Making a Bad Idea Even Worse
Dennis Schroader
ECO 308
Nicholas Bergan
March 30, 2009
Every year politicians and pundits spend countless hours on Sunday morning news shows debating how to improve economic conditions for the country as a whole and for the lowest wage earners in particular. To be fair, they have taken advantage of the twenty-four hour news cycle and are on the air much more frequently than Sunday mornings. These debates inevitably lead to discussions of the minimum wage with someone crying about the injustice that unskilled, inexperienced workers aren’t paid enough to support a family of three. The minimum wage defies actual market forces and does not actually do anything to help the poor. Minimum wage laws serve only to establish an artificial floor for wages, thereby circumventing market forces and artificially raising prices.
The CATO institute published Policy Analysis No. 106, written by Matthew Kibbe, then a graduate student of economics and fellow at the Center of the Study of Market Processes at George Mason University. In this policy analysis, Kibbe asserts:
“Minimum-wage legislation is and always has been the result of special-interest politics. Behind the rhetoric of economic justice and fairness lie purely self-serving political considerations. [sic] The simple truth about the issue is that any minimum-wage rate that is forced onto the market will have only negative effects on the distribution of economic justice. Minimum-wage legislation, by its very nature, benefits some at the expense of the least experienced, least productive, and poorest workers” (1988).
The Real-nominal Principle states, “What matters to people is the real value of money or income – its purchasing power – not the “face” value of the money or income” (O’Sullivan, Sheffrin, & Perez, Survey of Economics: Principles, Applications, and Tools, 2008, p. 40).
Minimum Wage Effect on Labor Costs
Among the many inputs used by companies for production is labor. That labor comes with a cost which includes wages, mandatory employer match of federal withholding, unemployment insurance, L&I, and other labor related expenses. In most states, all of the aforementioned costs of employment are calculated as a percentage of wages. When that wage goes up, so do all of the other costs associated with employment.
“For many businesses, particularly those in the service industry, such as restaurants or manufacturing companies that are labor intensive, the cost of payroll is the single largest line item on the profit and loss statement” (BusinessTown.Com, 2003). Assuming that most of the personnel of such firms are minimum wage earners (a faulty assumption, as will be discussed later, but it serves to illustrate the point), any small increase in the per unit cost – the hourly wage times the number of employees – is likely to have a sizeable impact on the firms’ profitability.
In an article for the Washington Policy Center, Carl Gipson, Director of the Center for Small Business, wrote:
“For most businesses, the largest expense is the cost of labor. When labor costs increase, a business has only a few options. First, it can simply absorb the cost (often limited to businesses with large cash reserves). Second, it can take active steps to decrease the cost of labor—often through layoffs, increasing workloads for employees or implementing automation. Third and most common, it can increase the cost to the consumer to cover the difference” (2007).
Gipson goes on further to state, “When a government actively takes steps to arbitrarily set a higher wage rate th[a]n the market dictates, it faces the unintended consequence of passing the cost onto taxpayers.” Gipson’s article refers specifically to wages earned by employees of companies bidding for government contracts, but if the word “taxpayers” is substituted with “customers”, the rest of the statement holds true for non-state businesses.
Minimum Wage Effect on Unemployment
The law of supply and demand with regard to market equilibrium tells us that as prices increase, demand decreases. This is as true of employees as it is with pizza. As the minimum wage increases, the demand for minimum wage labor decreases. This is illustrated by the following graph taken from the Congressional Joint Economic Committee Report:
(Saxon, 1996).
Congressman Jim Saxon (R-NJ), used this graph from the Bureau of Labor Statistics to demonstrate that a higher minimum wage results in higher unemployment, particularly among teenagers and other unskilled/inexperienced workers. The greatest danger lies in their inability to gain valuable work related skills and experience, thus becoming more productive and able to demand higher than minimum wages. Craig Garthwaite, chief economist at the Employment Policy Institute, wrote in an article for the Seattle Post Intelligencer, “Decades of research confirm Nobel Prize-winning economist Gary Becker's observation: "A higher minimum will further reduce the employment opportunities of workers with few skills” (High Minimum Wage = High Unemployment, 2003). Higher than natural unemployment also has a significantly detrimental affect on a nation’s Gross Domestic Product. The text states, “… in 1983, when the unemployment rate averaged 9.6 percent, typical estimates the shortfall of GDP from potential were near 6 percent” (O’Sullivan, Sheffrin, & Perez, 2008, p. 312).
