Restatement of Principles: Minimum Wage

Restatement of Principles: Minimum Wage

August 11, 2014

By: Patrick Hedger – Policy Director, American Encore

The minimum wage is a matter of basic economics trapped in contentiousness by our universal sense of compassion.  In this debate, there is one point, in my view, that is not subject to question. Americans are an exceedingly compassionate people. Completely in spite of our diversity at every level, Americans are united by a fervent sense of charity. It is reflected in our massive and growing civil society of organizations, a marvel of the world for decades, directing desperately needed resources to every imaginable cause with tenacity that exceeds even that of the worst caricature of a greedy baron of business.

That being said, while emotions can get the best of us all, its time that we collectively come to our senses. The minimum wage is bad policy and talk of raising it is dangerous politics.

In response to such an assertion, I’m sure plenty of critics would (and likely will) point to any number of studies that claim to prove there are no negative economic impacts from increasing the minimum wage. To this I would be expected to reply with my own slew of citations to studies that claim to prove the exact opposite.  (In fact, I will. Here, here, and here.)

This kind of back and forth has been going on for too long and its not getting us anywhere. Studies and statistics are all well and good, but they are too often pointed to without proper consideration of context or what they actually do and do not say. Mark Twain summed up this point pretty well when he famously wrote, “There are three kinds of lies: lies, damned lies, and statistics.” But I personally think Scottish author Andrew Lang captured the problem better when he said something to the effect of, “Politicians use statistics in the same way a drunk man uses lamp-posts – for support rather than illumination.”

So with that, let’s forget the numbers for a moment and instead look at the principles. In other words, lets not look at what we think to be true and in its place consider what we cannot deny to be true. In this light, we should be able to clear things up and begin to actually move forward in this important discussion.

The natural fears about minimum wage are generally that it will cause unemployment and increase prices, both of which will slow down economic growth or potentially reverse it. Those arguing for a minimum wage increase will point to numbers that show economic growth and low unemployment in certain areas in spite of extant minimum wages or recent increases passed into law to write off such concerns.

Ok. Great. But no one was ever arguing that the economy couldn’t be healthy or grow with a minimum wage in effect.

The point is that basic economics tells us that at some level, be it infinitesimal or massive, the overall economy will be in a worse position with a statutory minimum wage than without one.

Don’t believe this? Then why stop at $10.10 an hour, as what seems to be the demanded figure at recent protests? Why not $25 an hour? Or $100 an hour? Or even $1,000 an hour? If ANY of those seem ridiculous and irresponsible to you, then you’ve proved the point.

Let’s now look at the basic economics at play here.

When the price of anything goes up, the incentive is created to use less of it. Think about when gas prices went from an afterthought to a major item in people’s budgets. People began consuming less gas. Don’t think so? That must mean you have some other explanation for the spike in the number of Toyota Priuses on the road. I’d be curious to hear it.

The same principle applies to labor. When labor becomes more expensive, people try to use less of it. The divergence in the sides of the minimum wage debate begins near here. Those supporting an increase in the minimum wage generally don’t see wages for what they really are: prices. The minimum wage debate? Let’s call it by its real name: the minimum price debate.

When framing it in this light, you can then ask supporters of the minimum wage (price) if they support other minimum prices. Would they support a minimum price for gasoline for example? Better yet, how about a minimum price for gasoline set by politicians in Washington who receive campaign contributions from the oil companies?  All the same arguments apply. If you want a minimum price for labor, there is no reason you shouldn’t want a minimum price for gas, or bread, or milk, light bulbs, or any other commodity. Wouldn’t a minimum price for bread help bakers after all?

At this point we begin to see that the foundation of logic below the pro-minimum wage arguments is actually no more than a mirage.

Now of course some will still argue that people need a “living wage”; after all, gasoline, groceries, and lightbulbs don’t have to pay for food, water, clothes, and shelter and those of the ones in their care. Here is precisely why we have a minimum wage in the first place, people are too afraid to argue beyond this fairly compelling point. The compassion component kicks in and it’s not necessarily something to be ashamed of. However is something that must be overcome, because the living wage argument helps perpetuates policies that are a disservice to those they're intended to assist.

