Would Paying a McDonalds Worker Significantly More, be Bad for the Economy?

Misconceptions Among Conservatives About How a Free Market Economy Works

Recently I was discussing with an American conservative, the fact that e.g. McDonalds salaries are significantly higher in Norway than in the US. At current exchange rate it is around $20, but usually it has been around $25.

High salaries on the other hand are more similar to the US. For professions such as lawyers and surgeons it can be a lot less.

The conservative charged that paying a McDonalds worker that much was not only more than he/she was worth, but also bad for the economy, as it caused misallocation of resources and hence lower productivity.

I think that was a great starting point to talk about several misconceptions people have about how a free market economy works.

The implication by the conservative is that somehow what the McDonalds worker is paid in the US, around $10 is the true value of their work. The further implication is that in Norway the worker is paid twice his worth.

But that is a gross misunderstanding of how a market economy works.

No job has an inherent value in a market economy. Rather the wage is determined by supply and demand.

This is affected by the strength of the negotiating parties. E.g. if a good is sold in a market where there is only one buyer and many sellers, then the price will drop due to the advantages negotiation position of the single buyer. This happens at a more granular level. Hence when there are a few big buyers and many smaller sellers they price will be lower than if there was many smaller buyers. That is why a whole-seller can buy for cheaper. So there are several factors deciding the price:

  1. The number of units of the goods and service actually in demand and supply.
  2. The average quantity bought or sold by each buyer and seller.
  3. The desperation of the seller or buyer. E.g. does the seller have cash to wait with selling or do they need cash immediately?

Every market is different. The Norwegian labour market is not the same as the American one. The type of work in demand and the type of workers in supply is different. The situation of each worker and company is different. The preferences of consumers is different.

So what explains these price differences? If the price of McDonalds workers is higher it must mean that either the demand for fast food is much higher or the supply of fast food workers is much lower.

Alternatively the negotiation position is different. Remember how the size of buyer or seller, shifts the price in their favor. Likewise a desperate seller will reduce the price while a desperate buyer will increase it.

In Norway there is an easy and cheap access to quality education, which reduces the pool of unskilled labour. Hence this must cause the price of unskilled labour to go up.

The US in contrast has among the most expensive educations in the western world, which means a reduction in skilled workers, and hence a higher supply of unskilled workers, thus pushing down the price of unskilled work.

In Norway almost 80% of the population is organized in various unions. This is the result of laws and regulations which protects the unionization rights of workers. In contrast in the US, laws protecting unionization rights are quite weak and often hostile. Some states e.g. ban unionization of public sector workers. Union busting tactics is widely accepted and has little consequence.

This means the typical low skilled worker in Norway has a much stronger negotiation position when determining salary.

It is worth remarking that there is nothing anti-market about unions. The father of free market economics, Adam Smith favored unions on the grounds that they would push wages closer to the real market value of the work. That was based on his observation that business frequently colluded in various ways to artificially depress salaries below market value. Examples of this abound even today. One of the latest was how Silicon Valley companies made secret agreements to not poach each others workers.

Desperation affect the salary you are willing to accept. In the US poverty is a far more significant problem than in Norway. Welfare benefits are harder to access and lower. This means many workers have no choice but to accept low salaries. Their poverty and lack of alternatives gives them a very poor negotiation position.

In Norway starving or being without accommodations is exceedingly rare. Unemployment benefits are generous enough that when you are between jobs you don’t have the same desperation and urgency to take any job that appears.

Ever since the post war years full employment has been one of the highest priorities in Norwegian politics. The labour party, which had dominated politics for many decades has had that as their number one priority since they were formed.

Consequently unemployment numbers in Norway has usually been around 3–4%

To get as many people in work as possible, the government has always spent a lot of money on retraining unemployed workers. The US spends almost no money on this and makes it the responsibility of individual workers.

Hence by keeping unemployment low, you push up wages. This is well known. We see frequently in the US how the stock market reacts very negative when employment number get low. They know that means wages go up, which they consider bad for business.

High wages is more of an accepted reality in Norway.

Say we kept increasing the salary of McDonalds workers until it had significant changes. What would happen?

An assumption by the conservative I talked to was that this would cause misallocation of resources and cause inefficiencies.

Typically when salaries increase, two things will happen: The the price of the product sold will increase, but not by as much as the salaries are increased. Instead owners typically also take a hit on their profits because they want to stay competitive.

That causes some more equal distribution of income between capital owners and wage laborers. You see some drop in inequality. Higher prices lead to lower demand. That means fewer people will buy hamburgers. Ultimately that means some burger joints have to close down or hire fewer people.

Money spent on McDonalds workers and investing in a McDonalds restaurant will have to be invested elsewhere. That investment will have to go into something else people are willing to pay for. When consumers are buying fewer hamburgers, they have money to spare for buying other products.

That, something-else, is what the capitalists have to invest in instead. Hence we aren’t really getting less stuff or fewer workers. We are just getting different things and people employed in different professions.

What you can’t claim from this observation is that it causes misallocation of resources. The significant amount of capital allocated to fast food in America is hardly good allocation. People need to eat less fast food, not more, especially given the epidemic of obesity in America.

Fast food is not an efficient industry. It is highly labour intensive which means efficiency is low. Somebody working in a factory e.g. produce far more stuff per time unit and this production typically increases over time as techniques and automation improves. The efficiency gains in fast food in contrast are very minor.

This means that if large parts of working population was employed in the equivalent of fast food, then the economy would be almost stagnant, because it is almost impossible to create a significant increase in output per McDonalds workers over time.

Hence there is no reason to believe moving capital out of the fast food industry is causing a loss in efficiency in the economy.

What I suspect the conservative I spoke to had misunderstood is the way economists talk about efficiency with respect to taxation in the economy. Economists have a very narrow definition of efficiency, which basically means that resources are allocated exactly to the preferences of consumers.

The idea is that in any economy we have limited resources. How to we distribute the limited resources in the most optimal way. The Econ 101 answer is that we do it according to supply and demand and we assume what people demand is what is best for them.

Reality of course is not like an introductory text book to economics, as I’ve discussed repeatedly in the failures of capitalism series:

So efficiency doesn’t fall because you increase the salaries of McDonald jobs, unless these are somehow replaced by jobs which are even harder to increase the efficiency of.

The most obvious counterpoint to these discussion that people bring up is unemployment. But one can not simply concluded that reducing one type of employment causes overall unemployment to rise. The rich had to fire their armies of servants starting with the late 1800s and early 1900s. We still manage to employ most people despite all those jobs lost.

Unemployment happens when McDonalds workers are fired and the new companies or services created require skills they don’t possess. You get structural unemployment. Any rapid change in the makeup of an economy will cause people to not re-adjust fast enough.

This problem is also exacerbated in societies which don’t focus on skill development and retraining of workers.

In principle the capital not used on McDonalds restaurants could be used to create industries with higher efficiencies and thus better pay for workers.

Written by

Geek dad, living in Oslo, Norway with passion for UX, Julia programming, science, teaching, reading and writing.

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