In 1931, in the midst of the Great Depression, the United States Congress passed the Davis-Bacon Act, a law that requires contractors to pay "prevailing wages" on construction projects undertaken for the federal government. This legislation led to the passage of "little Davis-Bacon Acts," or "prevailing wage" laws, in over 40 states, including Kentucky.
What are prevailing wages? The short answer is that in many jurisdictions, including the federal government, prevailing wages are typically wages set at or near the union-scale level. Prevailing wage laws, then, force contractors on government construction or other projects to pay their employees at the same rate as unionized members of the relevant occupation--whether it be bricklayers, carpenters, electricians, or other categories of workers--even if non-union contractors could perform the same work less expensively by paying their workers lower but mutually agreed-upon wages.
Ever since the enactment of the Davis-Bacon legislation, the question of the impact of prevailing wages on the market for construction worker labor has been an issue among economists. The major question raised is simple enough: Does the enforcement of the prevailing wage statutes distort labor market outcomes associated with public construction projects? The report under review here, prepared by the Kentucky Legislative Research Commission, deals with this issue in the particular case of the Commonwealth of Kentucky, which has had its own prevailing wage law since 1940. Currently, the Kentucky law is applicable for construction projects with a total cost of $250,000 or more. In its letter of transmittal (memorandum) to the Governor of Kentucky, the Commission describes the matters dealt with as consisting of "whether or not Kentucky's prevailing wages accurately represented local wages and if the use of prevailing wages increased the costs of public construction" (p. iii).
By way of background, two different procedures are employed in determining prevailing wages in Kentucky. For 81 of the State's 120 counties, the prevailing wages are set by an entity known as the Kentucky Labor Cabinet. These rates are based on wage data collected from contractors and unions at public hearings held in the various localities. The rule for determining the prevailing wage is straightforward. If the submitted data show that a majority (51%) of workers in a particular construction worker category are paid the same wage, that wage is viewed as the prevailing wage. If there is no clear majority wage, a weighted average of the submitted wages is calculated to determine the prevailing standard.
In the other 39 counties, the prevailing wage determined by the Federal Government is accepted for use in implementing Kentucky's prevailing wage law. These wages are set by the United States Department of Labor on the basis of information collected from contractors and construction worker labor unions. The Federal Government uses a similar rule to that used at the state level to make wage determinations.
Prevailing Versus Actual Wages
We turn now to the relationship between actual and prevailing wages. In this regard, the Kentucky Legislative Research Commission's findings are unambiguous. They state in their Executive Summary, "Currently, neither prevailing wages set by the Kentucky Labor Cabinet or the United States Department of Labor yield prevailing wages that are representative of local wages" (p. ix). Rather, the bias is in the direction of prevailing wages being higher than actual wages.
The source of the discrepancy between prevailing and actual wages is found in the dominance of union scale rates in the data employed in determining prevailing wages. Among wage standards set at the state level, 81 percent of the wage rate data collected at local hearings originates with union workers, despite union workers accounting for only 18 percent of the construction labor force. This leads to union wage scales dominating the determination of prevailing wage standards. The Commission reports that in 372 determinations where there was sufficient evidence to assess union influence, 256 (or 68%) of the prevailing wage determinations were identical to the union wage.
Similarly, the Commission's report presents evidence which indicates that the federal prevailing wage rates used in Kentucky are biased upward. Prevailing wage rates are compared with Bureau of Labor Statistics information detailing actual wage rates in 27 separate instances. The median percentage differential between the prevailing and actual wage rates is 17 percent, in favor of the prevailing wage.
Impact on Construction Costs
Having established that prevailing wages in Kentucky are greater than actual average wages paid, the authors of the report turn to the question of the impact of prevailing wages on construction costs for public projects. They begin their consideration with the following remarks:
Public projects in Kentucky are typically awarded to the lowest bidder. In the absence of prevailing wage laws, contractors are free to select among various mixes of inputs, such as labor and equipment, in an attempt to develop a competitive bid. Prevailing wage laws constrain contractors from one avenue by which they can reduce bids and, therefore, the costs of construction. To the extent that prevailing wages are higher than the wage that would be paid to at least some workers, paying prevailing wages could increase the costs of construction (p. ii).
Having said that, they add:
When faced with paying higher wages, contractors will attempt to shift from using low skilled labor to more productive labor or increase the use of equipment. This substitution tends to offset some of the additional costs associated with prevailing wages. Although there are several studies which conclude that there are no additional costs associated with prevailing wages, there are a number of technical problems which raise doubt about their validity.
The studies just referred to are numerous, and are summarized and discussed on pp. 45-70 of the report and in an Appendix B.
