Living wage mandates revisited

Two candidates for the Labour Party leadership have promised that they will require the payment of "living wages" for all government employees and for all government contractors. Matthew Hooton asked about the likely effects.

Were the government promising an $18.40 minimum wage across the board, things would be rather worse. The median hourly wage in the 2012 NZ Income Survey was $20.86. A minimum wage that's 88% of the median wage would be rather, well, breathtaking. Recall the median wage is the one where half of all wage earners earn more and half earn less. Workers vary in ability; a minimum wage at 88% of the median would disemploy anyone who cannot produce value equal to just a bit less than the median worker. This would obviously be very bad. Recall that unemployment weighs far more heavily in disutility than do wages. Chris Dillow made the case a few months ago. Those who want to improve the lot of the working poor do far better by pushing for wage subsidy schemes like Working For Families [New Zealand's EITC] than by making it too expensive to hire lower productivity workers.

The proposal here isn't for an $18.40 minimum wage but rather for a living wage mandate for government workers. The effects then are more minor. Imagine that we have rent control on a bunch of apartments but no rent control on new buildings. We'd then expect excess demand for the rent-controlled flats, but a clearing market elsewhere. Similarly, a living wage mandate in the government sector shouldn't have huge equilibrium unemployment effects. Lots of people queue for jobs in the high-paying sector, but they take lower-paying jobs in the private sector.

The main effect will be an increase in the cost of providing some government services. At the margin, this should mean that we have a few fewer things done by government, albeit within the context of an expansion in the size of government under a future Labour government. There would also then need to be an increase in taxes to fund it, or reduced spending in other areas to compensate, or higher deficits. I suspect Labour would bridge the gap via tax.

There will be some transitional unemployment as marginal jobs undertaken by government get shifted away from the government sector. If some of these workers were earning substantial rents in the government sector and are not employable above the legal minimum wage in the private sector, there could be some increased longer-term unemployment from that. But that shouldn't be any substantial part of the market. There will also be rather a few transitional costs where bureaus start renting fully serviced buildings with gardening and cleaning provided as part of the rent rather than either hiring those kinds of workers directly or through a contractor.

Another important effect: contractors will enjoy less of a cost advantage relative to government departments; we could easily read the policy as a way of trying to knock out contracted services to benefit public sector unions. See my discussion on the same issue when some city councils were talking about similar ideas. Some of my discussion of the likely effects of maximum wage gap mandates in government also apply.

Note as well that government sector workers are already overpaid relative to their private sector counterparts. While this may worsen the imbalance, it means that fewer government workers would be caught in the interval from the minimum to the proposed "living" wage than would be the case among private sector employees. The costs of a living wage mandate may be lower where imposed on the government sector than where imposed broadly. Imagine it in the limit: a $500/hour minimum wage in government. I expect that while government workers would earn a lot more, government would be a much smaller share of the economy. And think of the productivity gains in government: we'd only be choosing to use government rather than markets where we expected the social value of some government function were exceptionally high indeed.  

So while I wouldn't expect large disemployment effects from the policy, it's hardly a great idea. If you want to increase the wages of the working poor, you hardly should be starting with government workers, who earn more on average than those in the private sector and who typically also enjoy greater job security and flexibility. And if you want to run transfers to the working poor, generalised wage subsidies are the least distortionary way of doing it. Labour's proposed mechanism would be likely to reduce the efficiency of government services by pushing away from contracting out, and to skew the optimal balance between government services and other goods and services by increasing public sector costs.

Update: John Key also is no fan of Labour's proposal. He suggests additional costs where aggregate wages are bid up, or at least that's my interpretation of his argument that companies wind up having to pay more and that consumer costs then go up. That's possible within particular labour markets but I have a hard time seeing big aggregate effects.

Let's think of the market for service workers in restaurants. Suppose that the lowest-skilled workers work the cashier's station at the cafeteria in some government office. And let's suppose that this cafeteria continues to exist rather than the venue being leased out to a private sector firm, which it would under a $18.40 living wage mandate. The highest-skilled workers work at the fancy high-end restaurants, or work more complex jobs requiring a lot of balancing of tasks.

