Small Raise per Worker Goes a Long Way

More than one-third of Los Angeles County’s labor force--2.4 million working people--earn an average of $5.64 an hour for a 33-hour work week. At about $9,300 a year, the earnings of these low-wage workers place them below the national poverty line for a family of two.

The Los Angeles City Council is debating a “living wage” ordinance that seeks to ameliorate low-wage poverty through establishing a minimum wage of $7.50 an hour plus health benefits for employees of city contractors, subcontractors, concessionaires and subsidy recipients. Thousands of workers will receive a substantial raise if the City Council passes this ordinance. But would the living wage ordinance actually reduce poverty? The answer is not obvious.

Critics believe that the ordinance would place severe strains on the city’s already overstretched budget, perhaps forcing painful cuts in other city efforts that benefit lower-income families. Critics also claim that the ordinance would discourage firms from locating in L.A., which in turn would increase unemployment and poverty. Are these criticisms valid?

Several colleagues and I have written a study addressing these questions. We estimate that under a broad interpretation of the measure, the living wage ordinance would bring an average of about $3,700 a year in higher pretax income to as many as 11,000 working people, their families and communities, which translates to a total increase in wages to the working poor of nearly $40 million. The council is also considering a narrower measure, which would reduce the total wage gains to $20 million or less. In either case, these higher wage costs would be readily diffused among the approximately 850 firms that do business with the city because the total annual spending of these firms is roughly $4 billion. Even with the broad measure, the ordinance would impose cost increases for the average affected firm of about 1% of total spending.

Most affected firms would be willing to absorb these costs. Some may not, but competitors seeking the same contracts likely would step into the breach. Through intelligent bargaining, the city could purchase the same quality of services with absolutely zero impact on the city budget.

Assuming a broad ordinance, cost increases for about 15% of the affected firms will exceed 1% of their spending. The city should expect to absorb a share of the increased costs. But even if the city allowed firms to pass through all cost increases above 3%, the costs to the city would amount to approximately $7.5 million or 0.2% of the city’s $3.4 billion annual budget.

Yet even these calculations significantly overstate the impact of the living wage on both the city budget and the affected firms. This is because the living wage would be phased in over several years, when existing contracts terminate and new ones are put out to bid. As a result, for both the city and the affected firms, the net annual increase due to the living wage would be insignificant.

Efficient firms will not flee the city due to these new costs. Nothing in the ordinance encourages this. The same rules for city contracting would apply to firms whether they are located in Los Angeles, Santa Monica, San Diego or Denver. More important, many companies in L.A. already pay their workers a living wage and still compete successfully, because they operate with much lower turnover and higher morale. Implementing the living wage ordinance will encourage more firms to operate along this high efficiency/high morale path.

The cruelest pitfalls in economic policy making result from the “law of unintended consequences,” doing harm while seeking to do good. A well-designed living wage ordinance would avoid such pitfalls. It would bring substantial benefits to a relatively small but still significant number of working people, their families and communities, while costs are spread widely enough so that they are negligible both for any individual firm and for the city.