In dealing with the specific issue of the impact of prevailing wages on construction costs, the fundamental problem is an efficiency-wage consideration. In short, do the higher wages implicit in the prevailing (or union) wage premium lead to increased worker productivity, either through greater work effort, the hiring of more productive workers, or a higher capital-labor ratio. Evidence on this point is provided by Steven Allen, who concludes that an earlier union vs. non-union productivity advantage had disappeared by 1982. If this is the case, productivity feedbacks are a non-issue.
The Kentucky Legislative Research Commission, not content to rely solely on the Allen findings, collected data that describe wages paid to workers on prevailing wage covered projects as well as wages paid to the very same workers when employed on private (non-prevailing wage) jobs. The data set for this comparison consisted of 283 workers (90 on road projects, 47 in state non-road activity, and 146 employed on education projects). The results of the analysis are summarized as follows:
Overall, the 283 workers were paid $86,029 more as a result of the prevailing wage. This indicates that prevailing wages resulted in a 24% increase in the wage costs for these projects ... It is important to understand that this estimate does not imply that prevailing wages increased the cost of these projects by twenty-four percent. Rather, it indicates that the wage portion of construction costs was twenty-four percent higher as a result of the prevailing wage. It is argued by some that the additional wage costs of requiring prevailing wages are offset because contractors substitute more productive workers or use more equipment. Because this analysis only examines the workers that actually worked on the project, it incorporates any productivity gains achieved by this type of substitution. Since prevailing wages paid on the projects are still higher than the wages that these workers are paid on private projects, any productivity gains do not effect the full wage cost associated with the prevailing wage requirements (pp. 57-59).
The total cost effect of the 24 percent prevailing wage premium observed in these data will depend on the relative importance of labor costs. If labor costs represent one-half of total construction costs, the taxpayers' bill for public construction projects will be 12 percent greater. If they are 40 percent of total costs, the extra cost of public construction will be 9.6 percent. A labor cost share of 30 percent will produce a 7.2 percent extra project cost burden.
Some Additional Considerations
Beyond the questions of determining the prevailing wage premium and assessing its impact on public construction costs, the Kentucky report also responds to a variety of arguments made by proponents of prevailing wages. Among them is the proposition advanced in the often-cited study entitled, Losing Ground, that reductions in tax revenues resulting from declines in construction worker earnings exceed any construction cost savings associated with repealing prevailing wage laws.
This argument is, at best, a strange one. On the one hand, it suggests that repeal of prevailing wage laws in nine states reduced the annual earnings of construction workers by an average of $1,835 (1991 prices) while, on the other hand, arguing that the construction cost savings associated with these lower earnings are less than the taxes that would be paid on the lost earnings. For this to be true, each dollar of lost earnings must reduce construction costs by less than the marginal tax rate on income in a state. For example, in a state with a five- percent marginal tax rate, construction cost savings per dollar of lost earnings would have to be less than five cents. Given the findings that the very same workers were paid 24 percent more on prevailing wage projects than when working in a non-prevailing wage setting, this does not seem to be applicable in the case of Kentucky.
There are other problems with this argument. The report quite properly concludes that this analysis does "not provide sufficient evidence to conclude that the repeal of prevailing wages would result in lost tax revenue that would exceed reductions in construction costs" (p. 67).
Confirmation of these findings is provided by an exercise in polling conducted by the Kentucky Legislative Research Commission. It surveyed six different groups of Kentuckians involved with prevailing wage projects: contractors, representatives of unions with members working for contractors, city government officials, county government officials, local school district representatives, and municipal utility officials. Of these groups, two expressed strong support for the prevailing wage system - contractors with union workers and union officials. This is exactly what would be expected given the finding that there is a significant prevailing wage premium that arises because prevailing wages tend to be the union wage. Contractors with union workers have committed themselves to paying that premium and, consequently, are at a competitive disadvantage relative to contractors with non-union workers. Therefore, it is in their interest to support government intervention that will mandate higher labor costs for their competitors.
As to the union officials, their support for prevailing wages has an obvious motivation--higher wages for union members and more money for unions. The prevailing wage premium is nothing more than an economic rent that is being captured by union members. The recipients of economic rents generated by a policy regimen are not disinterested observers of that regimen. Quite the contrary. They have a vested interest in supporting the policy involved. Perhaps this explains the near unanimous approval of the prevailing wage system expressed by union officials, 97.7% of whom feel that the effects of prevailing wages are either somewhat positive or very positive.
The remaining groups bear the burden of these economic rents, either directly as the funders of prevailing wage construction projects, or as a construction company with non-union workers that has a competitive disadvantage foisted upon it by the government regulatory apparatus. Among this latter group, when polled as to the effects of prevailing wages, nearly two-thirds replied that they were somewhat negative or very negative. By contrast, three-fourths of contractors with union workers feel that the prevailing wage system has either somewhat positive or very positive effects.
