Washington Monument

The Dangers of the Minimum Wage

The question of a minimum wage is a feel good issue that is hard to debate in our society of sound bites. The concept is based around the attempt to right social injustice by creating a "living wage" capable of supporting a family above the poverty line. The problem is that minimum wages are part of the systematic destruction of the free market and the underlying lower class. These very laws that are being pushed to help the impoverished are actually perpetuating the cycle of poverty.

Most minimum wages work by setting a base wage that an employer can pay for labor. The concept is that in a free market, the poorest people are not paid enough to survive. We must, therefore, compensate by making the lowest wage possible more palatable.

It sounds good on paper.  The problem is that the United States has a free market (At least in theory).  By increasing the minimum wage you create inefficiencies in this market.  These inefficiencies manifest themselves from the nuisance of increased prices for consumers to the terrible consequence of unemployment for the unskilled. 


The Demographics

Let’s examine the statistics relating to who is actually affected. According to the Bureau of Labor Statistics 2006 report, of the 72.5 million hourly-wage workers in the US, only 1.7 million were minimum wage recipients. That's about 2.3%. Of the minimum wage earners, about 5.3% are in families that earn less that the poverty line.

What does this mean? Of the 72.5 million hourly wage workers, the great majority either has a second job or lives with other family member and is not the sole income earner in the family. In short, 94.7% are not the intended recipient of the increase. Who are these people? Typically they are people that have additional sources of income such as semi-retired people. Also, housewives (or househusbands) looking to get outside and earn a little extra cash would fit in the category.  Finally, a very important labor segment is teenagers, which we will explore more in depth later.


Economics 101: Labor is a Market

If a company can pay as little as the minimum wage, why would they pay more?  Sometimes the have too.  An employee that is productive is a valuable commodity.  An efficient employer will recognize that the employee is valuable and fairly compensate to prevent losing them. If they don't, the employee is free to shop their skills to another employer who will recognize their value. This the way the labor market works.

In the case that the employee doesn't become more valuable, they remain at that wage. In time the employee realizes that they are not getting an increase in their salary and thus will choose to stay at the current job and wage or perhaps try a different vocation.

The result is that the labor market rewards workers for their skills. If they have skills, they are duly compensated. If they don't, they need to pursue lines of work where they will develop them. Minimum wages prevent this process from happening by rewarding people for not developing skills.

One cold cruel reality is that some people will never develop skills for a number of reasons. These people are a small minority of the labor market and need to be helped in a more targeted fashion. Minimum wages help these people at the cost of creating barriers to entry for unskilled workers and costing every citizen more every time they shop.


Unintended Consequences

Assume an employer in a perfectly competitive market has 5 employees and an hourly labor budget of $40 that they use to pay employees. Currently, each employee makes $8 per hour. Lets say a minimum wage was implemented that would change the base wage to $10 per hour.

The employer has two choices. Either fire an employee, leaving 4 to work within the hourly budget or raise prices by a corresponding amount. In the first scenario, if the company could get by with fewer employees, the employer would have recognized this already and laid a person off. So, the only option left is to raise prices on all consumers by a given percentage. But, with an increase in payroll, there is a corresponding increase in payroll taxes, so a $5 payroll increase results in the consumer having to absorb $7.5 in increased costs.

We’ve raised the wage for 100% of the minimum wage earners to help 5.3% of the market. And those costs are passed though to the consumer, of which the minimum wage earners are.  Remember that we determined that about 94.7% of the minimum wage market has a secondary source of income.  So the other 5.3% has to shoulder the increased consumer cost of everyone else.  Sure they have had an increase, but with payroll taxes the cost of goods have risen proportionally.  Interference in the market has resulted in an increase in the cost of living while not appreciable helping the needy.

There is always the notorious scenario that is occasionally brought out by those ignorant of economics. This would be that the CEO's and managers in the world could just write off the extra cost of labor from their extravagant salaries, corporate junkets, etc. 80% of businesses in the US are small businesses and rarely do they have the ability to pay labor increases out of petty cash. Those that do have the excess resources understand the market and how the additional cost of labor is passed on to the consumer. Businesses are in the business of making money and rightly so.

The result is that a minimum wage is merely a tax increase and not a very smart one. It gums up the works of an efficient labor market by setting limits on what people are willing to work for. And when you set limits, there are always side effects.  Some of them are very damaging


The Tragic Consequence

The real problem with minimum wage is its fierce impact on the unskilled and those seeking their first job experience. Unemployment among 16–19-year-olds was 17.3% in 2005, as opposed to 5.6% overall. When split out by ethnicity, Hispanic and black teens had unemployment rates of 25% and 40% respectively.

The same people that have been pushing the minimum wage have been squealing about the long term social effects of the youth unemployment. The ironic point is that they are potentially interrelated. By interfering with the free market, minimum wages prevent at risk youth from obtaining their first positive job experience. These youths fall to a seedier career path, eventually making decisions that will forever bar them from being a significant contributor to the labor market.


All Criminals Are We

We already skirt the minimum wage in a number of areas.  We just don’t think of it as such because the people we pay are usually children.  How many people pay babysitters the minimum wage?  How much do you pay the neighborhood kids to feed your pet when you are out of town? 

These are examples of people ignoring minimum wage laws because it’s convenient or because the people involved are just kids.  In reality, these are important labor markets because they teach children how to be responsible, work and negotiate.  Why are they paid less?  Because of their lack of labor skills, they are less valuable.  However, the popular and skilled babysitters are usually booked up on Friday nights and command a much higher wage. The free market system works even in these circumstances.


The Proper Solution

There are ways of helping people that don't interfere with the market and actually enhance it. Forget about minimum wages. Let people work for whatever wage they want to. People control the labor market by the fact that they can choose to not take a job. If an employer is paying too little, eventually they will be unable to fill that position because their competitors are paying more.  

The advantages are that unemployment would be incredibly low.  People would be free to negotiate based on their abilities.  New markets would open up that would allow people with physical or cognitive disabilities to enter into the labor market.  These people were previously barred from the market because they didn’t posses enough value to justify the minimum wage salary.  Now at a reduced wage they could actually participate. This would increase their independence.

Look toward job training as a long term solution for head of households and other interested parties.  By increasing the job skills of a worker, they increase their knowledge capital and become more valuable to the market place and the nation as a whole.  This is the key to the long term success of an individual in a labor market.  Once a skill set is learned, it is enhanced through experience creating a very valuable human resource.  By becoming more valuable, individuals can earn higher wages, fairly and without subsidies.

The increased demand for job training will result and more jobs being created to support the job skills industry.  Thus the result of this approach is not only a better long term job skill set for the workers, but increased employment in a number of support sectors.

In closing, interfering in the free market is always a bad idea.  The minimum wage is such interference and it is a nice idea that is disastrous in implementation. It is only through examining their finer points that you really appreciate that minimum wages are not only pointless, they could well be contributing to the decline of the working poor.


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