July 28, 2014

Establishing a Minimum Wage for Contractors

Key materials

The Department of Labor’s (DOL) proposed rule, “Establishing a Minimum Wage for Contractors,”1 is intended to implement Executive Order 13658. The stated purpose of the Executive Order is to increase efficiency and cost savings in work performed by federal contractors by raising the hourly minimum wage that contractors pay their workers.2 The proposed rule establishes standards and procedures for implementing and enforcing the minimum wage protections for federal contractors required by Executive Order 13658.

Review of the research cited in the proposal indicates that the proposed rule is unlikely to achieve its stated goal. The cited research suggests that increased wages do accompany increased productivity. The research does not, however, indicate that the value of the increased productivity exceeds the cost of the increased wage. This comparison is pivotal to the stated purpose of the Executive Order. The proposal suggests that an increased wage causes increased productivity. But the research is either agnostic as to causal direction or indicates that the causality runs in the opposite direction. The direction of causality is pivotal to the estimates of the proposed rule’s benefits; thus, the cited research fails to support the fundamental premise of the proposed rule.

In addition, there are two important unintended consequences of raising the federal contractor minimum wage: first, it can adversely affect the most vulnerable workers; and second, the rule as currently stated could be enforced in a manner so that its impact would extend to far more businesses than originally intended.

DEPARTMENT OF LABOR’S CLAIMS

In seeking to implement Executive Order 13658, the proposed rule states that:

There is evidence that boosting low wages can reduce turnover and absenteeism in the workplace, while also improving moral and incentives for workers, thereby leading to higher productivity overall.3 

The proposal, however, misinterprets the research, inappropriately generalizes results, fails to mention important caveats, attributes gains from other factors to increases in the minimum wage, and fails to take into account tradeoffs or evidence from the marketplace. More importantly, the proposal assumes that higher wages cause greater productivity. This is not a common understanding of the relationship. Standard economic theory maintains that higher productivity causes higher wages.4 Whether and under what circumstances the causality might run in the opposite direction is a matter for empirical study and is not accepted as a general economic rule. 

A. The proposal takes evidence of causality and assumes the reverse causality. 

Highly productive workers, on average, command higher wages than do less productive workers. This is because profit-seeking employers see that highly productive workers can contribute more value, and so they compete for these workers by offering higher wages. Productivity causes wages. While higher wages accompany higher productivity, it does not follow that higher wages cause higher productivity. This reverse-causal assumption underlies the arguments laid out in the proposal, yet is absent from the arguments laid out in the research the proposal cites. 

B. The proposal misapplies the research results. 

The proposed rule states that absenteeism will decline with an increased wage: 

Research shows that absenteeism is negatively correlated with wages, meaning that better-paid workers are absent less frequently (Dionne and Dostie 2007; Pfeifer 2010).5

Dionne and Dostie find that “the use of incentive pay . . . had ambiguous effects on (workplace) absences . . .” The researchers’ primary finding does not involve the effect of pay on productivity but the effect of work arrangements (work-at-home options, reduced work weeks, shift work) on workplace absences. They found no clear evidence that higher wages accompanied greater productivity.6

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