The real problem Hazlett ignores is the existence of market failures in the actual world. The labor market in particular is rife with failures, in areas from search costs to market power, to the point where many labor economists model the labor market as a monopsony, i.e. a single-buyer market, which is one of the classic situations where government intervention to raise prices can increase total surplus. There's a whole discipline of labor economics that deals with the fact that the labor market is imperfect in excitingly complex ways.

In general a real market is imperfect in any case where firms make profit above their cost of capital -- i.e. most of it -- since perfect competition is supposed to drive profits to zero everywhere. The employees of a firm making profits certainly can be paid more without imperiling production, since the profits could simply be reduced.

Almost throughout, Hazlett makes exactly this (very common, for those with a political axe to grind) fallacy, supposing implicitly everywhere that no company is profitable despite the fact that we are manifestly not living in that world.