The living wage may be a fashionable left-wing idea, but we don't actually need it

Ikea, the self-assembly furniture giant, has announced that it will be introducing the living wage next year. Those who campaigned for it are celebrating it as a major victory. And granted, they have won the debate: just about everybody seems to be in favour of the living wage these days. But does that make it good economics?

Let’s go back a few steps. Before the late 19th century, economists struggled with what was later called the "diamond-water paradox": why is water was so cheap, while diamonds are so expensive, even though water is vital, while diamonds are clearly not? They eventually discovered that what mattered was not how much we value a good overall, but how much we value it at the margin: how valuable would one additional unit be, given how much of the good we already have?

If lost in the desert, we would pay any price for a glass of water. But here’s the thing: most of the time, we are not lost in the dessert. Once our thirst is quenched, we use additional units of water for non-vital purposes like watering the garden, and the price of water is determined by how much we value these optional units.

The same is true in other sectors. The first pint of beer is a delight, the second one still very quaffable, while a third one is nice but not indispensable. If pubs want to sell more than one pint to each customer, they have to lower their price to what that last, optional, less quaffable pint is worth to us.

In a sense, supporters of the living wage are still stuck in the old economics of the diamond-water paradox. They argue that cleaners and binmen should be paid a lot more, because society could not function without them. But this confounds the overall value of these professions (which is indeed huge) with their marginal value.

No, we could not imagine a society without cleaners and binmen, just as we could not imagine life without water. But we could imagine a society in which offices are a little bit less clean, and in which the bins are collected a little bit less frequently. This is why minimum wage hikes do lead to negative employment effects, as most of the empirical evidence confirms. Sure, these effects can be masked by other, employment-raising effects elsewhere in the economy, but this does not mean that they are not there.

The standard counterargument is that wage rises pay for themselves, because a better paid employee is also a more motivated, a more loyal and more productive employee. No doubt, this is true for some companies, and Ikea seems to be one of them. But do such companies really need "social justice" campaigners to tell them what would be good for their business? No. My best guess is that Ikea would have done something similar in any case, just without calling it "the Living Wage". My second-best guess is that Ikea wants to earn Brownie points by announcing something that sounds leftish and therefore fashionable, but that they will simply compensate by making plans to hire fewer people over the next few years than they would otherwise have. Companies have done this before.

My argument is not that we should simply accept low wages and low living standards as a "fact of life". But how is the living wage calculated in the first place? Partly with reference to the cost of living, which is, to a very large extent, driven by government policies. Housing costs, in particular, are grossly inflated by our insane planning system. If we could sort out those problems, market wages – especially the lowest ones – would stretch a lot further. It would also raise productivity, thus providing scope for genuine, market-driven increases in the wages of the low-skilled. As ever, proper economics would beat shallow virtue-signalling.