What constitutes a living wage? Despite the lack of any universal definition, we can generally say it’s the cost of all the things you need to purchase to live in the place that you live.

Here is where this term immediately begins to discredit itself. Advocates of minimum wages and living wages and all the associated policies tend to look at what it costs to live where people work…but not where people live. People usually don’t live right where they work. The “living wage”, by whatever made-up measure you use, for Midtown Manhattan is obviously higher than that of Brooklyn, or Queens, or Newark, New Jersey. Working as a barista at the Beverly Hills Starbucks? Then you probably don’t live in Beverly Hills. But I’m sure there are plenty of properties in the greater Los Angeles area in your price range.  Yet imagine if tomorrow we put into place a law that requires your employer to pay you a living wage based on what it costs to live where that business is located. Forget the obvious questions of how to or who gets to do all the necessary calculations. Here we’ve created a set of two perverse incentives.

What stops the Beverly Hills barista from moving into Beverly Hills? On the flipside, what stops the Midtown Manhattan business from moving to Newark? Or out of the country entirely? Well then we’ll base the living wage on where people live, not work, instead. Right?

Not so easy either. Here you’ve actually expanded the perverse incentive for employees and expedited the outsourcing incentive for businesses. Now the employee can find the most expensive places to live and demand the requisite raise while employers face the decision to accept (if they can), outsource, or close.

These obvious challenges essentially render the entire living wage concept inoperable. Yet surely this won’t stop those who seek a minimum wage based on what it ‘costs to live’ (by whatever definition). Therefore, they’re now left with seeking some uniform wage for the entire country. Already this will drive outsourcing at some level. Even in the service sector this will occur. Can’t afford to pay the national living wage to your cashier? There’s an app for that. In fact there are probably thousands of them for your iPhone, which is made in China.

But there’s also another way businesses will cope with an increase in the minimum wage to accommodate whatever version of the living wage. How? They’ll raise prices. Grocery stores will raise the prices of milk and bread. It’ll be more expensive to hire cashiers and baggers after all. And property management companies will raise the price of rent. It’ll be more expensive to hire routine maintenance workers after all. And gas stations will… wait a minute. Won’t all of that just raise the cost of living?

These impacts are undeniable. They happen every time the price for labor is artificially increased, be it due to a living wage, or a minimum wage, or whatever new benefits employers become forced to provide (see: ObamaCare).  The question is to what extent that they do happen. Hiring is ceasing, firing is beginning, old businesses are moving, and new businesses aren’t starting. The impact may be profound (see: ObamaCare) or it may barely register, but at some level it is happening somewhere to someone and for that, the entire country is that much poorer.

Those familiar with it and with a careful eye already see the famous economic parable of which the minimum wage is an example. Raising the minimum wage is akin to breaking a store’s window.

The broken window fallacy is a famous story that economists use to show, in simple terms, why policies that force businesses to spend or unhand more of their money than previously required are generally bad for the entire economy.  Imagine a shoe shop on Main Street. It has a big window, behind which the shopkeeper displays all the shoes he has for sale. He needs the window because he wants to be able to show the shoes to people passing by, but also needs to prevent those passing by from simply walking off with them! The window is therefore a requirement for him to do business. Along comes a mischievous little boy. He hurls a rock through the window, smashing it to pieces. The shopkeeper is now forced to pay $200 to buy a new window and pay a glazier to install it. Some people would say that’s good for the economy! Now the glazier has work and $200 to spend.

The problem with this logic is that no one considers what the shopkeeper was going to do with that $200. Maybe he was going to buy a new suit, which would have meant $200 and work for a tailor. To this critics will say now the glazier can buy a suit! True, however even if the glazier buys a suit, the economy is still poorer to the effect of $200.

How? The shopkeeper already had a window, and had to pay for two in order for the glazier to buy a suit. If the window hadn’t have been broken, the shopkeeper would have just bought the suit himself, having only needed to buy one window. Yet since one of the two windows is now gone, the economy is poorer, or worse off, to the value of one window.

