No matter how many times certain ideas are completely debunked, many, nevertheless, have a way of always returning. The present push by Democrats to increase the federal minimum wage rate is one such debunked idea returning for its tired and predictable reprise.
Currently the federal minimum wage is $7.25-per-hour. The president and congressional Democrats would like to see this rate increased to $10.10-per-hour by 2015, a 39% increase. The city of SeaTac, WA, has recently increased its minimum wage for certain workers to $15-per-hour, from $9.32, a 60% increase.
The president and his allies frame this debate in terms of fairness. Why should some work at wage rates barely above the poverty line?
Unfortunately since many have little or no training in economics, have never learned how to focus on the long-term economic effects of various governmental programs, have never learned that wages are simply a name given to employers’ labor costs and have no special economic properties beyond that, harmful populist measures, such as laws increasing the mandated minimum wage, often pass with little thought to their long-term consequences. The primary long-term negative effect of mandated minimum wage increases is a guaranteed general increase in unemployment and a specific increase in unemployment among those already at the bottom–such as the black teenager, the unskilled, the uneducated–those for whom the minimum wage laws were supposedly created to help most.
Today the black teen-aged unemployment rate is about twice the rate of whites. This was not always so. Before the 1950s, before the time minimum wage rates were raised drastically for the first time, the black teen-aged unemployment rate was comparable to the non-black rate. And this was even in spite of large areas of the country still suffering from explicit racial discrimination against blacks. Yet the black unemployment rate at that time was hugely and significantly lower than it is today.
Why does raising the minimum wage rate tend to increase unemployment? A main reason is that many workers’ skills are not worth to their employers the required new, higher minimum rate. Although an employer may entirely need his workers at the lower rate, at the higher rate employing them may no longer be profitable. These workers lose their jobs.
So even though a worker is quite willing to work at the old lower rate, and the employer receives real benefit by employing the worker at the lower rate, the government deems this voluntarily agreement illegal. The employer by law must pay the higher rate if he wishes to continue employing the worker. The government, in effect, is stating that it would prefer the worker be unemployed than to work at the lower rate. Thus the obvious result: an increase in unemployment.
A less obvious result is that since a lower-skilled worker cannot legally offer his services at the lower rate, and thereby gain new skills while on the job so to be eventually worth the higher rate, he is thus effectively locked out of the legal employment market. The traditional avenue of working one’s way up the ladder, gaining new on-the-job skills, is, under these circumstances, removed as an option from the employee. He simply cannot legally do so. (The worker can, however, offer his services on the black market, out of view of the government, and no doubt many are forced to do just that. And ironically when this occurs, the government ends up, as a side effect, with less incoming tax revenue since black market wage payments are generally made in cash.)
In response to these mandated higher labor costs some may argue that employers can simply raise their prices to offset these increased costs. To some extent, this is true. But in most cases, raising the price of an item means consumers will choose to buy less of it, or to substitute for it some other less expensive item, thereby ultimately reducing the employer’s profits. For instance, if the cost of coffee rises, perhaps drinking tea becomes more attractive to the consumer.
Also one must consider that those employers who had been only barely surviving while paying the lower wage rate will have no choice but to raise their prices–for them any increase in business costs, labor or otherwise, is fatal. But once these barely surviving employers do raise their prices, many will soon go out of business entirely as customers, reacting to the increased prices, reduce their purchasing accordingly–thereby creating another route to more unemployment.
Some on the left argue from a misplaced moral perspective that industries who pay their employees below-sustenance wages should go out of business. But let’s follow that argument to its logical conclusion. First and most obviously, everyone working in such an industry that “should go out of business” immediately loses his job (thus, more unemployment). Second, consumers lose whatever products such an industry had provided, which will tend to increase consumer prices for that product, a reaction to its reduced quantity. Third, and most important and often overlooked, even though the worker’s pay rate had been low, it was (and probably still is) the best alternative he had at the time. Otherwise he would have taken a more attractive alternative to begin with.
Thus in spite of the worker’s own desires, he is forced into alternative areas he had previously deemed less desirable. And even worse for such workers, the additional competition for the available jobs in these less desirable areas will tend to lower these jobs’ wage rates.
