Minimum wage: Who wins, who loses? - Island of Sanity

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Economics

Minimum wage: Who wins, who loses?


When the government increases the minimum wage, who gains and who loses?

If you read the newspaper or watch TV news, it is clear that they believe the answer is: Low-wage workers gain. Big business loses, but who cares? they can afford it. Small business loses too, and that may be a problem. From a few casual conversations -- I make no claim that this is a scientific survey -- it appears that teenagers think that they are among the big winners when the minimum wage is increased. I have also heard a number of politicians give speeches in which they expressed the idea that poor families benefit.

This analysis is routinely stated as obvious fact. People who say this don't really present an argument that it is true, they simply take it for granted that it is true, and proceed from there to their conclusions. But in fact it is completely wrong, almost backwards, as a little serious thought will show.

Suppose that a company is paying a certain employee $6 per hour. This employee does work that brings in $7 per hour. So the employee is making $6 per hour, the employer is making $1 per hour profit, and presumably everyone is at least somewhat satisfied with the relationship. Now suppose the minimum wage is increased to $6.50 per hour. The employee gets a raise and is presumably happy. The employer is now making only 50 cents per hour profit on this employee's work. The employer is unhappy, but the relationship is still profitable, so he grumbles and pays it. In this example, the reality fits the TV scenario: the low-paid worker benefits, the business loses.

But now suppose that minimum wage is increased again, to $7.50 per hour. Now the employer is losing 50 cents per hour for every hour that this employee works. Maybe the company has enough other employees, employees who produce more than they are paid, that the company can afford to take a loss on this one person. And maybe the boss feels some loyalty to his employees and isn't going to lay somebody off unless he absolutely has to. In that case, the low-paid employee still gains.

But maybe not. What if with this latest increase in the minimum wage, the company finds that it has many, many employees who now cost the company more than they bring in? The company can't afford to operate at a loss forever. Sooner or later it's going to have to tell these employees, "We're sorry, but we just can't afford to keep you on any more." If it doesn't do this, than the whole company goes broke, and all the employees lose.

Thus, an increase in the minimum wage helps employees who are: 1) low paid, and 2) who produce more than the new, higher minimum wage. These employees get a raise. But minimum wage laws hurt employees who are 1) low paid, and 2) who do not produce more than the new, higher minimum wage. While an employer may keep them on for a time out of loyalty, in the long run they will inevitably lose their jobs. Indeed, this person may now be unemployed for the rest of his life. No one will hire him under the new minimum wage, knowing that he can never produce enough to pay his own way. The only way that he can make himself worth hiring again is if he can increase his productivity. But the main way to increase his productivity is to increase his skills, which usually requires gaining experience. And he can't gain any experience, because no one can afford to hire him. The minimum wage has ruined this person's life. (In real life his situation is not totally hopeless: He may be able to increase his skills through education, attending a trade school or some such -- if he can find a way to get the money to pay for it. Or employers may find ways to enable lower-skilled employees to become more productive. For example, they may invent new machines that are simpler to use.)

Or look at it this way: If a minimum wage of $5.40 or $6 is good, because it forces employers to pay their workers a decent salary with no bad side effects, than wouldn't a minimum wage of $7 or $8 be even better? Indeed, why not set the minimum wage to $100 an hour, and all Americans would instantly be made rich, right? Surely the flaw in this is obvious: There is no way that a company could afford to pay all its employees $100 per hour. Very few people could produce enough to pay their own way, and the company would quickly go broke. But the difference between $100 per hour and $7 per hour is just one of degree. Yes, it is surely true that there are lots of people out there who produce more than $7 per hour. But not everyone. The law can set a minimum wage, but it can't create the money to pay it out of nothing.

Most people think of minimum wage laws as a restriction on employers: Thou shalt not pay less than x dollars per hour. But it is also a restriction on employees: You are not allowed to offer your services for less than x dollars per hour. Even if such an arrangement would be to your benefit, for example, by allowing you to gain experience in a field that is difficult to enter, or allowing you to get a job that pays something when the only other choice is no job at all.

Who really gains from minimum wage laws? Well, just look at who routinely lobbies Congress and the states for higher minimum wages. Is it associations of teenagers? Hardly. It's labor unions. Why? Almost all union members make well over minimum wage. So why do they even care what the minimum wage is?

They care because they're smart. They know that the people who benefit most from minimum wage laws are higher-paid workers. How? Suppose you are an employer with a job opening. Two people apply for the job. One has skill and experience in the field. You estimate that his work will bring in $16 per hour. The other has no relevant skill or experience. You estimate that, with a little on-the-job training, he might be able to produce half that, or $8 worth of work per hour. (It is, surely, not unreasonable to suppose that a skilled, experienced person could be twice as productive as an unskilled person.) Which do you hire? If you say obviously the first one, you've answered too soon. You forgot to ask what sort of salary each expects. Suppose the first person, knowing his own qualifications, demands $13 per hour. After all, if you won't pay it, the company down the street will. The second person, knowing his own lack of qualifications, is willing to settle for $4 per hour. So the experienced person would give you a net profit of $3 per hour on his work, while the inexperienced person would give you a net profit of $4 per hour. The inexperienced person is the better deal. (A dollar an hour isn't a big difference, but multiply that by hundreds or thousands of employees and it adds up.)

