beneficiaries of Seattle airport’s $15/hour minimum wage:

“Are you happy with the $15 wage?” I asked the full-time cleaning lady.

“It sounds good, but it’s not good,” the woman said.

“Why?” I asked.

“I lost my 401k, health insurance, paid holiday, and vacation,” she responded. “No more free food,” she added.

The hotel used to feed her. Now, she has to bring her own food. Also, no overtime, she said. She used to work extra hours and received overtime pay.

What else? I asked.

“I have to pay for parking,” she said.

This may have come as a surprise to some, but not to those of us who are familiar with economic theory. The minimum wage hike here was large and sudden, so the impact was dramatic and visible.

It should be noted, however, that sound economics does not draw causal connections between events (such as a minimum wage hike and a cut in workers’ benefits) because of examples like this one. If A and B happen to coincide, we cannot say whether this was a coincidence, or whether some third event, C, caused both A and B, or whether A and B will continue to coincide outside of the particular context in which they were observed. The thesis that a minimum wage hike will lead to cuts in workers’ benefits where possible rests on a solid, timeless theory derived from known premises about human action and the nature of economic competition.

The unhampered market is a selective process that selects for those entrepreneurial strategies that can generate the highest possible returns. If an entrepreneur directs capital such that his costs exceed his revenues, he must change his approach or face continual losses and eventual bankruptcy. If an entrepreneur directs capital such that his revenues exceed his costs, he can plow his profits back into his business and he can get greater sums from creditors, so he will come to control more capital in the future. The outcome of this process is to move the task of allocating resources from less able hands to more able hands.

Entrepreneurs hire factors of production (including labour) when their expected marginal revenue products exceed their costs. If they didn’t behave in this way, the selective process described above would “retire” them from entrepreneurship. If an entrepreneur expects a return of $12 for an additional hour of cleaning services, and he can hire a cleaner at a wage of $10, he will do so. He will continue to hire cleaning services until his expected return for the next hour of cleaning services falls below $10.

Employee benefits simply fold an additional transaction into this process. Rather than paying for cleaning services and then contracting separately for the cleaner’s parking space (which will often come with additional costs), the entrepreneur can purchase a different service, cleaning services with parking space, the expected marginal revenue product of which will be lower than the expected marginal revenue product of only cleaning services by the cost of providing the parking space. However, since cleaners value parking, they will also accept lower wages when the employer provides parking. If the cleaners are willing to accept a wage cut for parking that is greater than the cost to the employer of providing that parking, both parties can exploit additional gains from trade by contracting with the parking benefit.

Now, consider what happens when the government imposes a price control such as the minimum wage. The minimum wage applies to contracts with and without benefits. Employers provide benefits because, although these benefits cost more to provide, employees are willing to accept wage cuts that are at least equal to the cost of the benefit. At the imposed higher wage, the employee cannot legally accept a wage cut in return for a benefit, so those gains from trade must be foregone.

This is precisely what happened to the worker quoted above. However, since we derived the result from sound economic theory, we can generalize the result beyond this particular worker, beyond this particular wage hike, and far beyond the Seattle airport. We can generalize it to any time and place where people buy and sell factors of production under competitive market pressures.

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