2/12/2007

Minimum Wage Laws

A bill proposing to raise minimum wage from $5.15 to $7.25 recently passed the House and is currently up for debate in the Senate. Minimum wage is a law often taken for granted as a sound economic and social tool, so I thought it would be interesting to put forward some classical arguments against it. These arguments are much the same as those against tariffs and price-fixing, and in general can be found in the short book Economics in One Lesson by Henry Hazlitt. For the sake of classification, Hazlitt's views are fairly Libertarian. He is also frequently grouped as a member of the Austrian School of economics.

Anyway, here are the arguments. One perspective that is rarely stated clearly is that a minimum wage of $7.25 makes it illegal for someone to work for less, even if he wants to. For example, if Adam's labor has a market value of $7, a minimum wage set at $7.25 may have the effect of putting him out of his job. So long as there are people available, say, Bob and Cindy, whose labor is valued at or above $7.25 there will be no incentive for anyone to hire Adam. Prior to this wage law Adam could have competed with Bob and Cindy by working for less, but now it is illegal for him to do so! Unless there is a large shortage of labor it is difficult to force employers to pay workers more than the workers' market value. And even in a shortage, the value of labor would tend to adjust itself.

But even in a situation where companies have no choice but to pay higher wages, there are compelling downsides to a minimum wage. A company that is already operating on a sufficiently thin profit margin, if forced to pay higher wages to its workers, will go out of business. That raising the cost of business can, in fact, hurt business is rather obvious but often overlooked. Or consider - if minimum wages are raised, driving the cost of labor up, alternative methods of production may seem attractive to employers. A factory owner who would not have previously considered mechanizing his workforce with high-tech robotics, for example, may be enticed to do so now, if the new cost of human labor is comparatively more expensive.

Both of these examples are demonstrated well in this case study. Though the writer of that blog is unequivocally Libertarian, his personal experiences stated in the article are factual, so I think his credibility is still good. A nice one-liner from the article is "If the government set a price floor for gasolene, say at $3.00 a gallon, would anyone out there argue that people wouldn't use less gas?" This seems similar to something Hazlitt points out: wages are no different than any other price of any other commodity and it is unfortunate that we think they can be handled on a separate basis.

Of course, some might say, most companies, if they must, will be able to raise their wages to the legal minimum. But even this dubious assertion overlooks a few things. As a result of higher wages the companies will not be able to grow as quickly or produce as much as before; and indeed, if they want to maintain their pace of growth they will have to raise prices. So the prosperity that is passed to the workers is borne by the consumers at large and by anyone who would have benefited by these companies' continued expansion (e.g. the unemployed). The losses of the consumers and the still-unemployed are much harder to notice than the gains of the workers, but they are no less real.

This argument has brought forth some key reasons why minimum wage is ineffective as both a tool of charity and a stimulant of growth. Changing the owners of money is not what helps an economy; increasing material wealth is the only true improvement. A worker's value, and hence his real wages, rises when he is able to produce more - not when the government declares him to be worth more. To truly help raise wages a government should enact policies that encourage growth and increased efficiency, not the opposite.

4 comments:

Demosthenes said...

"John Galt" is entirely correct about the efficiency consequences of raising the minimum wage. Although the small-business tax cuts that the Senate has added should alleviate much of the cost to businesses, there is no way for the government to raise the price of labor without creating a certain amount of inefficiency in the economy. But while the economic argument is entirely true, and very much in keeping with classical liberalism, the author falls into the trap of mistaking economic efficiency for the well-being of society.

The core of what I object to in the author's argument lies in the following statement: "Changing the owners of money is not what helps an economy; increasing material wealth is the only true improvement." While this is correct from a strict economic perspective, it ignores the true reason for the increase in the minimum wage. The Democrat-led Congress did not vote to increase the minimum wage because they believed it would increase minimum wage, they did it because they believed it would improve American society and increase equality and opportunity. None of these goals are those of an economist, but there are few who would not see them as the obligations of a government.

