On the flip side of the gasoline “price-gouging” claims, I frequently hear people talk about minimum wage and even raising minimum wage to a “fair, living wage”. I love conversations that start this way because I get to respond with my favorite answer to stupid statements: a series of questions that tests just how well the speaker knows his or her subject.
Some person: If someone works, they are entitled to earn a fair, living wage.
Me: Who gets to decide what constitutes fair? You? Politicians?
Some person: ::insert vague statement about how community and society should decide without any mechanism of implementation or gathering consensus.:: (when I chase this statement down through a series of questions, the result is usually that it should be decided in the voting booth.)
Me: Oh, so you mean by each member of the community, acting in his rational self-interest, unfettered by governmental restrictions, an equilibrium value for the price of a particular unit of labor can be decided in a way that is consensual – and therefore fair – to all parties?
Some person: Well, uh, that’s ok, but… there has to a minimum.
Me: Again, who decides what that minimum is?
Some person: Well, I mean, there has to be one. If someone is working 40 hours a week, they’re entitled to earn enough to cover the costs of living.
Me: Did you just make that up?
Some person: Don’t you think that corporations like Wal-Mart should have to pay their employees more?
Me: If they did, where do you think that money will come from?
Some person: From the salary of some fat-cat CEO.
Me: You mean the salary money that he uses to buy products that are made by people who need jobs? Or the salary money he invests in the stock market, fueling new companies and innovation? Or the salary money he puts in the bank, providing money for home loans for people who otherwise wouldn’t be able to get one?
Some person: Uh….
Me: Assuming the salary of the CEO stays the same, the wage increase you’re shooting for is going to be passed down to consumers in the form of higher prices. You used Wal-Mart as an example. Do you think rich people frequently shop at Wal-Mart? Or is your plan to increase wages of unskilled laborers with money taken in from products bought by those very same unskilled laborers at places like Wal-Mart?
Some person: Uhhh…
Me: Yeah, exactly.
Aside from the inherent unfairness of choosing someone to decide what constitutes a “fair, living wage” or the immorality of introducing coercion into voluntary agreements between employer and employee, government-mandated minimum wages bring with them a hoard of economic and practical problems. When it comes to minimum wage, the people hurt the most are the ones supposedly helped by these programs.
Minimum wage is a government-imposed price floor that is generally set higher than the equilibrium price for unskilled labor. Introductory economics classes (using the neoclassical model) teach that price floors create a surplus of supply, as shown below:
Clik here to view.
The Blue line represents demand and the Red line represents supply
In this case, minimum wage reduces the demand for labor and increases the relative supply of labor, resulting in higher unemployment. This does result in higher wages if you are lucky enough to find a job. It also drives the wage rates up for skilled and semi-skilled labor, as employers often find it cheaper to pay an existing employee a little bit more per hour to do the work of a minimum wage employee, rather than hiring a new employee and complying with minimum wage laws, payroll taxes, social security, etc. So the short-term losers here are people working jobs that would pay minimum wage and the short-term winners are semi-skilled and white-collar workers – not people generally considered part of the “working poor”. Of course, economic decisions must focus on the long run. In this case, the unskilled laborers lose the most, but due to lack of economic efficiency, we all come out worse in the end due to higher consumer prices and higher unemployment. No matter how you cut the minimum wage issue, the fact is that the people you are trying to help are the ones losing.
Minimum wage, along with a government-run welfare program, also creates an economic disincentive problem known as the “Welfare Trap”. The welfare trap is a situation where the threshold for government welfare benefits is similar to the pay one would earn in a minimum wage job. This increases the incentive to attempt to get welfare benefits when they may not be necessary. For instance, let’s say that someone is eligible for welfare and welfare pays $200 per week. Let’s say that his local minimum wage lets him earn about $240 dollars per week at Wal-Mart or some other job. He could do manual labor for 40 hours per week to earn the $240, or he could sit at home and do nothing and only earn $40 dollars less. Your first thought is probably: I bet that is very rare. If you believe that, you should talk to economists all over the world, who devote countless hours to solving this very problem. Of course, the solution already exists, but government just can’t let go of its addiction to the votes and power that these “feel-good” programs give.
Once again, the attempt to rectify an economic problem with political action has created a mess. And once again, the correct action for government to take is to stay out of the market. No one person is qualified to say what constitutes a fair wage. People who believe that society should decide what wage is fair are mistaken if they believe that the voting booth is the place to make economic policy decisions. By allowing the free market to set a wage, everyone gets to decide on a dynamic wage for these jobs through a series of consensual transactions. The free market is infinitely more fair, infinitely more ethical, and doesn’t require the additional overhead cost of the salaries of politicians, bureaucrats, and enforcers.