The living wage mandate then comes in. Currently employed cafeteria workers then are earning huge rents. Suppose we then have a lot of job applications from higher-skilled restaurant workers and, as consequence, job redefinitions to make better use of the more highly skilled staff. We then have more competition for more highly skilled restaurant staff and could see some bidding up of wages within that market. But there would still be low-skilled cafeterias in the private sector. With migration into that sector from former public sector workers who had been displaced, we could see some bidding down of wages in that part of the market. I can see mechanisms where there's bidding up of private sector wages in some markets, but I'd also expect potential bidding down where lower-tier government workers move back into the private sector. 

The Tiwai Point Subsidy

Matt and Paul have both covered the subsidy to Rio Tinto that facilitated a new contract between RT and Meridian Power. There is not a lot to say about the actual policy; Matt's "Urg" pretty much sums it up. But a few points about the politics of this are worth noting. 

1. There was nothing inherently wrong about the a long-term contract between Meridian and Rio Tinto at favourable rates. I believe that in the past transmission constraints meant that the opportunity cost of power delivered to Rio Tinto was not necessarily the wholesale price elsewhere on the grid. And I also understand that the smelter was drawing power fairly evenly throughout the day rather than mostly at times of peak demand. I stand to be corrected on both those points, and maybe Meridian negotiated poorly in the past, but, absent government subsidies in the past, these were normal commercial transactions that should not colour our opinion about the subsidy announced yesterday. That subsidy should be criticised on its own merits. 
2. It is hard to believe that the decision was not affected by the political capital the government has tied up in its asset sales programme. Again, however, that should not colour our opinions about the policy. The policy would not be any better if it were motivated by different objectives. 
3. Labour are totally on the right side on this one, but it is notable that Clatyon Cosgrove's reaction reported in this Stuff article, framed things entirely in terms of it using taxpayer's money to facilitate the partial sale of Meridian. It would be good to hear a clear statement from Labour that they are opposed to corporate welfare of any kind, and, if it were them, they would have just let Rio Tinto close down the smelter. As it stands, they might be saying that National paid a subsidy for the wrong reasons, but they would have done the same in order to protect jobs in Southland. I haven't seen the news coverage. Has anyone seen if a journalist has put this question to Labour? 

Chasing the Xenophobic Vote?

One piece of evidence perhaps consistent with that that Labour's "dey terk yer house" xenophobic housing policy was in pursuit of votes that otherwise go to NZ First: shortly after Shearer announced it, traders at iPredict downgraded Winston's chances of returning to Parliament.

It's hardly conclusive: it's a pretty thin market. But traders reckoned that Peter's chances of returning to Parliament dropped from about 85% to about 62% on Sunday, 28 July.

And here's the strange part. Q&A, the TVNZ Sunday newsmagazine programme on which Shearer made his announcement, airs at 8:50 a.m. I'm not sure at what time after 8:50 Shearer made his announcement, but the trading on NZ First started at 7:19 Sunday morning, when what looks like a single trader pushed Peters to a 30% chance of returning to Parliament. That returned to 68% later in the day, and since eroded to 54%. So either:

• iPredict's time stamps are a couple hours out;
• Somebody knew what Shearer was going to announce and predicted that it would hurt NZ First - that somebody would most likely be in Labour as the announcement only came on Q&A;
• Something else served as shock to NZ First prices early Sunday morning and that move then stuck, perhaps because of the Shearer announcement, perhaps because of something else.

I don't think iPredict's time stamps are out. I shorted one "NZ First not to be in Parliament after next election" share at 10:35 to check it, and it's reporting that that's the last trade time. So pick one of the other two. 

If somebody in the Labour camp put a few bucks against Peters in anticipation of Shearer's Q&A appearance, that would be interesting.

Thanks to @JohnnySharland for the pointer.