Economic efficiency is a worthy objective for a government, but it is not the only objective, nor should it necessarily be the primary objective. If Bill Gates moved to a poor African country, that country would have "increased its material wealth." Yet the government of this country would be morally reprehensible if it did not find a way to redistribute some of this newfound wealth to its poorer citizens. Similarly, the United States government would be remiss if it did not put some of the fantastic wealth that our economy generates into improving the lives of its workers at the bottom of the ladder.

$5.15 an hour, for forty hours a week, for fifty weeks a year, makes someone a whopping $10,300. I think our economy can afford a bit of inefficiency to do better than that.

Steph Blake said...

“So long as there are people available, say, Bob and Cindy, whose labor is valued at or above $7.25 there will be no incentive for anyone to hire Adam. Prior to this wage law Adam could have competed with Bob and Cindy by working for less, but now it is illegal for him to do so! Unless there is a large shortage of labor it is difficult to force employers to pay workers more than the workers’ market value.”

Two interesting things:

This argument would work well for an industrial society, say, the America of 50 years ago. And I would argue that it still works well for third-world countries: enforcing a minimum wage of even $5.15 an hour in most of the countries where our products are made would be considered unthinkably lavish. And as for the statement “Unless there is a large shortage of labor it is difficult to force employers to pay workers more than the workers’ market value,” well, this certainly happens: with increasing globalization, companies can pick up and leave in a constant race for cheaper labor.

But this is American legislation we’re talking about. Certain jobs will always have to be done: Morgan Stanley needs janitors, and Princeton University Dining Services needs servers (who are, disturbingly, just about all Caribbean or Hispanic: just let them all in as undergrads and we’d have no more problems with diversity). For these folks, raising the minimum wage will make their lives a little bit closer to bearable.

Also:

Bob and Cindy’s labor is valued at $7.25 an hour. I suppose the economics meaning of this is that value is what employers are willing to pay. But I’m an English major after all, and the word “value” is pretty interesting: What is it that makes Bob and Cindy’s labor valued at $7.25 an hour, management’s labor valued at $7.25 a minute, and the CEO’s labor valued at $7.25 a second? From what I see around me, it seems if you’re a Nicaraguan living in the Princeton area your value is $5.15, and if you’re a Princeton student you’re headed off for the Holy Grail, the source and meaning of all life: I-Banking.

I believe that the idea of “value of labor” has been stressed to the level of absurdity. We’ve been getting better, cheaper, more efficient, and paying the human cost. All we see is sanitized, standard products—not the people, living thousands of miles away, who produce them. The closest we can get to that is, if we keep our eyes open, the people who are serving us, now that we’re Princeton students, assured a place in the upper echelons of society (provided that’s not where we came from in the first place). I know this makes me uncomfortable: but I won’t make any fancy economic arguments to relieve that anxiety.

mmk said...

Always a hotly contested issue in Congress, the debate over minimum wage has been raging for decades. While Galt argues that minimum wage is an inefficient deterrent of economic growth, I would argue, on the other hand, that minimum wage is a fair and necessary market regulation policy.

Thousands of adults struggling to make a living rely on federally mandated minimum wage to get by. If this government sanctioned minimum wage were to be abolished, firms would be given much more freedom in their hiring choices, potentially putting many low-wage adult workers who depend on minimum wage, out of a job; firms would be able to hire teenagers, for instance,—still living as dependents and therefore willing to work for much less—instead. Understandably, a company is not going to pay seven dollars an hour for a factory worker when a teenager is willing to do it for half that, and arguably just as well.

Furthermore, an inappropriately low or non-existent minimum wage would arguably give corporations an unfair power in the market. A flooded job market, especially during recessions, gives workers the choice between accepting terms of employment laid out by firms, or starving. This gives corporations huge and potentially abusive power over their labor supply. Minimum wage, many economists argue, sets a reasonable price floor, thereby providing workers with much-needed protection from potential exploitation.

Indeed low-wage labor markets are often characterized as monopsonistically competitive; as outlined above, this type of competition gives employers significantly more market power than the employees, leading to a type of market failure which ends in workers being paid less than their marginal value (basically, the fair value of their labor as determined by a perfectly competitive market). Assuming this characterization of the low-wage labor market is accurate, an appropriately set minimum wage could increase both wages and employment—obviously, workers wages would increase but, furthermore, more people may be encouraged to work by this more adequate compensation.

