Minimum Wage Madness

President Obama proposed raising the nationwide minimum wage from $7.25 to $9.00 in his State of the Union address last week.

The idea that politicians can set a minimum price for wages and automatically increase the wealth of the country is so pervasive that it warrants discussion. Wgoing deep into economic theory, the case against increasing the minimum wage (and, indeed, against the minimum wage itself) is that the government cannot arbitrarily increase the cost of doing business without adversely impacting profitability and employment.

The idea that increases in the minimum wage can easily be paid for out of the profits of business without damaging the economy only makes sense if every business in every industry is run by the Monopoly guy and his buddies, all running around in their top hats and monacles with big bags of money thrown over their shoulders.

If we try to understand economics better, however, we can see the fallacy of this argument. First, businesses exist to make a profit. If not for profits, the business wouldn’t exist and neither would the jobs it provides. Additionally, different companies earn different levels of profits, so arbitrarily taking profits out of the economy will impact companies differently. Typically it is the small business that is less able to absorb this loss of profits. So, strategies that attack profits are likely to result in higher prices, higher unemployment or both.

This is an entirely logical conclusion. If a company’s costs of production go up because they have to pay their employees more, they have to compensate for it in some way. One way is to pass the cost increases on to the consumers by raising prices. Assuming that workers who earn minimum wage are also consumers, which is a pretty safe conclusion, we can see how this betters their situation in no way whatsoever.

Another way a company can react to hikes in the minimum wage is to cut employment. The company can choose to reduce their workforce and expect a smaller number of workers to produce the same amount of output. Or, depending on the cost of machination, they can choose to invest in machinery that will stabilize their production costs. If this happens, an even larger number of employees will be thrown out of work.

Economist Walter Williams has written about this phenomenon several times, noting specifically the impact of minimum wage requirements on the canning industry in American Samoa, where increases in the minimum wage caused a loss of 2,000 jobs.  Williams asks the key question, “Which is preferable for the Samoan worker – being employed at $3.25 or being unemployed at $5.25?  Which buys more of life’s essentials?”

Economists have also noted how minimum wage laws negatively impact the part of the workforce that can least afford it, namely low-skill workers. Labeling a worker as low-skill is not an insult for, after all, how can someone acquire skills but by working. But if a government raises the minimum wage above the level which low-skill workers provide value to a business, the business is much less likely to hire them into these entry-level positions. This means that the people who badly need the opportunity to learn and develop skills never get that chance.

When politicians talk about the minimum wage, the only thing we hear about is the people whose paychecks will increase by $1.75 an hour and, based on this observation alone, the policy is considered essential. However, this kind of thinking is lazy and uncaringly casts aside the consumers whose prices are raised and the workers who are currently employed but who will lose their jobs once the policy is implemented.

Even if we believe that politicians are simply trying to be helpful, it should be obvious logically and by looking at the evidence that minimum wage policies do no good, at least if we look at the economy as a whole.

Some ideas sound reasonable if they’re not thought through completely. Unfortunately there are many people who don’t engage in the process of considering all the impacts of government interventions in the economy. In the end, believing in the efficacy of the minimum wage is about as helpful as believing that if you add enough layers of carpet to your ground floor apartment, you’ll end up in the penthouse.