As protests in New York for increasing the minimum wage made Andrew M. Cuomo to announce a raise, well, many economists would argue that the minimum wage should be abolished entirely and instead we should focus on a more efficient earned income tax credit.
Let me start off by saying that the reasons some people support minimum wage increases are obvious. I think it’s important to acknowledge that the people trying to increase minimum wages are doing so with good intentions. These people are laudable in their intentions but deficient in their analysis. If we could wave a magic wand and help those at the bottom of the economic ladder move up a rung or two, we should do it. But enacting a social reform is not like waving a magic wand. It is more like prescribing a drug with a long list of side effects. Sometimes the side effects are worse than the disease.
All that being said, if I’m actually about to invest my time into a legitimate conversation regarding wage floors, then we need to acknowledge specifically how wages work, I know this seems rudimentary or tedious but all too often I start having a conversation with someone and later realize that I’ve been basically banging my head against a wall for the entire duration due to a lack of understanding for basic economic concepts and principles.
Like most other prices, wages are set by the market forces of supply and demand. The major difference between high-wage workers and low-wage workers is not that the former are better organized or better liked by their employers – it’s that their higher productivity enhances the demand for their services. Workers earning only $9 or $10 an hour are typically those with the fewest years of education and the least experience, which depresses the demand for their labor.
Therefore, this current campaign for increasing minimum wages subsequently wants to repeal the law of supply and demand and raise wages by fiat. The goal is to help low-wage workers. Unfortunately, it wouldn’t work out that way. One of the many adverse effects of a higher minimum wage is a reduction in the amount of labor that employers demand.
For example, let’s use the janitorial staff at any large corporation. How often does a company need its janitorial staff to vacuum the halls and clean the toilets? It’s a judgment call. An increase in the wage from $8 to $10 an hour raises the cost of labor by 25 percent. It is wishful thinking to suggest that this won’t affect the number of workers hired in any way. The actual proposed minimum wage of $15.25 is an even steeper price increase. I just like to keep the numbers small and round for simplicity.
Obviously, we also have to acknowledge that employers are always making cost-benefit calculations, weighing the benefits of one project (hiring more janitors to clean toilets) against others (hiring more sales representatives to increase revenue). By raising the relative price of unskilled workers, the passage of a steep minimum wage increase shifts the trade-offs in a way that means fewer of those workers will be hired.
Moreover, the adverse effects of a high minimum wage go beyond its impact on total employment. In addition to reducing the amount of labor demanded, a high minimum wage compounds the problem by increasing the amount of labor supplied. In other words, not only are there fewer jobs available for unskilled workers, but more people apply for those jobs.
Very simplistically, increasing labor costs obviously leads to an impact on labor demand. This should go without saying.
In addition to the employment impact of raising minimum wage, we also have issues with inflation, price elasticity, and overall policy effectiveness. In regards to inflation, it’s easy to assume that rising labor costs will encourage firms to raise prices, which multiplied out over the scale of an entire economy, does lead to inflation. This is why we don’t see countries tying in minimum wage laws with inflation; it’s basically like chasing your own shadow. If the costs associated with producing toilet paper increase by 30%, how much will the end price of toilet paper be? Will it increase by 30% to maintain steady margins? In some sectors the answer is yes, and in others the data is a little fuzzier. Price elasticity does play a role in this discussion but I think that’s best saved for another day.
Lastly, mostly because I’m getting bored of typing all this, we have an issue with policy effectiveness. What is the ultimate goal of increasing minimum wage and does it accomplish that goal? If we look at data from across the globe we see that there is no correlation between minimum wage and rates of poverty. Australia has the highest minimum wage in the world yet has a rate of poverty almost identical to our own. Belgium has the lowest rate of poverty in the EU yet they don’t have a minimum wage. I’m not necessarily saying that correlation equals causation, or vice versa. But at the same time, I think it’s safe to assume that increasing minimum wage is definitely not like waving a magic wand. There are simply too many prevalent variables that go into poverty other than wage floors. In Australia we have seen very high cost of living, high prices, and reduced demand for low skilled workers which all contribute to poverty. The benefits associated with increasing minimum wage are negated elsewhere making it a much more viable political tool for rallying low income voters rather than a legitimate economic tool for combating poverty.
If you read this entire article, I applaud you. Honestly, I’m not even going to go back and proof read any of this because I’m so bored of listening to myself talk. In addition, to those who are interested, there are a variety of more well targeted and more efficient policies than wage floors being implemented around the world to help low skill/low income individuals without some of the adverse macroeconomic side effects. I encourage everyone to read up on something called the earned income tax credit, which in my dream scenario of a budget, our federal government could afford easily.