Benefits Vs. Capital

Spencer writes the following in the comments to my post about monopsony and the minimum wage:

“If wages increase, the employer would want to increase workers productivity normally that would entail improved working conditions.

But you are claiming that employers react to higher wages by implementing policies that reduce productivity — that does not make any sense and is contrary to economic theory.”

I want to make a clear distinction between benefits and capital. Benefits are things that the employer provides that make workers happier to work for that employer, ceteris paribus. Capital is what the employer provides to make each worker more productive.

The reason employers provide benefits (above those legally mandated) is because their employees implicitly pay for them by taking a pay cut. People must be paid more to do more unpleasant work, and less to do less unpleasant work, so investments employers make to make working for them less unpleasant are implicitly paid for through lower wages.

As Spencer suggests, economic theory does predict that a binding minimum wage will lead firms to shift away from low-skilled labour and into other factors of production, including capital. This will make those low-skilled workers still employed at the higher wage more productive, such that their marginal product is at least as high as the minimum wage. My claim is that a binding minimum wage leads employers to provide fewer benefits than they otherwise would.

Often, the same thing can function as both a benefit and a capital investment. Modern garbage trucks allow garbage men to pick up garbage faster, but they also make the job less unpleasant by minimizing the amount of garbage the garbage men actually handle. If I were running a private garbage-pickup service (are there any?), my choice to invest in a modern garbage truck would depend both on how much more productive it would make my workers and on how much it would reduce the cost of hiring and retaining workers. If the truck costs $200,000, the extra productivity it generates is $150,000, and the decreased unpleasantness is worth $60,000* to the workers, then I would buy the truck. That would allow me attract and retain workers for $60,000 less, and I would net $10,000 in additional profits.

If, however, the workers were subject to a price floor on wages that would not allow them to accept a pay cut greater than $40,000, I would not consider the other $20,000 of value created for the workers, and I would not invest in that particular truck, as it would earn me a net loss of $10,000.

Worker training can also function as either a capital investment or a benefit (from the firm’s perspective). The distinction economic theory makes is between firm-specific human capital investments and non-firm-specific human capital investments. The firm captures workers’ productivity gains from firm-specific human capital investments, because a worker who knows all the ins and outs of working at firm A but cannot transfer his skills to firm B has a low reservation wage and therefore a poor bargaining position. Firm B would pay him the wage of an unskilled worker, so firm A doesn’t have to pay him more than that to retain his services. However, if the worker gains skills that would serve him equally well at A or B, then he can use those skills to negotiate a higher wage for himself.

Thus, training a worker with non-firm-specific skills is a benefit from the firm’s perspective, as the worker will capture his additional productivity through higher wages. So workers must pay for non-firm-specific training through implicitly lower wages. If wages cannot be lowered below a price floor, then the worker cannot buy the training.** This means that we can’t theoretically predict whether the minimum wage will increase or decrease the total amount of worker training, as we would expect firms to offer more firm-specific training per worker and less non-firm-specific training.

While the minimum wage is a price floor on wages, it is also an implicit price ceiling on benefits. The most a worker can implicitly spend*** on benefits from his employer is his marginal product minus the minimum wage, unless he is willing to take his entire compensation in benefits, in which case he can get an unpaid internship or volunteer position. Few poor people can afford to work unpaid internships, so the minimum wage is more damaging to them than it is to people from wealthier families.


* That $60,000 figure is a future-discounted stream summed across all garbage men.

** The worker could contractually agree to continue working at a low wage for a period of time after training has increased his productivity as a way of paying for the training. This could mitigate the negative effect of the minimum wage, but such contracts come with their own difficulties and risks.

*** I suppose they could get around the minimum wage by changing the payment from an implicit wage cut to an explicit payment, but there are obvious pitfalls to doing so. Imagine the headlines: “Walmart charges employees for training!”