Debunking the Argument for Raising the Minimum Wage

The 2014 campaign season is upon us and among the issues that will be hotly debated is the minimum wage in America. Currently sitting at $7.25 an hour, the federal minimum wage has remained idle since 2009 and many in the county are calling for a raise. At last month’s State of the Union address, President Obama announced that he will unilaterally raise the minimum wage to $10.10 an hour for newly hired federal employees and called on Congress to do the same, stating, “It’s good for the economy, it’s good for America.” Editors Note: The President signed yet another executive order on Wednesday, requiring federal contractors to pay employees at least $10.10 an hour. Locally, mayors around the state have expressed support for a minimum wage raise to $9.50 an hour. During a “Raise the Wage” conference at the state capital last Thursday, Minneapolis Mayor Betsy Hodges proclaimed, “Raising the minimum wage is crucial to ensure that people who work for a living, can make a living.”

For most people, raising the minimum wage appears to be an obligatory humane and compassionate mandate -- this is a myth. While philanthropy is the greatest of human virtue, meddling with the natural laws of economic markets has unforeseen adverse consequences. Let’s inspect the arguments made by proponents for a minimum wage increase and see if their conclusions are true.

“Those who work full-time deserve to make a living wage.”

This is the foundational argument by all who support increasing the minimum wage -- while benevolent in nature, it is destructive in effect. In reality, the implementation of a minimum wage causes unemployment for the very people it is meant to protect: low-skilled workers. The reasons for this are numerous. Low-skilled workers do not create high levels of value because they do not possess high levels of productivity. Therefore, if a firm must legally pay an employee an hourly wage that exceeds the production value of that employee, the business will choose not to employ them. Looking at an example should help clear this up a bit.

Let’s say the owner of ABC Industries currently employs Johnny Alphabet at $7.25 an hour, the minimum wage. ABC Industries is the leader in sales of wooden letters for children and currently, Johnny Alphabet is able to produce $8 worth of wooden letters per hour. Since Johnny produces $8 of revenue per hour while only costing $7.25, it leaves ABC Industries with $0.75 of profit in which can be used in various ways beneficial to the company. Suddenly, the legislature of the state in which ABC Industries is located declares a “war on poverty” and passes a law that requires all firms to pay their employees a minimum of $8.25 an hour. Well, what was once a profitable operation for ABC Industries has suddenly transformed into a failing business. That $0.75 profit has now turned into a net loss of $0.25. Since ABC Industries employs many individuals like Johnny Alphabet, the firm must make some drastic changes in order to stay in business, starting with replacing labor that doesn’t produce enough value. When employing low-skilled laborers becomes too costly for firms due to increases in wage mandates, one way to replace them is with more skilled workers. While high-skilled workers will demand more in wages than their low-skilled counterparts, their level of productivity creates more value for the firm. Let’s return to the fictitious ABC Industries for another example.

Imagine that Johnny Alphabet works in a group with two other letter builders, with each individual making $7.25 an hour. Together the group is able to create $24 worth of letters ($8 per individual) in an hour at the cost of $21.75 – a profit of $2.25. Once the minimum wage is increased to $8.25 the group is now costing $24.75 per hour without any increases in productivity -- a net loss of $0.75. In order to rectify the situation, the firm may replace the low-skilled workers with highly trained, skilled laborers. Although the skilled workers cost $11 per hour, they each produce $12 of revenue. By hiring two high skilled workers ABC Industries can continue to get $24 of revenue production while only spending $22 -- a $2 profit. In an attempt to increase the pay of the lowest wage workers through an increase in the mandated minimum wage, the legislature cost them their jobs. Another way firms may get around paying inflated minimum wages is through substituting their low-skilled laborers with capital, i.e. new technology, machines, robots, etc. Generally, firms are hesitant to take on the high initial costs of purchasing and installing new capital equipment. This sentiment changes when the cost of employing low-skilled manual laborers becomes too high due to government mandates such as the minimum wage. As the cost of labor rises, firms are more willing to take on high short-run costs of capital substitution. In the long-run the costs will be less than they would have been without reassembling the factors of production (labor and capital). Once again, the workers who are supposed to benefit from the minimum wage have suffered because of its existence -- are you beginning to see a pattern here? Large increases in the minimum wage create higher competition among low skilled positions, further putting pressure on the employment aspirations of low skilled workers. For example, fast-food workers across the nation have been rallying together in protest for a minimum wage hike to $15 an hour. If such an increase were to be implemented, workers from many different industries would flood the low-skilled labor market in search of a job with less demanding job descriptions and relatively high pay. Now, not only are these low-skilled workers competing with a higher number of applicants for a relatively fixed number of jobs, but many of their new competitors hold higher skill sets, an attribute employer’s won’t look over during the hiring process. Once again, a raise in the minimum wage has hurt the very people it was designed to help. If the above hypotheticals aren’t convincing you, let’s take a look at some of the actual unemployment numbers from the 16 – 19 year old age group -- an assumingly low-skilled demographic. In 2012, the unemployment rate for all US workers between the ages of 16 – 19 was 24%. Breaking the demographics down into racial groups shows further insight into the unemployment epidemic for low-skilled workers. In 2012, 38.3% of Black US workers 16 – 19 years old were unemployed, 28.6% for Hispanics, 20.8% for Asians, and 21.5% for Whites. The unemployment rates for 16 – 17 year olds offer even stronger evidence that low-skilled workers are being denied entry into employment opportunities.

“Raising the minimum wage will benefit employers because employee moral will be higher due to higher wages, increasing productivity.” 

This argument does not merit such an in depth analysis as the “living wage” argument, but since it is frequently touted we should briefly discuss it. In order to dismiss this argument one only has to use logic. Assuming all firms want to maximize productivity – which in the free market they generally do -- why haven’t they thought to simply raise their employee’s wages before? If increasing productivity was accomplished by merely raising wages, wouldn’t the majority of firms have done it already? The solution to increasing productivity is not easily obtained through government mandate, and we should not be fooled into thinking so. Though it is undesirable for consumers and employees, it is possible for business’ to continue to hire and employ low-skilled workers at a “natural” rate despite a raise in the minimum wage. In order to do this firms would be required raise extra revenue or cut costs elsewhere in order to compensate for the wage increases. One way to raise revenue is to raise prices on the firm’s products and services – a loss for the consumer. It's hard obtain a higher living standard, no matter a worker’s pay, when price levels for goods are rising. Another option would be to cut the firm’s costs. Instead of training employees and promoting from within the business, firms may find it more affordable to outsource these duties – another loss for the low-skilled employee. If a worker is stuck in a job where mobility is restrained, they will be just that, stuck. With no opportunity to improve their skill set through investments in human capital, there will be no opportunity for upward economic mobility. Last year saw many legislative pushes for a minimum wage increase stall before they could be implemented. The calls for a raise have already begun here in 2014. A long debate full of demagoguery and empty promises lies ahead, let us use economic knowledge and education to diffuse them.   Photos via: Google  

The personal views expressed in this post are the writers’ own and do not necessarily reflect the views of Minnesota Connected or its sponsors.