The Many Problems With "Equal Pay"

Richard Epstein 

Last week marked the observation of “Equal Pay Day.” That day is meant to draw attention to how a woman who works full time earns “77 cents for every dollar a man earns,” as President Obama has put it. Though a detailed analysis reveals that the claim of a systematic pay gap is spurious, the President wants to enact reforms to decrease the so-called inequality in the labor markets.

The President’s political advisors have clearly made the calculated gamble that his brand of economic populism may help achieve two ends. First, it may divert attention from the still unpopular rollout of the President’s Affordable Care Act. Second, it may rally women voters around the Democrats for the upcoming mid-term elections by putting Republicans in the uncomfortable position of waging a “war against women.” But a dubious economic agenda drives our populist President, whose plans to further regulate the economy will harm the economic prospects of women and men alike.

Bad Diagnosis

The initial mistake of course comes with the President’s perception of economic inequality in labor markets. President Obama states that a woman earns less than a man “even when she’s in the same profession and has the same education.” In so doing, he pays no respect to the principles of supply and demand, which bring the two sides of the market into balance. Those forces make it highly unlikely that a system with so many informed parties will be as seriously out of balance as he claims it is.

Nor does the empirical evidence support the President’s claim that women make less, once efforts are made to control for other variables that influence the outcome. His double use of the word “same” ignores the wide variations within any given job category, and equally wide variations in the education that men and women bring to their work, both within and across the two sexes. For instance, a definition of the medical profession that lumps together pediatricians and neurosurgeons misses huge differences in training and skills. The marketplace accurately reflects the higher returns to certain kinds of work relative to others, and thus gives strong and accurate signals on how both men and women should invest in their educations.

Without exception, more sophisticated studies that seek to control for some of these differences narrow the perceived 77 percent gap. But they do not eliminate it entirely. One common inference is that the persistence of that measurement gap is indicative of some lurking discrimination between the sexes throughout labor markets. Not likely. A far better explanation is that these statistical studies cannot incorporate into their regressions each relevant variable that matters to a skilled manager or recruiter, even after controlling for hours worked or, most critically, years out of the work force. Such issues as a willingness to travel, working overtime in dangerous neighborhoods, making cold calls to prospective customers, handling risk, or responding to hostility in interpersonal relations are likely to be relevant in how much an employee is paid. The effect of any one of these variables could be small, but in aggregate, they really matter. Yet, they are too numerous and too difficult to quantify, to be incorporated into the statistical models that predict unequal pay. So it is just wrong to assume that any unmeasured variation should be attributed to some undocumented form of discrimination.

There is also the key role of marriage. Married woman often cut back on their labor market participation to become the primary caregiver within the family. It is easy to praise, as Frank Bruni did in his recent New York Times Op-Ed, the heroic efforts of individual women to balance the demands of home and workplace. But it is much more important to understand the economic dynamics. These decisions are not made in isolation. They are made jointly by husbands and wives who think that this form of specialization will advance the family’s well-being of which income is only one part.

Defenders of equal pay often draw the wrong inference from this indisputable labor market asymmetry by claiming that women’s contribution in the home goes unrecognized. Not so, especially when the market value of these services are added back to market wages to get a more comprehensive measure of women’s productivity where it will systematically reduce the perceived wage gap. At that point, the total economic contribution of married women with children will creep up, and could well approach the income of single women, who make about 96 percent of the income of men.

The claim that women are playing against a stacked deck is wrong for still other reasons. Labor markets are intensely competitive, so the claim about systematic pay gaps has to assume both that women managers are hostile to women’s economic welfare, and that competitive markets are massively inefficient in matching people with positions. Competition for labor tends to lead to efficient outcomes. Indeed, by the standard account, price discrimination cannot survive in competitive markets, which means that the differentials in wages track differences in performance. Put simply, one danger of the Equal Pay Act is that it could mandate equal wages for unequal work, i.e. for two workers with different productivity.

