Schansberg: ‘Who Prevails with the Prevailing Wage?

July 16, 2013

by Eric Schansberg, Ph.D.

A prevailing wage is a legal arrangement to set minimum compensation (wages and benefits) in public-sector construction at rates above where market participants (demand and supply) would otherwise reach equilibrium.

As always, the basic choice is between markets and government; we either allow people to do what they want — or not. And as always, there are both ethical and practical considerations. Ethically, one should ask how this could be a role for government. Practically, how will the law work in practice?

Prevailing wages (or “common wages”) are state and local versions of the 1931 federal Davis-Bacon Act. They exist in 32 states, including Indiana and all surrounding states. They are imposed on a minimum project size of $350,000 in Indiana. (The Davis-Bacon threshold is only $2,000.) Typically, prevailing wages are set at or near the “prevailing” union compensation.

By definition, prevailing wages are a minimum wage applied to one segment of the labor market. It benefits those who keep their jobs, but imposes a burden on owners (who will lose money or avoid the regulated market) and taxpayers. Although it is difficult to calculate the cost increases — particularly when trying to aggregate those estimates — it is clear that the artificially high wages will increase costs significantly.

Public Choice economists have observed that motivated and powerful interest groups are regularly able to get politicians to impose subtle costs on the general public in order to pocket concentrated benefits. For example, we could take $1 from 300 million people and redistribute $30,000 to 10,000 people. The former group would be mildly irritated if they notice at all. The latter group will invest considerable energy in political markets to see the legislation pass. In a democracy, small interest groups often carry the day against the far-larger but far-less-energetic general public.

With prevailing wages, the model is more complicated since union workers benefit disproportionately — and often at the expense of — non-union workers. So, we have a powerful interest group working against a less-powerful interest group and the general public.

The less-powerful interest group may be well positioned to work with the general public to change the law, but it will be difficult given public apathy and ignorance. (Import restrictions on steel are another example, benefiting the domestic steel industry while harming firms that use steel as a prominent input.)

What difference would it make to repeal “prevailing” wages? We can confidently say that the prevailing wage increases the cost of public-sector construction projects, resulting in some combination of higher taxes and lower quality and quantity.

Would repealing prevailing wage laws “make a difference”? Yes, as economists often say, “at the margin.” The recent passage of a right-to-work law in Indiana provides a useful comparison. Prevailing wage is probably a relatively small factor at the macro level. Still, why is it ethical or practical to impose these costs on others?

With a predominantly Republican government in Indiana, prevailing wage may be the next interest-group privilege to fall.

Eric Schansberg, an adjunct scholar of the Indiana Policy Review Foundation, is professor of economics at Indiana University Southeast. This essay is based on his presentation to the foundation at its summer seminar this month in Indianapolis.


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