Labour's Housing Policy

I am baffled by the Labour Party proposal to ban foreign speculators from owning houses in New Zealand. O.K. that is not strictly true; as Matt over at TVHE notes, the policy is easy to understand as a cynical appeal to xenophobic New Zealand First voters. But David Shearer is a better person than that, and so I would prefer to remain baffled and try to think through the logic of the proposal.

Consider a very simple model of the New Zealand housing market in which there is a fixed supply of identical houses that will not change over time, and an unchanging demand. Let there be no on-going maintenance or other costs to owning a house, just the one-off capital costs. Finally, let there be a risk-free interest rate of 5%, let demanders be risk-neutral and indifferent between renting and owning for a given cost, and let rental income to a landlord be exempt from tax so that there is no tax advantage to owner-occupied housing. In this world, there would be an unchanging equilibrium rental price for housing over time, and an unchanging price of houses that would be equal to this rental price times 20.

Now change the model a bit. Imagine that demand in one year’s time will double and then stay constant from then on, but that will not be known in the one year before the change. In this world, the equilibrium rental price and the equilibrium house price will both double in one year’s time and current owners of houses (both owner occupiers and landlords) will receive a one-off capital gain at that time.

Now make one more change. Imagine that the future increase in demand becomes known now, but for some reason only known only to people who are not citizens or permanent residents of New Zealand or Australia. In this version of the model, the rental rate would continue to remain constant for a year before doubling, but foreigners would bid up the price of houses now to the point where the capital gain between now and in one-year’s time was sufficient to exactly offset the fact that current rentals are insufficient to cover the capital cost of the house.

Now compare this model to the one where the demand increase was a surprise to everyone. Renters pay exactly the same amount of rent in each period, owner occupiers receive exactly the same capital gain, but can realise it's present value straight away. Foreign speculators receive only the market rate of return on their investments, just like any other inflow of capital that allows New Zealand to fund investment in excess of its saving. The only distributional effect would be a shift in the capital gain from those who would have bought houses during the year before the demand increase to those who would have sold, but there seems no particular reason for policy to favour one of these groups over the other.

In this world, it is hard to see what possible benefit there would be to a policy of banning overseas speculators from owning houses, which is what Labour are proposing. Of course, the assumptions in these three models are extremely unrealistic. So what changes to the model or what welfare function can make sense of this policy? We could relax all the assumptions about indifference between renting and owning, risk neutrality, homogeneity of the housing stock, no tax advantage to owner-occupancy, and no other changes over time, but it wouldn’t change the basic intuition. We could assume that supply is not perfectly elastic, but that would imply that the earlier rise in price from speculation would generate an earlier supply response and hence more housing affordability. And we could assume that, maybe, New Zealanders and Australians know at least as much about the New Zealand housing market as non-Australasians and so can bid up the price of housing without overseas help, in which case banning foreign speculators would have no effect at all.

It is easier to make sense of other parts of Labour’s housing policy. Building 100,000 houses would obviously reduce prices if it added to rather than displaced construction that would otherwise occur, although the policy is silent on how it would find the land on which to build the houses given council zoning restrictions. Similarly, a capital gains tax that excluded the family home, while doing nothing to change supply and demand, would be a way to reduce prices to owner occupiers while increasing prices to renters. Such a policy proposal wouldn’t make much sense from a party representing lower-income households (who are more likely to be renters), but it is perfectly consistent with a party that proposed exempting fresh fruit and vegetables from the GST.

But Labour’s Press release focuses mostly on speculation. The point needs emphasising: speculation that pushes up prices is only profitable if those prices were going to increase anyway for non-speculative reasons. Preventing speculation (if it were possible to do so) only delays the eventual price rise. Doing something about the future price increases by addressing supply constraints would not only be a long-term solution, it would remove the incentive for speculation at the same time. In other words, any politicians whose housing policy consists mainly of an attack on speculation is essentially conceding that they have no long-term solutions at all.