Minimum Wage Effect on Purchasing Power
In addition to the real macroeconomic damage of decreased GDP due to unemployment caused by a high minimum wage, there is a microeconomic detriment as well. As previously discussed, increasing wages increases the cost of doing business which causes a decrease in employment and an increase in product prices. When the price of goods increases, the real value of a dollar decreases. This is known as the Real-nominal Principle.
The politicians who legislate increases in the minimum wage may do so with the intention of lifting the poorest workers out of their poverty. Good intentions cannot always be accurately ascribed to those holding elected office, but for the purposes of this discussion, we give them the benefit of the doubt. Unfortunately, good intentions are not good enough. At least a passing familiarity with economic principles is necessary for making good public policy.
The following graph shows the purchasing power of the federal minimum wage, both nominal and inflation adjusted from 1958 to 2001. While some would view the information contained herein as proof that the minimum wage has not kept up with the cost of living, this data more accurately demonstrates that as the minimum rises, the cost of goods rises, thereby decreasing the purchasing power of everyone in the economy, but most notably the minimum wage earners.
(Fiscal Policy Institute, 2002).
Dr. Tim Kane, Ph.D, writes in an article for the Heritage Foundation:
“The notion that increasing the federal minimum wage will push up real wages is also fiction. Average pay in America has been increasing steadily in recent years, despite the fact that the minimum wage has not changed since 1997. Real wages rise when productivity rises. Labor productivity has gained 26 percent since 1997, and real earnings for non-supervisory workers are up 7 percent.” (2005).
Myth of the Living Wage
The whole idea of a “living wage” versus the minimum wage is nothing new. According Robert Shelburne, of the United Nations Economic Commission for Europe, “The current attempts to define a wage rate that would provide an “acceptable” standard of living which is above the minimum required for biological existence go back at least to the Middle Ages.” (The History and Theory of the Living Wage Concept, 1999). More recently – say within the last half century – politicians misuse the concept of a “living wage” by contrasting it against the current minimum wage laws. In an article originally appearing in the Boulder Weekly, Ari Armstrong writes, “Is a policy better merely because we say it's "living" versus "minimum?" (“Living Wage” Hurts the Poor, 2003).
To further exacerbate the problem, politicians – who are more likely to be lawyers or teachers rather than business-persons or economists – ignore the principle of diminishing returns. Our text assumes that wages are stagnant and that diminishing returns is a function of how much each person is able to accomplish given the facilities available (O’Sullivan, Sheffrin & Perez, 2008). The principle of diminishing returns states that as one input increases while all others remain fixed, the marginal benefit of each unit of increased input will decrease. Economists assume that all firms are operating at or near the point where marginal benefit equals marginal cost. Politicians seem to fail to realize that the price of labor is one of those inputs. When that input increases while all others – including labor force – remain the same, the marginal cost curve shifts. In order to continue operating at that equilibrium point, firms are likely to make do with fewer employees.
D.W. MacKenzie, professor of economics at State University of New York, wrote:
“The economic case for a living wage is unfounded. Current minimum wage rates do create high levels of unemployment among low productivity workers. Higher "living wages" would only make these problems worse. The alleged moral case for a living wage ignores the fact that minimum wage increases adversely affect the very people whom advocates of living wages intend to help. If politicians wish to pursue sound policies, they should consider repealing minimum wage laws, especially where teens are concerned” (Mythology of the Minimum Wage, 2006).
The idea that a living wage is required for everyone who works at the lowest paid rung on the economic ladder is, in itself, ludicrous. To prove that statement, we examine just who earns the minimum wage. Consider the following statistics compiled by the Heritage Foundation. These numbers indicate that the vast majority of minimum wage earners either do not have a family to support or are not the sole wage earner in the household. That fact alone alleviates any real need for a so-called “living wage”.
Table 1
Demographic Characteristics of Minimum Wage Workers
16-24 years old 25+ Total
Men 35.2% 33.6% 34.4%
Women 64.8% 66.4% 65.6%
White 83.6% 79.5% 81.7%
Black 11.1% 11.8% 11.4%
Asian 1.7% 5.4% 3.4%
Married 4.8% 42.5% 22.5%
Wage and Income Characteristics of Minimum Wage Earners
Part Time 67.0% 55.6% 61.7%
Full Time 33.0% 44.4% 38.3%
Avg. Family Income $64,273 $33,606 $49,885
At or Below the Poverty Line 16.9% 22.8% 19.5%
Family Income > 200% of Poverty Line 64.7% 44.8% 56.1%
Education Levels of Minimum Wage Workers
Less Than High School 36.3% 22.0% 29.8%
High School Graduate 20.9% 38.5% 29.1%
Some College 35.6% 20.5% 28.5%
Associates Degree 3.4% 8.5% 5.8%
Bachelors Degree or Higher 3.4% 10.6% 6.8%
Source: Heritage Foundation calculations based on the Bureau of Labor Statistics, 2005 Current Population Survey and merged outgoing rotation group files
Furthermore, we know from the law of supply and demand that as supply increases, prices decrease, and as demand increases, prices increase. In this case, the price is wages. Lowering or eliminating the minimum wage will necessarily increase employment. As to the argument that eliminating the minimum wage will lead to abuse of employees, the fact is that employment in America is non-compulsory. Workers also obey the law of supply and demand. They will not supply their labor unless the demand yields a price (wage) sufficient to make it worth their while. This is exactly how everyone who does not work for minimum wage operates in the real world.
