Utopia, you are standing in it!

Living wage activists believe that businesses can profitably pay their low-paid workers a lot more. The living wage pay increase will not jeopardise the survival of the business or jobs because their workers will be more productive because of the living wage increase. Morale will be higher and job turnover will be lower. Both of these will increase productivity perhaps enough to offset the increase in labour costs.

In a nutshell, living wage activists have discovered a hitherto untapped entrepreneurial opportunity for profit. These living wage activists are happy to disclose this secret to lower costs to the world at no fee.

What they are arguing is businesses do not notice a profit opportunity that these political activists have noticed and are now publicising widely. Entrepreneurs are leaving money on the table that could easily be snapped up simply by paying their low-paid employers higher wages.

Source: Mancur Olson (1996) “Distinguished Lecture on Economics in Government: Big Bills Left on the Sidewalk: Why Some Nations Are Rich, and Others Poor.” Journal of Economic Perspectives 3-24.

This money on the table metaphor is similar to the big bills left on the sidewalk metaphor. There is easy money to be had from paying low-paid workers more because these workers will quickly become more productive because of the higher wages.

Living wage activists do not address why entrepreneurs had not discovered this insight into cost saving themselves. After all, every entrepreneur, every employer knows that if they pay more, they will get a better class of job applicant.

Of course, if this insight by the living wage activists is true, all workers should be given a similar increase in their pay because their productivity will go through the roof as well.

Entrepreneurs profit directly from spotting every new opportunity for profit. They have no reason to turn money down particularly when it is obvious and straight under their nose.

The modern theories of the firm focus, in part or in full on reducing opportunistic behaviour, cheating and fraud in employment relationships. The cost of discovering prices and making and enforcing contracts and getting what you pay for are central to Coase’s theory of the firm put forward in 1937.

The profits of entrepreneurs for running a firm is directly linked from their successful policing of the efforts of employees and sub-contractors to ensure the team and each member perform as promised and individual rewards matched individual contributions (Alchian and Demsetz 1972; Barzel 1987). Alchian and Demsetz’s (1972) theory of the firm focused on moral hazard in team production. As they explain:

Two key demands are placed on an economic organization-metering input productivity and metering rewards.

The main rationale in personnel economics from everything ranging from employer funding of retirement pensions to the structure of promotions and executive pay including stock options is around better rewarding self-motivating employees who strive harder and reducing the costs of monitoring employee effort.

Does a higher minimum wage really reduce employment? econ.st/1gp4Jbs http://t.co/WGMZGLKHmI—
The Economist (@EconBizFin) July 30, 2015

At bottom, the efficiency wage hypothesis is entrepreneurs are unaware of the higher quality and greater self-motivation of better paid recruits for vacancies but wise bureaucrats and farsighted politicians notice these gaps in the market. Bureaucrats and politicians notice these gaps in the market before those who gain from superior entrepreneur alertness to hitherto untapped opportunities for profit do so and instead leave that money on the table.