The same principles apply to artificially increasing the price of labor. Imagine that you own a burger stand. You hire a cook that makes you 10 burgers every hour for $8. He voluntarily accepts those terms. Then the government comes along and says that you must now pay him $10 an hour. But wait, has the government promised you more burgers per hour? What if your cook physically cannot produce more than 10 burgers per hour? You get no additional burgers per hour, but now those 10 burgers cost you $2 more. The economy is now poorer by the value of that $2 per hour. Why? Because now $8 only buys 48 minutes of cooking burgers. Or, in terms of burgers, $8 dollars only buys 8 burgers now instead of 10! A $2 dollar minimum wage increase may not seem like much, but to you as the owner of the burger stand, your labor costs have now gone up 20 percent for no additional output!

Supporters of the minimum price for labor, whose defense is now on rather thin ice, will undoubtedly say it falls on you the businesses owner to accept this added cost so that the cook can have a better life. Maybe some businesses owners can and some will, although this doesn’t entirely remedy the fact that the going rate for burgers per hour has now jumped no matter what.

But what if your business is a new business? What if your profit margins are razor thin, which they are for many millions of American businesses? What if you aren’t making a profit at all? Is it fair to now raise your cost of labor by 20 percent when you can’t afford it? Some may say you can raise prices to disperse the increased cost of labor to customers. True, but consider two things here.

First, doesn’t increasing the cost of a product, in this case especially with food, in an area just get back to what we already discussed about raising the living wage? Secondly, what if your business has a wealthy competitor that can better afford the increased price of labor without raising prices? People will just go to the competitor for their burgers and your business will close.  This presents an uncomfortable question for most ardent supporters of the minimum wage:

Do they think that only rich people should be able to start businesses and hire people?

An even more uncomfortable oversight for minimum wage supporters is what happens to the employees when employers are faced with artificially increasing labor costs. If a business has to close because their labor costs have gone up by something like 20 percent are the employees better off or worse off? Would they rather have a job at $8 an hour making $64 a day, or no job at $10 an hour making $0 per day?

Here’s one final uncomfortable question to tear away at the compassion façade that surrounds the politicians that defend the minimum wage. Should it really be illegal for some people to have jobs?

The minimum wage at a fundamental level is discriminatory, albeit unintentionally. Consider again the cook that can only make 10 burgers per hour. At $8 an hour that’s $1.25 per burger. If the minimum wage goes up to $10 an hour, to maintain the $1.25 per burger price, he must now make 12 and half burgers per hour. If he does not have the skills to produce burgers that are safe to sell and eat at a rate of 12 and half an hour, then he becomes unprofitable to employ. 

This can be extrapolated out to any product or service imaginable. If prices cannot go up but the rate of labor per hour does, then the rate of productivity must also go up for the business to avoid any change at the margins. People without the preexisting skills won’t be hired and therefore may never acquire those skills they need to get a job in the first place!

Altogether, such a simple policy of relatively innocent and harmless intentions has the potential to completely erode away the health of the economy. The impacts may or may not register as statistics in a study, depending on the size and type of increase, but just because we cannot see it doesn’t mean it’s not there. Even little tremors have the potential to destabilize entire fault lines and set off massive earthquakes. Other consequences we may never see because what we have sacrificed for artificial prices for labor is prosperity never realized. This is a concept theorized and presented with a kind of eloquence I could never do justice by the famous French economist Frédéric Bastiat in his essay entitled What Is Seen and What Is Not Seen. In it he gives us the parable of the Broken Window discussed earlier along with so much more.

In closing, after nearly 2,700 words of extrapolated basic principles to demonstrate the economic threat of policy like the minimum wage, it is necessary for me to briefly discuss the even greater threat posed by the politics of such a policy and those like it. The fact of the matter is that campaigning on the promise to raise the minimum wage is much easier than campaigning to end policies like it that are rife with unintended consequences. Here I am, now over 2,700 words on basic theory alone, while a pro-minimum wage politician, in their bid for the power to impose all sorts of other policies we know to be wrong, can simply prey on the good nature of Americans with something simple and to the effect of “poor people should have more money!” Indeed they should, but for America to succeed and be great once again, it is necessary for us to restate this principle:

The poorest among us must become richer because of economic opportunity, not at the expense of it.

It's Time for an American Encore