Dear Dr. Dollar:
It’s conventional wisdom that when wages go up, as in the case of a union campaign or minimum wage increase, prices go up. My guess is that if the owners could have raised the prices, they would have already. What is the right answer?
—Jeffrey Trivers, New Orleans
This article is from the May/June 1999 issue of Dollars and Sense: The Magazine of Economic Justice available at http://www.dollarsandsense.org/archives/1999/0599drdollar.html
This article is from the May/June 1999 issue of Dollars & Sense magazine.
This “conventional wisdom” has a long and dishonorable history. In the 19th century, some defenders of the status quo developed theories of why workers could never improve their position. Perhaps the most vulgar expression of this position was Thomas Malthus’ argument that if workers got more wages, they would simply have more children, increasing the supply of labor and forcing wages back down. Others argued a wage increase would simply get passed on as a price increase, leading to no real wage gain and no improvement in workers’ buying power.
Although some economists continually resurrect this argument, it has no foundation in history or theory. Historically, over the last 150 years workers in the U.S. and many other countries achieved real gains in their incomes, gains that outstripped price increases. This is true in spite of the decline in workers’ real wages since the mid-1970s.
The realm of theory also challenges the “conventional wisdom.” When workers of a single employer win wage increases, through union action, for example, the owner is likely to try to recoup the higher costs by raising prices, not by dipping into profits. However, as the question points out (“if the owners could have raised the prices, they would have already”), the owners are constrained by the market. When they raise the price, they cannot sell as much, by the basic “law” of economics that demand falls when prices rise. Owners would lose more profits from sales dropping than they would gain from a price increase, forcing them to bear some of the costs of the wage hike. In general, the more an enterprise holds monopoly power, the more it can pass along the cost of the wage increase to consumers.
Different principles apply to the economy in general than to individual companies. If workers across the economy obtain a wage increase, their rising wages boost consumer demand (since workers are also consumers). With workers’ greater buying power, it might seem employers could charge them higher prices and thereby recoup the cost of wage hikes. Yet workers are not the only buyers in the economy. Companies and their owners are also buyers, accounting for a substantial portion of overall demand; any wage increase lowers their profits and thus their buying power. So overall demand does not increase enough to allow price hikes that would wipe out the original wage gains of workers. Owners are still constrained by the market.
Also, the actions of the government’s monetary authorities, minimum wage policies, and the strength of labor unions all affect employers’ power to raise prices to pay for wage increases. Ultimately, these are matters that depend on the relative political strength of workers and employers (see Dr. Dollar, D&S, March/April 1999).