The High Wage Economy: the Stephenson critic

A recent trend has emerged in economics. The claim is that high wages can have a dynamic positive effect on market economies.  The intuition is that high wages increase productivity because they incite management to find new techniques of production. In essence, its an argument about efficiency wages: efficiency wages increase incentives to innovate on the part of managers, they can also incite workers to acquire more human capital and work harder and more diligently.

In economic history, this claim has been taken up by scholars like Robert Allen (see his work here for the general public) who argues that the Industrial Revolution took place in England because of high wages. The high-wages of England in the 17th and 18th centuries (relative to all other areas in Europe), together with cheap energy, created an incentive for capital-intensive methods of production (i.e. the industrial revolution). In fact, a great share of the literature on the desirability of high wages for economic development has emanated from the field of economic history.

I have always been skeptical of this argument for two reasons. The first is that efficiency wages is a strange theory that relies on debatable assumptions about labor (strangely, I have been convinced of this point by Austrian scholars like Don Bellante and Pavel Ryksa). The second is that numerous scholars have advanced large criticisms of the underlying data. Robert Allen – the figurehead proponent of the high wage argument – has been constantly criticized by historians like Jane Humphries (see here) for the quality of the data and assumptions used. Allen defends himself on numerous occasions and many of his replies (mainly those on the role of family size in living standards) show that his initial case might have been too conservative (i.e. he is more “correct” than he claims).

Until a year or two ago, I was agnostic on the issue even though I was skeptical. That was until I met Judy Stephenson – a colleague at the London School of Economics. Judy did what I really like to do – dig for data (yes, I am weird like that). She went to the original sources of data used by Allen and others and she looked at what any Law-and-Economics buffs like me like to look at – transaction costs and contracting models.

She recently published her work as a working paper at the LSE and what she found is crucial! Labor was not hired directly, it was hired through contractors who charged costs on the basis of days worked. But this did not translate into wages actually paid to workers. The costs included risks and overheads for contractors. Somewhere between 20% and 30% of the daily costs were not given to workers as wages. Thus, the wage series used to claim that England (Stephenson concentrates on London though) had high wages are actually 20% to 30% below the level often reported. They are also substantially close to those in western Europe.

Thus, the high wage story for England seems weaker. This little piece of historical evidence brought about by Judy is something to think about carefully when one makes the argument that high wages are conducive to growth. Since most of the argument brought to the public was informed largely by this argument in economic history, it makes sense to be cautious when thinking about it in the future.


6 thoughts on “The High Wage Economy: the Stephenson critic

  1. hmmmm good points, Allen’s data is massively problematics, a lot of assumptions are basically wishful-thinking (eg: stable numbers of days worked per year, implying no unemployment ever) BUT there are strong material evidence that whatever the quality of the data collected, the argument of Allen does stand:
    1) people at the time did remark that workers in England/Holland were enjoying higher wages (that’s actually where the fact that the Brits call the French “froggies” come from, as they were so poor that they could not afford beef or pork or poultry and had to settle for frogs). Trade commissions keep saying the same thing on both sides of the Channel (see for instance the response of the Rouen manufacturers to the proposal of free trade with the UK in 1786)
    2) there was a strong current of migration from continental Europe to England/Holland, which does suggest the existence of a pull effect. Actually “suggest” is too weak a word. Offers of employment posted in French newspapers in the 18th century always come with (significantly) higher wages than those posted by the locals.
    3) a much higher number of labour-saving inventions come out of England than out of the continent. An example I rather enjoy comes from the world of painting. Turner, Gainsborough and Constable worked alone and produced relatively small labour-saving pictures, at the same time Canaletto, David and Boucher headed large studios and proposed large labour-intensive works. In a sense, English painters “invented” modern art to solve their man-power issues.
    4) the composition of trade to and from England is also a clear indication that the intuition of Allen is probably correct. Labour-intensive stuff such as silk cloth came in and labour-saving stuff such as machine-made cotton-cloth went out.

    What is weak indeed in Allen’s book is his claim that there is no fuel crisis in Europe in the 18th century, but that is another matter entirely.

  2. That still implies that the cost of labor drives innovation, so the 20-30% contract gap simply shows that reductions in search costs could raise wages and lower costs simultaneously while still incentivizing innovation.

    Furthermore, this is a supply side effect and efficiency wages can have dynamic effects on labor productivity through increased effort, increased focus, increased health, decreased stress and increased work intensity. In fact, efficiency wage + leisure effects are strong enough that a person working 25/wk tends to be more productive, absolutely, than one working 40.

    Capacity utilization in the US is 77% but averages 83%. If we were perfectly competitive, even assuming a positive relation be utilization and depreciation and an inclusion of spare capacity to accommodate that depreciation, the capacity utilization should be 94-96%. Where higher wages do not get siphoned off due to debt, they raise effective demand and capacity utilization. Productivity growth is positively related to utilization due to learning by doing, human capital accumulation and increased competition between producers.

    Higher wages also allow higher investment in children’s education and health, which has long term positive dynamic effects.

    Finally, if financial markets are complete, than wages vs. profits wouldn’t matter, as worker saving would just as effectively fund investment (which is relatively interest rate inelastic!) as entrepreneurial saving.

    Studies on lottery tickets and guaranteed income find that the wage-elasticity of labor is quite low or, at least, labor supply curves are S-shaped. This means that high enough wages push past the second crest and incentivize higher labor force participation.

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