Canadian governments have long regulated ‘minimum’ wage by setting a wage rate below which employers and employees cannot agree. The theory is that this intervention in the ‘free market’ and ‘free’ bargaining is necessary because of the vast inequality of bargaining power between employee and employer and the fact that Canadians want a certain standard of living. The minimum wage is a direct admission by governments that unregulated labour markets produce inappropriately low wages.
But should governments regulate ‘maximum’ wages? This question is raised by President Obama’s tirade yesterday against bonuses being paid at AIG, an investment company that performed so abysmally last year that the company needed to come begging to the government for bailouts. Yet the company is still planning on paying out $165 million to the boneheads that led the company into this mess. The government has asked the company to provide it with the employment contracts and to tell it who negotiated the contracts, as if the very negotiation of employment contracts is suspicious. The government is now a majority owner of AIG, so it has a special interest here.
But the point is that wages negotiated in the ‘free’ market are suspect and when too high, the government should intervene and cut them. Presumably, if an employee is able to bargain a wage so high that the government is concerned about it, inequality of bargaining power is not the problem. So what other interest would justify a legislated ‘maximum wage’? Some have argued that executive pay should be tied to the pay of the lowest compensated employee in the form of a ratio as a way of closing the gap between the rich and the poor. (I discussed these arguments a while back) Do you agree with that form of regulation?
A market economist would presumably argue that the employee is worth what the market says he is worth, so that the idea of legislated ‘maximum wage’ is nonsense. Moreover, they would argue that capping pay creates ineffective incentives that will drive away the ‘best and the brightest’. For example, here is what Justice Richard Posner has to say about the executive caps Obama supports. Note that, at the end, he does concede that it is possible for executives to be ‘overpaid’:
All this said, I don’t deny that there is such a thing as executive overcompensation, owing to the weak incentives of boards of directors to police compensation. But that’s a long-term problem, rather than anything to do with fighting a depression.
So, if even Posner agrees the market sometimes fails by permitting overcompensation, what should the state do about this?