What are employers’ wage-setting options? A rational employer raising or lowering an employee’s wages is not acting capriciously. He neither raises wage rates out of the kindness of his heart nor lowers them out of the greediness of his purse. Instead, based on a wide variety of competing market conditions and the existence of businesses in competition with his own, only a very narrow range of wage-setting options are actually available to any employer at any given time.
For example, if he pays employees too much relative to market conditions, his business suffers relative to his competition, and he finds himself at a disadvantage; his costs are higher than theirs. And if he pays noticeably lower than his competition, he will tend to lose good employees to his competitors, again finding himself at a disadvantage. So unlike the freedom a parent may have doling out allowance increases to a child, an employer is quite restricted: he has only a very narrow range of wage options available if he wishes to stay competitive.
And consider an employer hit with an increase in the minimum wage rate who had been planning to expand his business . This increased wage cost may prevent him from having enough capital to do so. As a result any new employment that would have arisen from his business expansion is prevented or reduced. And not just for those whom he would have employed directly. Other businesses with which he would have transacted during his expansion, but now will not, will be that much poorer, thus exacerbating unemployment forces in these other businesses as well.
And even if the employer were to borrow to replace the capital he must expend paying higher wages, and thus goes ahead with his expansion plans, the amount he borrows is then no longer available to other businesses to borrow, thereby creating an identical problem for these other businesses and their possible business expansion plans. These are the kinds of secondary effects that need thoughtful analysis when creating new economic policy, yet rarely get such analysis, especially from our political leaders.
No one denies that raising the minimum wage rate does indeed benefit some workers in the short-term. But when considering the longer-term effects of such a rate increase, the kinds of considerations we’ve made here, we see there is more to the story. The real, negative consequences of such rate increases are generally more than enough to wipe out any short-term benefits to society as a whole. These negative consequences, so often overlooked, are nevertheless easily understood when pointed out. Still, for political reasons, the fairness argument, of which you will be hearing much between now and the 2014 midterm elections, is constantly rehashed. But it is a nostrum, an emotional argument devoid of economic understanding.
The only real way to increase workers’ standards of living is by increasing their productivity and thus their worth to employers. These remedies include new time-saving machines and inventions, greater management efficiencies within industries, and better worker education. Quite simply, the more a worker can produce for his employer, whether a worker provides skilled or unskilled labor, the more he is worth to his employer. When such a productivity increase occurs, employers in competition with each other naturally bid up the price of labor. This competition increases workers’ money wages (the amount they get in dollars).
A final question. What prevents an employer from underpaying his employees and pocketing the “excess” profits that accrue after an increase in worker productivity?
The employer would like nothing more than to add this increased-productivity gain to his own profits. Indeed, that’s why he’s in business. But ultimately one of his competitors will realize that he would have a competitive advantage by using at least a portion of this “excess” capital to raise the pay rates of his employees, allowing such a competitor to attract better employees (better in the sense that he expects to gain more profit from their services), and thereby gain a competitive advantage. It should be noted that when such a competitor raises wage rates in this manner he does so not out of the kindness of his heart, but instead out of his own self-interest. Such is the beauty of capitalism.
This is a great example of the free market’s “invisible hand” of which Adam Smith wrote so eloquently in The Wealth of Nations: the self-interest of free market participants, without any government coercion, increases the wealth of society as a whole. In the case we’ve been considering, competitors acting out of their own self interests bid up the price of labor, allowing workers to share the benefits of their increased productivity. Again, an employer attempting to keep for himself all the gains resulting from increased worker productivity would, in short order, find himself at a competitive disadvantage.
And in their roles as consumers, workers enjoy further the fruits of their increased productivity–an increase in purchasing power. When workers are more productive, they (and all society) benefit from the resultant increase in quantity of available products newly available at lower prices. Indeed, this is the only definition of an increase in standard of living that is actually meaningful–one that results in an increase in purchasing power. In contrast, a government-mandated increase in the minimum wage does not increase society’s standard of living–just primarily its unemployment rate.