July 28, 2016

The Mythology of Minimum Wages

Maurice P. McTigue

Vice President, Outreach
Summary

The labor market is just that—a market—where we as individuals trade our skills and time for remuneration. As a market, it is a sensitive self-balancing mechanism of incredible complexity responding to millions of actions taken around the world by millions of participants. Artificially interfering in the sensitive balance of this mechanism will create undesirable outcomes.

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The theory of minimum wages says that mandating an increase in the wage paid to workers will increase their total income. But does this theory hold true when subjected to scrutiny? 

Election campaigns invariably raise the debate over minimum wages, and this Presidential campaign is no different except perhaps that both campaigns favor increasing the minimum wage and appear to be in a bidding war to see who can offer the most. Politically offering increases to the federal minimum wage has a lot of attraction; it gives the impression of helping low income people—however research on the effect of raising minimum wages tells a different story. 

In reality, wage rates are set by internationally competitive forces. Increases in the cost of producing goods and services without accompanying improvements in productivity lead to a loss of competitive edge to the employer who is now forced to pay non-competitive wage rate in a competitive world. 

In the current economy, that frequently means investing in technology that automates these jobs resulting in the jobs being replaced by capital invested in machines. Alternatively the employer cancels overtime or reduces employees work hours resulting in a loss of total income for the employee. In the worst case scenario the employer reduces production or goes out of business consequently destroying some, or all of the jobs.

In an economy where government mandates set wages, who wins and who loses? The employer’s first response to this increased cost is to increase prices for their goods and services; this means that the consumers of those goods and services pay higher prices. Given that the goods and services produced from minimum wages are predominantly consumed by middle and low income people the burden of this new cost falls on them, hardly the outcome they intended. Alternatively the local goods and services are replaced by goods and services from other places that do not have to pay these higher wages causing the local jobs to be lost.

However, there is another group of people who are adversely effected by these policies as well and that is the unemployed who are looking for work and the underemployed who are seeking full time employment. A higher cost of employing immediately dims the chances of these individuals achieving their ambition of becoming independent self-supporting workers because it’s illegal to work for less than the mandated wage.

So who are the winners under this policy? Well they are foreign employers whose goods and services have just become more competitive and can now replace locally produced goods. A second winner is the producer of capital intensive automating systems that replace workers totally.

The labor market is just that—a market—where we as individuals trade our skills and time for remuneration. As a market, it is a sensitive self-balancing mechanism of incredible complexity responding to millions of actions taken around the world by millions of participants. Artificially interfering in the sensitive balance of this mechanism will create undesirable outcomes.