IKEA’s “Minimum Wage”

200px-Ikea_logo.svgIKEA has announced it will be raising the “minimum wage” of its US employees to $10.76 per hour, an increase of about 17% from the current minimum. The news comes in the midst of another “national discussion” (often code for anti-economic hysteria) about minimum wage “reform” (always code for an increase).

Economic criticisms of the public minimum wage are readily available, but IKEA’s decision is different. It does have some interesting economic implications, but there are a lot of other issues in this story worth discussing, not the least of which is the language used to report it. That is, I have to wonder why people use the term “minimum wage” to refer to the internal policy of a private firm. Maybe it’s just a convenience of language, but regardless of its true cause, this usage gives a rhetorical advantage to proponents of government-mandated minimum wages.

That is, using “minimum wage” to describe both entrepreneurs’ decisions and government regulation obscures the distinction between them, i.e. that one is chosen by employers and the other forced on them under penalty of law (often through the influence of larger competitors). Using the same term opens the door to falsely conflating policies, making it seem like private and political decision making are the same or similar. If private firms declare their own minimum wages, a government minimum wage loses its distinctiveness, and seems like just another benign entry on a long list of possible wage policies. It’s all too easy—as news outlets reporting this story demonstrate—to compare IKEA’s minimum wage to the federal minimum wage, as if each is just a different but harmless way to improve people’s welfare.

Confusing the language of public and private decisions in turn reinforces the common idea that wages are set at the discretion of business, with high wages due simply to the good nature of employers, and lower wages to greed and disregard for employee well-being. If this were true, it might make sense to consistently increase the minimum wage; after all, we want people to be better off, don’t we?

Language aside, however, economists might criticize IKEA’s decision as a foolish attempt by private firms to imitate public policy; essentially, the company is needlessly giving itself a choice between earning losses and experiencing the usual problems of unemployment and discrimination that result from trying to hold wages artificially high. While there is probably some truth in this kind of criticism, there’s more than one way to think about what IKEA is doing, and why higher wages may not be the end of the world for the furniture giant.

First, remember that minimum wages are most relevant for people earning relatively low wages, e.g. low-skill and teenage workers, so not every job is threatened by raising the minimum. In IKEA’s case, the new policy will leave wages unchanged for about half of its employees in the US.

But what about the other half? Will IKEA be obliged to let a large portion of its workers go? Not necessarily. What matters isn’t the actual wage rates IKEA pays, but the relation between wages and productivity. If wages are indeed higher than the value of the marginal product of labor, IKEA may simply try to squeeze extra productivity out of its workers to compensate—they may even be expecting to do so. This would be one way to mitigate potential negative effects of higher wages.

It’s possible though that raising its “minimum wage” might not have much negative impact on IKEA at all. That is, higher wages—despite whatever motivation is ultimately behind them—might just reflect a changing labor market in the furniture industry.

Consider wages from an entrepreneurial perspective. Remember, economic theory claims that wages tend to equal marginal productivity, not that they actually do in any given time and place. In the real world, entrepreneurs are constantly going through the process of matching wages to productivity, often no easy task. Perfect information about worker productivity (especially future productivity!) is not given to entrepreneurs. Instead, they have to discover it, or more accurately, they anticipate it and pay wages accordingly. The pricing of labor therefore includes speculation and trial-and-error, involving a never-ending process of entrepreneurial appraisal and judgment. Over time, wages will adjust to equal marginal productivity, but it’s difficult to know how accurate an entrepreneur’s judgments are at any given time. Furthermore, the data of the market are constantly changing, requiring entrepreneurs to start their appraisals anew.

Returning to IKEA, it’s not immediately clear whether their employees are already earning wages equal to their marginal productivity. It’s possible, for instance, that the firm has been under-pricing labor due to entrepreneurial error, and that higher wages will more closely reflect the value workers are providing to consumers. If this is the case, increasing the “minimum wage” might be just another way for IKEA to recognize their workers are more valuable than previously thought. In other words, there are many ways for entrepreneurs to adjust to new information and changing markets, and a wage policy like IKEA’s may be one of them.

Now, an added complication is that IKEA plans not simply to raise wages, but to link them to calculations of a “living wage.” Given that changes in the cost of living are not directly related to the productivity of IKEA employees, it seems impossible that fluctuating wages would even roughly match actual productivity. Assuming the company can’t find a way to coordinate changes in the living wage with employee productivity, indexing wages does seem like the kind of decision that will hurt IKEA over time. Still, if it does turn out to be a strategic error, the burden will fall on IKEA, which will be able to change its wage policy if necessary, unlike employers subject to government minimum wages.

Comments

  1. Could there be a link between the aforementioned Entrepreneurial process of matching wages to marginal productivity through the ‘living wage’ calculation? If IKEA discovered that over a period of time they were consistently under-paying employee’s due to an error in their wage determination process. Would it be feasible for them to look for an addition metric from which to tweak wages? Could this metric in fact be the ‘living wage’? Lastly, whom is determining the exact definition of ‘living wage’? If the determining agency(?) isn’t governmental but a group studying wages across the furniture wage record. Would this living wage still be considered a negative?

    That is a lot of questions that I hope someone puts an answer to at least a few.

    • Lee,

      Good questions. Yes, it’s conceivable that IKEA might use, say, increases in a living wage index as a proxy for its errors. The big question would be whether there is any reason to think that changes to the living wage would actually reflect IKEA’s underestimations of productivity. That’s not impossible, but it seems unlikely that the two would be similar over any length of time.

      As for calculating the living wage, there are different ways to do it, but the calculator I linked to is run by MIT. But regardless of who calculates the wage, it’s not necessarily a “bad” concept in and of itself. It’s just that it has to be understood in the context of worker productivity and entrepreneurial calculation. The trouble only arises if the living wage and marginal productivity are not the same, but people nevertheless insist that people be paid the living wage anyway. If the living wage becomes enshrined in law, for instance, then the conventional problems of the minimum wage arise.

  2. It would seem that IKEA is looking to gain favorability in the general public to drive more sales. This wage increase could just as logically be a prelude to raising prices at IKEA, with the expectation that the PR benefits coming from being a “socially responsible” company will lead people to continue shopping at IKEA, even if it costs more. Ultimately, wage increases are passed on to the final consumer.

  3. Seems like a PR stunt to cloak a move they’ve been planning, anyway. One reason why wages in a firm might not be sufficient to compensate workers due to entrepreneurial error is QE and the fact that inflation is understated.

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