Among those involved with the financing of prevailing wage projects, attitudes toward the system are decidedly negative. When asked whether prevailing wages increased construction costs, about 90 percent of city, county, school district, and municipal utility officials replied in the affirmative. Also, when polled about the impact of the prevailing wage system on the quality of construction, only a handful of officials (less than 10 percent) expressed the view that it improved quality.
Collectively, the results of the opinion polls administered by the Kentucky Legislative Research Commission reveal a set of attitudes that is powerfully consistent with the Commission's conclusion that the prevailing wage premium is directly associated with the union wage premium in the construction industry.
Evidence from Nearby States
An interesting question is whether Kentucky is somehow unique in its prevailing wage environment. To explore this issue, conditions in two nearby states are worth noting. First, there is the case of Ohio, where a five-year exemption from its prevailing wage law is running its course. The Kentucky report summarizes a preliminary analysis of the Ohio experience as follows:
The Ohio Legislative Budget Office is currently studying the effects of a five-year exemption of the state's prevailing wage law. Contractors that were awarded construction projects during the exemption were asked to estimate their bid amount if prevailing wages had been applied. Based on this comparison, interim reports on the study conclude that prevailing wages increased the costs by 10.5% on projects where a savings could be estimated (p. 53).
A similar series of events occurred in Michigan. In this case, a federal district court ruling (December 1994) held that Michigan's prevailing wage law was in conflict with a federal pension law, ERISA, and that ERISA takes precedence over the state legislation. The decision was later reversed by an appellate court (June 1997), but in the interval the Michigan prevailing wage law was not enforced. This affords the opportunity to assess the cost and employment effects of a specific minimum wage law during a period when it is not operative. An analysis along these lines is quite revealing. It shows that during the time when the Michigan prevailing wage law was in abeyance, employment in the construction industry surged--even after adjusting for variation produced by seasonal, weather, and business cycle conditions.
Perhaps the most revealing statistic in this regard is the ratio of construction jobs created to total new jobs. In an era when the prevailing wage law was enforced (June 1992 through December 1994), 78.61 new construction jobs emerged for every 1,000 new jobs of all kinds. However, from December 1994 through June 1997, a period without prevailing wages, that ratio was 48 percent greater, standing at 116.27.
In addition, the Michigan experience confirms the existence of a prevailing wage premium. The median percentage differential between the prevailing wage and the market wage in nine different construction occupations in 1992 was 31.6 percent in Wayne County, and 39.3 percent in Monroe County. In both cases, the median differential occupation was that of carpenter. These wage premiums, for a period when the prevailing wage law was in force, translate into higher construction costs. By contrast, when 20 different projects were examined for the period characterized by no enforcement of the prevailing wage law, "On average ... the savings were well above ... 10 percent" (Vedder, p. 14).
In summary, the experiences of two nearby states, Ohio and Michigan, are quite consistent with the findings reported by the Kentucky Legislative Research Commission. This indicates that the Kentucky analysis is not an anomaly that can be disregarded in the broader perspective of assessing the effects of prevailing wages.
The report of the Kentucky Legislative Research Commission on prevailing wages provides a rather thorough indictment of the policy of mandating such wages for publicly financed construction projects. As such, it offers an excellent summary of the case against prevailing wages and their tendency to restrict people from operating in a free market, where they would otherwise be able to allocate resources and use production factors most efficiently. Thus, prevailing wages retard job creation and lead to slower economic growth.
The Kentucky report should be studied by anyone interested in the issues that attend the prevailing wage question.
* Lowell Gallaway and Richard Vedder are both distinguished Professors of Economics at Ohio University, and are the authors of numerous books and articles on labor economics.
1. An Analysis of Kentucky's Prevailing Wage Laws and Procedures, Staff Report, Kentucky Legislative Research Commission (Lexington, Kentucky, December 2001).
2. "Can Union Labor Ever Cost Less," Industrial and Labor Relations Review, April 1988, pp. 347-73.
3. Peter Phillips, Garth Mangum, Norm Waitzman, and Anne Yeagle, Losing Ground: Lessons from the Repeal of Nine Little Davis-Bacon Acts(February 1995).
4. Ohio Legislative Budget Office, A Study of the Effects of the Exemption of School Construction and Renovation Projects from Ohio's Prevailing Wage Law, An Interim Report of a Five-Year Study - Year Two (January 2000).
5. For a description and analysis of this situation, see Richard Vedder, Michigan's Prevailing Wage Law and Its Effects on Government Spending and Construction Employment (Midland, Michigan: Mackinac Center for Public Policy, 2001).