WASHINGTON, March 17, 2014 — A majority of Americans want the federal government to raise the minimum wage, and Democrats across the country want to oblige them. President Obama proposes an increase from the current level of $7.25 per hour to $10.10 per hour, while in Washington, the Council of the District of Columbia believes the minimum for large retailers like Walmart should be $12.50 per hour. In California and New York City, workers in the fast food industry believe the minimum should be $15.00.
Some argue that a the minimum wage is not a “living wage.” At current levels, the annual income of minimum-wage workers would be about $15,000. This is barely above the poverty rate for an individual and far below the poverty rate for a family of four.
The problem is that the minimum wage hurts exactly the people it intends to help. The minimum-wage workforce is composed of a wide variety of workers: teens in their first jobs, older people supplementing their income, part-timers in college, and people who are trying to support families. It’s that last group that proponents of raising minimum wage claim we need to help, but raising minimum wage is a blunt instrument with which to do it, and that group is the group with the most to lose.
Any time a price, or wage, is set above the market equilibrium, surpluses result. A surplus of labor is called unemployment, and raising this wage causes unemployment. The CBO estimates that a wage increase of the magnitude Obama proposes would cost the jobs of, on average, 500,000 workers, with high estimates ranging up to a million. The ones who would lose their jobs would be the least skilled and least desirable workers, the ones least likely to find other jobs, the ones who can least afford to lose the jobs they have.
If we look at the latest figures for the unemployment rate, this seems to be true. While it was recently announced that the overall unemployment rate is 6.7 percent, the rate for teenagers is almost 25 percent. The rate for minority teenagers in some inner cities is close to 50 percent. The rate for women entering the work force for the first time is over 20 percent.
The minimum wage is hurting exactly the people it is supposed to help by causing very high unemployment rates.
If there were no minimum wage, the market would set the wage at the point where the number of people seeking jobs would exactly equal the number of jobs available, with different wages in different geographic markets and for different types of labor. Unemployment would be zero, except for some seasonality factors and the unemployment that occurs when people move from job to job.
Suppose the equilibrium wage were $5 per hour, then ask what would happen when we set the minimum at $7.25 or higher. The answer is simple: Some people who might have decided to stay at home or go to school will enter the workforce, raising the number of people who want jobs. At the same time, business will eliminate jobs that are worth less than $7.25 per hour to them.
More job seekers plus fewer jobs equals unemployment.
There would be fewer jobs available because the value of the output of some workers simply isn’t worth $7.25 per hour to the firm. A fast food operation, for instance, finds that they have a trash filled parking lot which the owner estimates costs her business about $250 per week. If she could hire someone at $5 per hour ($200 per week) to clean the parking lot, that person would be hired. But if the minimum wage were $7.25 (or $290 per week) the person would not be hired. The business person would not pay $290 to solve a $250 problem.
We might argue that some workers “need” more, but this is not a valid argument in our economy.
Assume we have 100 workers who get together and produce 1000 units of output per day. At the end of the day it must be decided how to divide the output, which becomes the income of the worker.
There are basically two ways to do this: We can divide the output evenly so that each of the 100 workers receives 10 units, or we can divide it according to contribution.
The logic of the first approach is that each person should be paid according to his need. Because each person has similar needs, all are paid the same. This system may have some success when the society is at subsistence level, producing basic needs like food, shelter, clothing and safety, but it fails in a more complex economy. There is no incentive to innovate, to work harder and produce more. No matter how hard an individual works, his pay is the same. This is why the system failed in countries like Russia and China and is failing in countries like Cuba and North Korea, where the standard of living is extremely low
In the U.S., people are paid (in principle) according to their contribution. Someone who works hard, figures out how to improve the production process and makes a large contribution may earn 40 units of output, while a worker who barely contributes may earn only 2 or 3 units. This is not an equal distribution of output, but it is arguably more fair. It encourages people to produce more in hope of greater rewards. This results in growth in the economy and vast improvements in the standard of living.
“Need” is an important social consideration, but it is not an economic consideration, nor should it be when firms offer wages. Need is a red herring that can be used to destroy jobs and economic growth.
Increasing the minimum wage will hurt the people it is trying to help by reducing the number of jobs available, encouraging more people to skip further education and enter the job market and raising prices of products to consumers — possibly by a large amount, considering the ripple effect that higher minimum wages would have throughout the economy.
There are better instruments for eliminating poverty than minimum wage. Democrats and Republicans alike favor increasing the Earned Income Tax Credit, a federal subsidy for low income workers and a much less blunt instrument than minimum wage. Job training programs are a way of improving labor quality, so that workers can command higher wages. These policies aren’t without their faults and critics, but if the goal is to improve the lot of the working poor, they are a much better place to start than minimum wage.
The best wage policy is to eliminate the minimum wage and let the market decide. People would know exactly what their output was worth, unemployment would fall dramatically, growth in the economy would accelerate and there would be little wage induced inflation. Yes, we should care about poverty, but a policy that kills jobs and growth is a poor way to go about it.