Conclusion
Although it makes for great political theater, the minimum wage is really nothing more than an artificial floor on the price of labor. In all markets, demand should dictate prices, not government meddling. Contrived price controls increase the cost of production to a company, thus disrupting the equilibrium of marginal cost and marginal benefit. A company has no choice at that point but to change other inputs: either reducing labor costs by reducing the workforce or raising prices to the customer, or both. In the case of laying off workers, the company reduces its cost of labor, but also reduces its potential customer base. In the case of raising prices to the consumer, the company serves to reduce the purchasing power of all of their customers and reduce their own demand. Neither case is desirable for employers, employees or the public at large.
The argument that the minimum wage is somehow a moral issue – that society as a whole must pay a premium to provide least skilled and most inexperienced workers with wages higher than they could demand on the free market – is absurd on its face. The fact is that the vast majority of minimum wage earners are not solely responsible for the support of their household. In fact, most of those who work for minimum wage are teenagers and college age young adults.
Perhaps the most important unintended consequence of artificially high employment costs, high unemployment, and diminished purchasing power is the negative affect they have on Gross Domestic Product. All of the facts point directly to the obvious conclusion that the minimum wage (never mind the so-called “living wage”) is an overall detriment to the lowest paid workers and society in general. Of course, if facts alone influenced policy makers, the minimum wage would be abolished and there would be no talk about this living wage nonsense.
References
Armstrong, A. (2003, November 20). “Living Wage” Hurts the Poor. Boulder Weekly. Retrieved March 28, 2009, from the Colorado Freedom Report web site: http://www.freecolorado.com/2004/01/livingwage.html
BusinessTown.Com. (2003). Payroll and the Cost of Labor. Retrieved March 28, 2009 from http://www.businesstown.com/accounting/slashing-payroll.asp
Fiscal Policy Institute. (2002) Minimum Wage Update. Retrieved March 28, 2009, from http://www.fiscalpolicy.org/MinimumWageGraphs.pdf
Garthwaite, C. (2003, December 26). High Minimum Wage = High Unemployment. Seattle Post Intelligencer on the Web. Retrieved March 28, 2009 from http://www.seattlepi.com/opinion/153901_unemploy26.html
Gipson, C. (2007). Living Wage Proposals: Imposing Price Controls on Labor. Retrieved March 28, 2009, from the Washington Policy Center web site: http://www.washingtonpolicy.org/Centers/smallbusiness/legislativememo/07_gipson_livingwages.html
Heardman, R, and Sherk, J. (2006, August 3). Who Earns the Minimum Wage – Single Parents or Suburban Teenagers? The Heritage Foundation. Retrieved March 29, 2009, from http://www.heritage.org/Research/Economy/wm1186.cfm
Kane, T. (2005, March 4). Minimizing Economic Opportunity by Raising the Minimum Wage. The Heritage Foundation. Retrieved March 28, 2009, from http://www.heritage.org/Research/Economy/wm676.cfm
Kibbe, M. (1988). Cato Policy Analysis No. 106: The Minimum Wage: Washington’s Perennial Myth. Retrieved March 28, 2009, from The Cato Institute web site: http://www.cato.org/pubs/pas/pa106.html
MacKenzie, D.W. (2006, May 3). Mythology of the Minimum Wage. Daily Mises. Retrieved March 28, 2009 from the Ludwig von Mises Institute website: http://mises.org/story/2130
O’Sullivan, A., Sheffrin, S., & Perez, S. (2008). Survey of Economics: Principles, Applications, and Tools. New Jersey: Pearson/Prentice Hall.
Saxon, J. (1996). Joint Economic Committee Report: The Case Against a Higher Minimum Wage. Retrieved March 28, 2009, from http://www.house.gov/jec/cost-gov/regs/minimum/against/against.htm
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