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Why some think legislating for higher wages will always backfire

This opinion article by Australian Chamber of Commerce and Industry chief of policy and advocacy David Alexander was first published in The Australian on Wednesday 23 November 2022.

From time to time different governments around the world will feel frustrated that the wages of their citizens are not high enough, so they reach for the big lever – legislation. This is what the Albanese government is proposing in Australia: “Get wages moving” by changing the law. Force wages negotiations away from enterprises and give government appointees and unions a bigger role.

Legislating for higher incomes sounds so easy. So obvious. Just change the law and watch wages rise. What could possibly go wrong?

Most people haven’t studied economics, but they can sense this solution just sounds a little too magical. If legislating to raise wages is the solution, then let’s legislate for even higher wages. Heck, let’s legislate to engineer super-high wages across the land.

Things obviously don’t work like that. The advocates for legislating higher wages are clearly neglecting to mention some important downsides.

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Let’s take a look at those downsides by stepping through what happens when governments decide to legislate to increase wages.

Here’s what happens in the short term.

Well, some businesses will be forced to put up wages, because that’s what the new system preordains. But other businesses will lay people off because they can’t afford to pay those wages. The loss of those jobs, and the eradication of those wages, are clearly significant downsides.

Businesses have just lost control of a key element of their business, making them less able to adapt to the infinite variety of consumer demands. If your business model was catering for budget-conscious families using lower-cost labour to provide lower-cost products, for example, your business model has just evaporated. This forced inflexibility is an immediate drag on innovation and economic growth.

As time goes on the second-round effects kick in.

The government has just induced a decline in profitability of running businesses, so investment in the economy is going to decline. This is the silent killer.

Businesses give up on their next project, buildings don’t get built, crops don’t get sown, mines don’t get dug, computers don’t get upgraded, research and development dries up, and along with this reduced activity the demand for workers declines.

Reduced investment means fewer jobs created, higher unemployment, and downward pressure on wages. With a crumbling economy even government-mandated wage increases break down over time. The weaker economy becomes the context in which future wage setting is made.

This was the case with countless failed utopian projects throughout the 20th century. One of the striking outcomes of these experiments was that the legislating-higher-wages approach would ultimately end up with lower wages.

The net effect of making the economy less attractive to invest in is to depress wages, notwithstanding what the law says.

The idea that legislating higher wages ends ultimately with lower wages may seem like a paradox, but it really just reflects the unsurprising fact that poorer countries, one way or another, produce poorer wages.

The way forward on wage progress is to set aside magical thinking and focus on the very real channels of growing incomes across the whole population.

Real, substantive wages growth can come from numerous sources, from workers skilling up to attract a wages premium, to innovative companies finding more productive ways to operate.

For government, policy settings need to encourage investment to maximise the “bidding war” for workers that helps drive wages growth. Encouraging investment means keeping tax levels modest, fostering competition, minimising government risks to investment, allowing pay to reflect productivity and creating an environment in which people want to bet on the future in Australia. These sorts of measures are not exciting, and they’re not fast-acting, but they are the tried and true foundations of solid wages growth across the income spectrum.

So far in the debate the government has provided a list of the advantages of legislating to increase wages. The natural next step will be for the government to share with the public the downsides of such a measure. Educating the public about upsides and downsides will enhance the quality of policymaking and minimise the chances of mistakes being made.

David Alexander is chief of policy and advocacy at the Australian Chamber of Commerce and Industry.

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