For nearly a century, economists struggled with the famous diamond-water paradox. Water, while so essential for life, is so cheap. Diamonds, on the other hand, are luxuries that command such a high price.
The resolution, articulated by Carl Menger, was that value is not inherent in goods themselves but comes from the importance individuals place upon them at the margin. Prices, as such, reflect marginal valuation conditioned by scarcity, not total usefulness in general.
A similar misunderstanding applies to today’s debate over a “living wage.” Advocates are often quite explicit in their demand. The National Employment Law Project, for example, insists that “every job should pay a living wage.” The moral appeal is clear. Economically, however, such an assertion assumes what needs to be proven: that every job creates enough value to garner such a wage.
Let us begin with a simple point: wages are prices. Just as the price of bread reflects supply and demand, so do wages for labor in particular occupations. They signal how scarce certain skills are and how much value workers add at the margin.
As Friedrich Hayek explained, the price system is “a mechanism for communicating information,” and wages are a part of that system. They are not arbitrary. They communicate where labor is most urgently needed and where it is less highly valued.
Imagine someone who chooses to manufacture horse-drawn carriages in the modern United States. Outside of niche markets, like Jackson Square in New Orleans, demand for such a good is minimal. Call him James. He is producing something very few people want, and the economic value he is, therefore, generating is quite low. Accordingly, the wage that could be sustained by his line of work will also be low.
James, however, is not discouraged. He insists that he deserves a “living wage” simply by virtue of being employed.
The absurdity of the demand should be apparent. It is not a question of the dignity of the work. Let us assume his craftsmanship is top-notch, and he is obviously not engaged in the production of anything morally objectionable. Yet, the value James creates is limited relative to other uses of labor and capital. So much so that, economically speaking, James is not even engaged in production but consumption.
Paying him a high wage, then, would require diverting resources away from more valuable activities. In effect, this would mean asking others to subsidize James’s “production” that consumers have already overwhelmingly revealed to be of little value. If James wishes to continue this work for personal satisfaction, he is free to do so. But it does not follow that others are obligated to sustain it.
The problem here is that the living wage argument implicitly assumes that wages should be determined by the needs of the workers rather than by the value of what they produce.
As Bernie Sanders has said repeatedly, “a job should lift you out of poverty, not keep you in it.” Superficial sentimentality presents this as understandable, but it does not follow that every particular job, in every place and moment, can and should bear a wage set by need rather than productivity, and do so indefinitely. Employment does not exist in the abstract. Jobs are specific — an auto mechanic in Acworth, Georgia in 2026, not simply a “job in the United States.” If local demand for that service is limited, the wage will reflect that reality and it ought to.
Once wages are detached from productivity, economic coordination begins to break down. If employers are required to pay wages above the value generated by certain jobs, several outcomes tend to follow:
- Some jobs disappear entirely
- Businesses substitute capital for labor
- Firms reduce hiring or restructure production
- Opportunities for low-skill or inexperienced workers decline
As economist Thomas Sowell bluntly put it, “the real minimum wage is always zero.” When the cost of hiring exceeds the value a worker can produce, employers will just not hire. This, of course, does not eliminate the need for income, but it does eliminate the opportunity to earn it.
None of this is to deny that people should wish for wages sufficient to support themselves and their families. In fact, economic progress engineered by capitalism over the last two centuries has made that wish increasingly attainable. That progress, though, followed a clear pattern: higher productivity leads to higher value, which leads to higher wages.
Policies that try to mandate higher wages in spite of productivity levels undermine the very mechanism generating rising standards of living. The issue lies in demanding that every conceivable job, regardless of its contribution to society, ought to sustain a person and his family.
Wages, like any other price, reflect the economic realities of a particular time and place. If wages appear low, this is not an injustice (assuming they are the result of market, not government, forces). This signals limited value currently generated by that activity relative to other possible uses of labor.
The lesson needed today is the same as the lesson from the diamond-water paradox. Prices do not reflect how important something feels. Instead, they reflect scarcity, marginal value, and human choices. Wages are no exception.