The claim of systematic discrimination in labor markets also ignores the large number of self-employed women who run their own businesses. Once again, specialization reigns. Women are more likely to work in areas of family and interpersonal relations than in construction or hedge fund management. It is dangerous to disregard this persistent pattern of revealed preferences because the President, or indeed any outsider, knows what’s best for individual men and women. Specialization by occupation and within occupations is a good thing, and increases gains from trade.

Finally, note two important measures of the overall success of women. They now constitute close to 60 percent of college enrollees, and represent an ever-growing fraction of students with advanced degrees. Women alsoweathered the past recession better than men, whether measured by profession, age, or level of education. There are also many affirmative action and diversity programs that give women a leg up in the workplace. No major structural flaws exist that government regulation can fix. And there are always powerful social forces that target perceived areas of injustice.

Unintended Consequences

Our false preoccupation with pay equity is not costless, for it leads to bad labor market regulations that hurt all workers. Employment relationships will only form and endure when the gains from the deal exceed the costs of putting it together. Every time a government regulation imposes some new restriction on the contracting parties, it increases the costs of the deal and reduces the benefits it generates, thereby killing jobs for men and women alike.

Of course, the long-term prospects in labor markets are grim for today’s young adults, the millennial generation. But indignant editorials in the New York Times urging more government action won’t help. These major losses are not just random events. They are driven by unfortunate regulatory choices. The Age Discrimination Act in Employmentprotects people with jobs over 40. How can that not hurt the generation behind them? The community rating requirements under the Affordable Care Act force young people to subsidize their elders. Large transfer payments via Social Security and Medicare do the same. No wonder the economic prospects of millennials are worse than their parents’.

The nonstop effort to turn today’s minimum wage into a living wage has the same effect, especially when the President justifies this initiative in the name of gender equity. His executive order requiring federal contractors pay all workers a minimum of $10.10 is, on average, supposed to raise the pay of women in the bottom quartile by 93 cents an hour, and that of men by only 60 cents. But that ignores the obvious risk that a higher fraction of these vulnerable women are more likely to lose their jobs, given the greater labor market distortions.

Similarly, the President’s executive order forbidding federal contractors from “retaliating” against employers that discuss their compensation with each other is another step in the wrong direction. His naïve view is that these conversations “encourage pay transparency” and allow employees to ferret out violations of the Equal Pay Act. But suppose they suggest that some men are underpaid in a given job category? What then? The truth is, lots of things can happen, not all of them nice. Most private firms prohibit these conversations and for good reason—to protect workers from social pressures to disclose sensitive personal information; to prevent petty jealousies, resentments, and false charges of preferential treatment; and to reduce the leakage of trade secrets to competitive firms. It also gives rise to yet another round of costly regulation from the Department of Labor that will only make matters worse. Why should a President with zero management experience in the private sector be so confident that he knows best?

Men, Women and Families

One common theme that the president raises is that his proposals are good not only for women but also for American families and the economy as a whole. Of course, he is right to say that “when women succeed, America succeeds.” Any overall improvement in labor productivity reverberates across the economy. But the President is blind to the difference between the rising tide that raises all ships, and the dam that makes water flow into one channel and not the other. Market transactions raise all ships by improving levels of productivity. The President’s regulations shrink the size of the pie in the effort to give women a larger share of what remains. But that strategy never works. Increased pay for women is always a blessing—all other things being equal. But that improvement takes on a different hue when it comes at the expense of an overall decline of the income and economic prospects for men.

So now just think of the position of the family when both husband and wife are affected by regulation. The overall pie shrinks, so if the wife gains $10 per week in salary, and the husband loses $12 per week, the change is a net negative, which only gets bigger when the administrative burden is added on to both parties. The losses in individual cases are only magnified when this scheme goes viral. Right now, the President can only act by executive order. But he is actively agitating for the now stymied Paycheck Fairness Act, which will introduce pay equity on a grand scale for all private firms. It is a prescription for the destruction of labor markets. There is no question that we have revved up enforcement of labor market regulation in the past generation, just as the prospects of millennials have tanked. So why double down on failure? Ask Obama, but don’t expect to get a coherent answer. Just more platitudes.