October 20, 2015

Happy Minimum-Wage Tales Unrealistic

Donald J. Boudreaux

Senior Fellow, F. A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics
Summary

I spend a lot of time talking and writing about the minimum wage. I do so because it sears my economist's soul to encounter a policy that is as popular with people as it is poorly understood by them. Opinion polls consistently show that an overwhelming portion of Americans — about 75 percent — support raising the minimum wage. Yet there is no economic principle that is more solid than the one that explains that raising the cost of engaging in some activity (such as employing low-skilled workers) results in people engaging less in that activity.

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I spend a lot of time talking and writing about the minimum wage. I do so because it sears my economist's soul to encounter a policy that is as popular with people as it is poorly understood by them.

Opinion polls consistently show that an overwhelming portion of Americans — about 75 percent — support raising the minimum wage. Yet there is no economic principle that is more solid than the one that explains that raising the cost of engaging in some activity (such as employing low-skilled workers) results in people engaging less in that activity.

Just as someone trying to sell a house knows that the higher the asking price, the fewer are the prospective buyers for the house, everyone should know that the higher the wage that a worker charges for his labor services, the fewer the prospective employers for that worker.

This fact holds when the government — through minimum-wage legislation — forces the worker to raise the wage he charges.

Although it's obvious to me that artificially pushing wages up through minimum-wage legislation causes some low-skilled workers to lose their jobs (or to not be hired in the first place), it's clearly not obvious to most of my fellow Americans. So I ask, “Why not?”

One reason, I believe, is that many of the same politicians and pundits who praise the minimum wage also loudly complain about the alleged greed and profiteering of business owners. An economically uninformed voter can therefore be forgiven for supposing that a hike in the minimum wage is fully paid for out of the “excess” profits of greedy businesses.

But, notes the economist, most minimum-wage jobs are in highly competitive industries such as food service and retailing. Being under intense competitive pressures, firms in these industries don't rake in excess profits; they earn just enough to satisfy their investors. If those profit rates fall even just a bit, investors scale back their support or even pull the plug. So, the typical employer of minimum-wage workers must find some way other than eating into profits to cover the added costs of a higher minimum wage.

One way is to reduce the number of low-skilled workers who are employed, combined with obliging those who remain employed at the higher minimum wage to work harder.

What about raising prices? Might that tactic raise enough revenue to fully cover the costs of a higher minimum wage?

Almost anything is possible, but higher prices charged by employers of minimum-wage workers are unlikely to result in all such workers getting a raise with none of them losing jobs. The reason is that when prices rise for restaurant meals, motel rooms and other goods and services supplied by employers of minimum-wage workers, consumers buy fewer of these goods and services. The result? Restaurants, motels and similar employers supply fewer such goods and services — which means that these employers need fewer workers.

Tales can indeed be told about how, under just the right set of circumstances, a government policy of artificially raising firms' costs of employing low-skilled workers will inflict no harm on such workers. But none of those tales is realistic.