But wait! Suppose the minimum wage is $6 per hour. The inexperienced person is forbidden by law from working for less than this amount. So your profit on his work is reduced to only $2 per hour. Now the experienced person is the better deal. Even though his income is well above minimum wage, the minimum wage law has benefit him at the expense of the inexperienced person.

Suppose that he and others like him succeed in persuading the government to increase the minimum wage to $8 per hour. Now -- assuming the numbers I gave above accurately reflect the situation -- he has succeeded in making it completely unprofitably for the employer to hire the inexperienced person. He no longer has to compete with such people at all. As long as he can produce that same $16 per hour, he can increase his own salary demands to $15.95 per hour and the employer will have little choice but to hire him at this rate. Even though, at a casual glance, it appears that the minimum wage law did not affect him directly, in fact it has not only eliminated potential competition for his job, but as a side benefit has increased his income by almost $3 per hour.

Some policians and social activists say that the minimum wage should be significantly higher. They talk about a "living wage", and call for a minimum wage sufficient to "support a family". I have heard numbers quoted of $20 per hour.

There are two huge problems with this. The first is that, as I have noted, it simply ignores the reality that there are many, many people out there who are incapable of producing $20 per hour. Such a law would inevitably produce huge unemployment. The second is that they are offerring a solution to a problem that does not exist, or more correctly, they are exagerrating a problem totally out of proportion in order to justify such an absurd solution. For when they talk about a "living wage", they paint a picture -- sometimes in so many words, sometimes implied -- of the person earning minimum wage as some hard-working man desperately trying to support his wife and children on $6 an hour. Even if this was true, it is not clear how taking away even the low pay he presently receives would help, but of course they don't see it that way, they talk as if the money to pay this higher salary will just magically appear from somewhere. But the picture isn't even accurate.

Want some statistics? According to the U.S. Census Bureau, there are 63 million Americans working jobs that pay less than $12,500 per year. That's 31% of American workers. Sounds pretty bad. But wait, only 15.7 million, or 8% of American workers, make less than $12,500 and are listed as "head of household". The rest are spouses, children, grandparents, and the like, who are living with someone else who, in most cases, is earning more. (And remember that that 8% may have a working spouse to help out, and if they really are supporting a family on that money, they almost surely qualify for government assistance. Oh, and also remember that those statistics include the self-employed, so if someone made a million dollars in 2000 and barely broke even in 2001, for 2001 he'd be included among those making less than $12,500.)

In other words, the vast majority of people working at minimum wage jobs are not fathers trying to support a family on this income. They are a teenager trying to make a few bucks to buy a new stereo or video game console, a woman who generally relies on her husband's income but wants some extra money to buy Christmas presents, a retiree who generally relies on his pension but got a job just to get out of the house and have something to do, and the like.

Sure, there are some number of poor people who are trying to work hard to support themselves and their families and just can't make it. Of course as a society we should look for ways to help them. But do we want to really help them? Or do we just want to give speeches about how much we want to help them and then quickly pass some pointless laws that do more harm than good?


Reality check: I freely admit that my examples in this article have been overly simplistic.

I have talked about an employee's salary as if it was the only cost to the company of having this employee, but this clearly is not true. The company must pay taxes and benefits, it must pay to provide this employee with a desk or tools or a cash register or whatever is needed to do his job, it must heat and cool the building he works in, etc. It could be quite difficult to calculate exactly how much it costs the company to have a given employee on staff.

Similary, in real life it is even more difficult to calculate the exact value of any one employee's work. Normally many employees must work together to produce income, and it is not easy to say exactly how much each contributed. For example, if a store did not have stock clerks moving inventory from the back room to the shelves, sales would surely pretty soon fall to zero as the shelves emptied. But exactly what percentage of sales should be credited to the stock clerks? Perhaps the easiest employee to measure would be someone producing the actual product to be sold. We could say that this person produced products today with a sale value of $500 while consuming $200 worth of materials, therefore he has produced $300. But then what about the contribution of the stock clerk to the value of those sales? Surely we wouldn't sell anything if we had no salesmen or advertising. Etc etc.

But none of this affects the basic argument above. To the extent that the employer can calculate what each employee costs versus what he contributes, this would change the actual numbers used, but it has no effect on the logic. To the extent that the employer cannot calculate the exact numbers, this adds some indecisiveness. In close cases an employer may not know whether an employee is paying his own way or not. But again, this doesn't change the basic argument, just the details in any given case.

Statistics are from U.S. Census Bureau, Housing and Household Economic Statistics Information Staff, dated September 23, 2002, available at //ferret.bls.census.gov/macro/032002/perinc/new01_001.htm.

© 2002 by Jay Johansen


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