The truth about the minimum wage

Last week, multiple states and cities passed ballot initiatives to increase their respective minimum wage. As if it were a referendum, liberal pundits have been quick to note that many of the states passing a hike in the wage floor are controlled by Republican state legislatures. However, the pundits continue to ignore the truth about the minimum wage. It is, no doubt, an unpopular truth, so most ignore it. The answer to a simple question should squash all debate regarding the minimum wage: If raising the wage worked, why do we have to keep raising it? Hold on to that thought, and let’s dig deeper…

Deeper

When most people think of supply and demand, they associate the idea with goods and services, which they pay for with their money, such as cable television, groceries and utilities.

The majority of Americans understand that if a drought occurs, then many plants will die. This will cause fewer plants to yield produce, which will cause the supply to be limited. Thus, the price will increase due to movement relating to the supply curve. They also understand that if Apple’s next iPhone was filled with new, groundbreaking technology, then the price of the iPhone 6 would soar due to movement relating to the demand curve.

However, many people do not associate minimum wage with supply and demand. This should not come as a surprise. The vast majority of Americans aren’t business owners. Due to this lack of experience, most do not understand the market laws at play.

Supply & Demand

The fact is, minimum wage is a perfect example of supply and demand. Actually, it’s Economics 101. Employees are suppliers of labor (supply). Employers are the consumers of that labor (demand). Since the minimum wage was created in 1938, economic deadweight loss has ensued.

The minimum wage is a price floor. This means that a firm can pay no less for your labor than what the government dictates. How is this creating economic loss? Wage floors prohibit voluntary labor contracts.

For example, say a 14-year-old kid wants his first job at McDonald’s. The candidate has no skills, he’s never worked before, is vastly inexperienced and presents a sizable risk to the firm. Due to the fact that the government has now mandated the employer pay the 14-year-old $15/hour, the firm decides to hire someone with more experience. The kid voluntarily offers to work for $7.50/hour. However, the government won’t allow it. A potential contract has now been killed, and economic deadweight loss is the result.

Furthermore, firms can only pay wages that are below their average revenue product of labor (ARPl) curve. In layman’s terms, if the firm only nets $1.00 of profit per unit of labor at a cost of $9.00/unit, then a $1.10 increase in each unit of labor will net the firm (-)$0.10.

If labor currently costs $9.00/unit, and the government mandates firms pay $10.10/unit, then the firm must do one of three things. The firm will either raise prices in order to maintain all units of labor, fire employees (results in decreased production–supply), or fire employees and require that current employees increase output to compensate for lost labor units. Yes, even a $0.20 increase will have this effect on some firms.

Various firms will react differently. The net result is lost jobs and increased prices for goods and services (inflation). Higher prices for goods and services are further accelerated by the fact that some firms are now producing less due to higher variable costs. This causes movement with relation to the supply curve and prices increase even if demand remains constant.

Democrats have attacked this as being a fallacy. It is not. It is an economic truism that all artificial floors and ceilings result in loss.  The Congressional Budget Office has already verified that increasing the minimum wage right now will destroy 500k-1 million jobs. One million people out of work? That’s exactly what we need while moving through a quasi recovery from the recession.

America’s Poorest Crushed

While proponents of higher minim wage laws argue that it will better serve the poor, the exact inverse is true. Wage floors actually hurt America’s poorest. Many low-skilled individuals seek “black market jobs”. These jobs are off the radar of government’s restrictive wage laws. Think of baby sitters, handymen, maids, farm hands and other similar “cash under the table” jobs.

The majority of employees in this market lack the training and experience to seek more lucrative jobs. Therefore, they often find themselves in poverty and unable to climb the career ladder.

As noted before, an increase in the minimum wage will cost jobs. One million workers who were previously employed at the old wage floor are now unable to find work. Fired because they lacked the marginal value necessary to maintain employment, these individuals will have an extremely hard time finding work at the new wage floor.

What will they do? They flood the secondary labor market looking for cash jobs because they cannot find employment at the new wage floor.

This causes a surplus of labor (supply) in that market. Therefore, as consumers (demand) of labor, firms can now pay less for each unit of labor due to surplus conditions created by the higher wage floor.

America’s poorest are now in a far worse situation than before due to the new labor surplus in their market. Their wages are now being reduced, and increased competition for available jobs now exists. This is then compounded with inflation from the minimum wage increase, which results in the purchasing power of the dollar to decrease. The net result? America’s poorest are now making less and their dollar is worth less.

To promote a minimum wage increase as salvation for America’s poorest is purely insidious. In reality, the effects on these Americans is simply detrimental.

Solution

The minimum wage has been raised countless times since its creation. Yet, it doesn’t seem to be working. If raising the wage floor worked, then people would no longer be in poverty and all would be prosperous. The solution is simple. America must return to sound fiscal policy and abandon the Federal Reserve’s fiat monetary system. Until this occurs, minimum wage will continue to be adjusted upwards. Soon enough, the wage floor will be $100.10/ hour, and a happy meal will cost $70.00. The wage itself isn’t broken— It’s the money that is broken.

2 thoughts on “The truth about the minimum wage

  1. Omar, as the brevity of your “Solutions” section indicates, there are no simple solutions. Overhaul of the current money markets would face opposition from many corners. You make a compelling argument about the deleterious effects of raising the minimum wage. How is this addressed in other industrialized nations, and what has been the outcome?

    Would you agree that The Medicare fee schedule has become the de facto minimum wage per unit of production for health care providers? If so, what would happen if that benchmark was not used?

    • Patti,

      Sorry I’m just now seeing this. Thanks for your response.

      I think the best answer truly rests in education and incentivizing social advancement. Some of that means purposeful and systematic reduction of welfare for those that are capable of working. Of course, some will still not be motivated to improve, but then the question becomes “How much responsibility does society have to care for those who though capable, have no interest in caring for themselves, or for those who have no interest in contributing to others?”.

      Re Medicare – Yes, it has. If it were not, I believe that insurance company profits would fall as their costs increased, and healthcare costs would decrease as market forces forced them down as provider margins would increase and allow for more competition.

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