Ultimately, this perspective paints price-floor legislation such as minimum wage as a necessary market regulation policy akin to anti-trust legislation, rather than an inefficient, economy-draining “hand-out” to low-wage workers. While opponents to minimum wage might point out that no collusion between companies to keep prices low has ever been exposed, it is important to understand that collusion is not the only propagator of unbalanced market power. Indeed, under the monopsonistic assumption, inequitable market power is a natural condition of this competitive paradigm.

In another point, Galt argues that if minimum wages are raised, increasing the cost of labor, than employers may simply higher fewer workers or seek “alternative methods of production,” such as machinery, thereby driving up unemployment rates. As economist Riddell argues, however, firms already minimize the number of laborers they need to produce their good. He points out that “a number of recent studies indicate that moderate increases in the minimum wage have had no effect on the rate of unemployment. Once the minimum wage is increased, firms must continue to hire the same number of unskilled workers in order to supply sufficient quantities to their customers”(see endnote) This therefore indicates that the demand curve for unskilled labor is extremely inelastic. In other words, employers demand for workers (labor) is very minimally sensitive to price changes in labor.

Moreover, new economic models recognize that employers are able to absorb some of the cost from an increased minimum wage through the resultant higher productivity (due to increased worker morale) and lower recruiting costs (due to a rise in readily willing and available workers). While Galt points out in his post, “a worker's value, and hence his real wages, rises [only] when he is able to produce more, not when the government declares him to be worth more” what he overlooks are the possible effects increased incentive and morale can have on worker productivity. By this line of reasoning, if a worker feels better compensated and more valued, his productivity increases and he is therefore worth more in real terms; immediate assumptions of causality may be reversed, but the result is the same—the worker is getting paid more for producing more.

Surely, no one would argue that price-floors could be raised indefinitely without negative consequences. It seems that there is a range, however, in which moderate wage-increases can help lift low-wage workers out of desperation without jeopardizing labor-demand and therefore employment. This theory was demonstrated by the congressionally legislated minimum-wage increase in 1996—-low-wage workers were able to gain back some much-needed earning power in real terms, and unemployment, interestingly enough, fell to its lowest level in decades.

Ultimately as a Democratic Member of the House, Loretta Sanchez, asserted in January, “for too long the disparity between the wealthiest and the poor has been going on and continuing to grow in America. And it is in no small part due to the Republicans not raising the minimum wage in almost 10 years…For Americans…this is an important law to pass today.”


1. Tom Riddel, Economics: A Tool for Critically Understanding Society, (San Francisco, CA: Pearson, AddisonWesley, 2005), 234.

cody said...

Since 1998 when real minimum wages (that is, adjusted to 2006 dollars) were at their highest level since the mid-1980s, the federal minimum wage has remained unchanged in nominal value (which of course meant that $5.15 in 2006 was worth less than $5.15 in 1998). And yet, real average wages have continued to rise since 1998, by almost 5%. Now, consider that unemployment rates in 2006 are virtually identical to those of 1998, and we are forced to one, logical conclusion: in the last decade while the Republican congress has "ignored" minimum wage, the average American worker has somehow, miraculously found a way to take care of himself and increase his real wages, without any "help" from the federal government.

I'd hate to channel Russell Kirk here, but raising minimum wage is an ideological victory that does absolutely nothing good for the economy as a whole. To the people who are able to keep their minimum wage jobs while enjoying an undeserved 40.8% pay raise, I say, go out, buy a lottery ticket, and put your good luck to good use. But the truth is, the vast majority of American workers working at or around minimum wage will have a harder time finding a job, and a harder time keeping a job.

It's time to apply those lessons in conservativism. A minimum wage increase is not going to eliminate poverty or close the wealth gap in America; it will however have many other severe, unintended consequences. The economy is in good shape right now, and this sort of idealism is just the thing to derail it.