Legislating pay hikes would work if money grew on trees
In his 2013 State of the Union message, President Obama suggested that Congress increase the federal hourly minimum wage from its current rate of $7.25 to at least $9. Several states are also debating an increase; indeed, the California Legislature recently approved and Gov. Jerry Brown just signed a bill that would boost the hourly state minimum from $8 to $10 in three years. In Florida where I reside, the legal minimum (with some important exceptions) is $7.79 and is inflation-adjusted annually.
Is the current national hoopla to “do something” about minimum wages another governmental mistake? Absolutely. Minimum-wage laws lessen employment opportunities for workers (especially teens and low-skilled workers) and hurt some of the very individuals that they are allegedly designed to help — the working poor. Boosting the minimum wage substantially at the state or federal level would be a public-policy mistake.
To see why this is so, let’s ask the following question: What likely happens when we increase the price of beer, vacation rentals, books, newspapers or almost anything, while holding other variables constant? Answer: Fewer units of beer, vacation rentals, books or newspapers are sold in the marketplace. In economic theory, that’s the so-called “law of demand” in operation; at higher prices, fewer units of some particular good or service are purchased.
There are several logical reasons for this conclusion. The first is that goods and services are purchased out of someone’s fixed income. If, say, I have $500 to spend (and no more) on bags of mulch for gardening, and the price of mulch increases, then I simply must purchase fewer bags of mulch. In economic theory, this is called the “income effect,” and it always operates to reduce the number of units sold.
Another reason a price increase lowers consumption is that buyers tend to substitute a relatively cheaper product for the good whose price has increased. Price increases for premium mulch push consumers to buy a non-premium mulch instead; developers substitute less-desirable building lots for more expensive ones; as newspaper subscription rates increase, consumers move increasingly to substitutes for news, such as the Internet. This so-called “substitution effect” practically guarantees that higher prices for some particular commodity will mean fewer sales of that commodity.
The law of demand operates in all markets, including and especially labor markets. If I operate a lawn service or a car dealership, or if I’m a big-box retailer, any increase in the cost of labor that is not accompanied by an increase in productivity will decrease my incentive to hire or retain workers. With my income revenue relatively fixed, I simply must use fewer factors of production. In addition, I also have an incentive to substitute a cheaper non-labor resource in an attempt to maintain the overall productivity of the operation. Thus, the monetary incentives associated with the income and substitution effects result in fewer workers hired or retained.
This is especially true if the worker is relatively inexperienced and only marginally productive. (Florida allows a lower “training wage” for workers under age 20, but only for 90 days. Most states are not even that generous.) After all, wages paid by an employer tend to reflect the estimated monetary contribution an employee is likely to make to overall production. If, for example, there is a new government minimum-wage law of $10 per hour and some employees currently generate, say, only $8 in revenue for the company, those workers are on their way to the unemployment line. The law of demand will simply not allow a rational employer to retain those workers or hire new ones with similar productivity profiles.
Some advocates of a higher minimum wage claim that “studies show” that increasing minimum wages does not lower employment as theory predicts. This is false on several levels. First, most careful studies do show employment declining. Second, the few that don’t may be seriously flawed since they fail to account accurately for certain variables, such as productivity and changes in personal income, that wash out the negative employment effects of higher minimums. Finally, in a strict sense, historical data cannot prove or disprove any theory (though it may be illustrative of probable outcomes) since it’s always unclear which variables are relevant and fully accounted for in any empirical study.
Minimum-wage laws always decrease employment opportunities and always interfere with free choice and the freedom of contract. They are supported by politicians seeking votes and by labor unions anxious to cripple nonunion competitors. They are also inherently discriminatory since they hurt only workers on the lowest rung of the employment ladder. Workers making $30 an hour are not directly affected. Increasing the minimum wage provides no boost to overall consumption, as advocates maintain, since the workers displaced easily negate any slight income change for the workers retained.
Increasing the minimum wage is hardly a “moral imperative” as some of its vocal, self-righteous advocates maintain. Indeed, government-mandated minimum wages are an immoral infringement on individual rights and an inefficient economic hoax parading as enlightened public policy. “I’m from the government, and I’m here to help you, the working poor.” Don’t buy it.
Dominick T. Armentano is a research fellow at the Independent Institute.