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Tuesday, February 19, 2013

Minimum Wage

It's been a while since I wrote a post of any substance, so I figured one was due.

In last week's State of the Union, President Obama announced his proposal of raising the national minimum wage from $7.25 to $9.00/hr, and indexing it to inflation (i.e. guaranteed raises of 1-3% every year for minimum wage earners). He touted the fact that this would help the low-income and those at the bottom rung of the economic ladder.

A quick look at minimum wages in the US shows that, adjusted for inflation, minimum wage workers are earning less than they were 30 years ago. What better way to combat this than raise the minimum wage?

While this sounds like a good idea on the surface, there is evidence that suggests raising the minimum wage actually hurts those it is intended to help and its ill effects are felt far beyond the immediate targets.

A piece in The Washington Post notes this and more:
UC Irvine’s David Neumark and the Fed’s William Wauscher conducted a literature review in 2007 that found a majority of studies found negative effects on employment — that is, a higher minimum wage meant fewer jobs. They found this was particularly true among low-skilled workers. (Washington Post)
As stated, it is only the "majority" of studies that negatively associate raising minimum wages and employment rates so it is by no means the rule, but there are some simple reasons behind

Let's assume the "majority" is correct. Why?

1. Labor value vs labor cost

Like all goods, every type of labor has a value and given a monetary equivalent.
Say you want to buy a piece of cheese pizza that you value at $2/slice. If you're suddenly required to be charged a minimum of $5/slice, you're not going to be too happy about it and you may even decline to purchase the pizza at all. However, there's a meat lover's slice valued at $5/slice. To get full your money's worth, you'll likely purchase the meat lover's over then cheese slice.

Similarly, an entry-level job at a fast food company is valued at $7.25 by management. This is due to the fact that the worker is able to perform duties that enable the company to recoup slightly more than $7.25/hour, thus pay for the worker's wages and other basic costs. If the minimum wage is raised to $9/hr, rather than hiring an entry-level person (likely uneducated or teen) that can only perform tasks worth $7.25/hr, the company will likely hire a more experienced person who's work is "worth" $9/hr.

Murray Rothbard addressed this issue way back in 1988:
If the minimum wage is, in short, raised from $3.35 to $4.55 an hour, the consequence is to disemploy, permanently, those who would have been hired at rates in between these two rates. Since the demand curve for any sort of labor (as for any factor of production) is set by the perceived marginal productivity of that labor, this means that the people who will be disemployed and devastated by this prohibition will be precisely the "marginal" (lowest wage) workers, e.g. blacks and teenagers, the very workers whom the advocates of the minimum wage are claiming to foster and protect. (mises.org)
In layman's (and today's values), this increase will actually cause those earning between $7.25 and $9.00 to lose jobs.

2. Companies like profit

Perhaps this is stating the obvious, but for a company to be solvent, they will do whatever they can to ensure they turn a profit and then maintain it.

Suppose the current minimum wage is $7 (for easier numbers) and that the Acme Fast Food Company makes an average of $100/hr.
The company uses 5 full-time employees, earning minimum wage. Food costs are 30%, and utilities/taxes/other costs are $25.
This results in a profit of 10%, or an average of $10/hr.
Breaking down the math: 
5 employees X $7/hr = $35/hr
+ 1 manager X 10/hr = $10/hr
+ Food costs = 25% ($25/hr)
+ Utilities/taxes/other = 20% ($20/hr)
= $90/hr (90%) costs  
If the restaurant is making an average of $100/hr, their profit is $10/hr (10%)
These numbers are obviously fictional and rounded for easy calculations, but they are on par for an average restaurant.

Suddenly, they are required to pay workers $9/hr.
What happens to their numbers?

Employees get an additional $2/hr each, food costs stay the same, utilities and other costs remain the same.
5 employees X $9/hr = $45/hr
+ 1 manager X 10/hr = $10/hr
+ Food costs = 25% ($25/hr)
+ Utilities/taxes/other = 20% ($20/hr)
= $100/hr (100%) costs  
As you can see, the restaurant owner is now making $0 profit.
While some people may say this owner and businessman should remain noble and keep all his workers employed, the owner is in the business to turn a profit.

The likely response? Fire a worker and recoup the lost profit from the employee's wages.
4 employees X $9/hr = $36/hr
+ 1 manager X 10/hr = $10/hr
+ Food costs = 25% ($25/hr)
+ Utilities/taxes/other = 20% ($20/hr)
$91/hr (91%) costs  
The owner is still making less of a profit than he was with the lower minimum wage (although if he had to pay for healthcare and other employee benefits, he might make that 1% back), and he is also down a worker.
This would result in more work for the remaining employees and potentially worse service for his customers.

Imagine, if this was the model across all industries, an additional 20% (1 out of 5) of minimum wage workers would be unemployed.

Those already earning above minimum wage?
Their wages would likely be frozen (or even reduced) to account for the increase of the other workers, but it's unlikely they'd be released. Thus, the effects of an increase in minimum wage affects those earning the least much harder than those further up the ladder.


Obviously these are simplified examples and much more could be said about each, but they give a brief summary into the detriments of raising minimum wage and its unintended consequences:
Minimum wage increases hurts those it tries to aid, specifically teens, part time workers, unskilled workers, and those generically on the bottom rung of the economy.
This is my opinion on Minimum Wage, backed by facts and numbers that I have gathered.
I would love to know if your opinion differs and any examples that can be given to prove the contrary.

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