Some restaurants offer burgers without fries and a drink. These restaurants cater to low-income people who enjoy fries and drinks but can’t always afford them. To rectify this sad situation a presidential candidate proposes The Happy Meal Act. Under the Act, burgers must be sold with fries and a drink. “Burgers by themselves are not a complete, nutritious meal,” the politician argues, concluding with the uplifting campaign slogan, “Everyone deserves a Happy Meal!”
But will the Happy Meal Act make people happy? If burgers must come with fries and a drink, restaurants will increase the price of a “burger.” Even though everyone likes fries and a drink they may not like the added benefits by as much as the increase in the price of the meal. Indeed, this must the case since consumers could have bought the meal before the Act but chose not to. Requiring firms to sell benefits that customers value less than their cost makes both firms and customers worse off.
The Happy Meal Fallacy is fairly obvious when it comes to happy meals but now let’s consider the debate over the gig economy and the hiring of employees versus contractors. Employees are entitled to benefits that contractors are not. Thus the standard conclusion is that classifying workers as contractors “is great for employers but potentially terrible for workers.” Wrong. Employees get their wages with fries and a drink while contractors get wages only. Would a law requiring firms to provide all workers with fries and a drink help workers?
If firms are required to provide benefits to contractors they will lower the contractor wage. But how do we know the extra benefits aren’t worth the reduction in wages? If the extra benefits were worth more to workers than they cost firms, firms would have eagerly provided these benefits as a way of increasing profits. Firms can profit whenever buyers are willing to pay more for a product than its cost. Benefits are a product that workers buy from firms.
Workers buy benefits from firms by offering to work at a lower wage. Firms are happy to sell benefits when workers will accept a wage reduction that covers the cost of the benefit. Thus, if workers value a benefit by more than its cost, there is a mutually profitable deal to be made. The firm will provide the benefit and wages will fall by more than the cost but by less than the value of the benefit. Both firms and workers will be better off. It’s implausible that firms and workers will overlook mutually profitable exchanges. Thus requiring firms to provide benefits with every job means requiring firms to sell benefits that workers value less than their cost and that makes both firms and workers worse off–just like requiring restaurants to sell burgers with fries and a drink makes firms and customers worse off.
If the cost of the benefits far exceed their value to workers, the firm will close. But even if the firm doesn’t close, firms and workers will both be worse off. The exact division of the burden will vary depending on particulars but the workers who value wages the highest and benefits the least will be the most burdened. Often these will be the lowest income workers.
The Happy Meal Fallacy can lead to very unhappy firms and workers.
Addendum: The theory of compensating differences in wages with benefits was pioneered by Adam Smith. See Matt Kahn for a short overview and Sherwin Rosen for a full treatment of the theory. Jonathan Gruber and Craig Olson offer empirical evidence. The MRU video, The Tradeoff Between Fun and Wages presents another application.