Does a minimum wage hurt the worker?

I previously blogged about my support for a sensible minimum wage, and part of the reason for my support has to do with the unequal bargaining power between employer and employee which causes labor to be valued below its true worth.

These posts received some negative comments from libertarian pro-big business types, and one of the most common comments was that the minimum wage hurts the worker.

How can we possibly hurt the worker by mandating that his salary be increased? Unfortunately, many liberals have such a limited appreciation of economics that they end their inquiry there. But those who know enough about economics to be dangerous will point out that increasing the price of something will decrease its demand. So some who oppose the minimum wage have argued that workers will lose their jobs when the minimum wage is raised because demand for their services will plummet.

However, the economic inquiry cannot end there, but requires an examination of the demand curve for low wage labor. All evidence suggests that the demand for low wage labor is extremely price inelastic, which means that an increase in the price of labor only causes a tiny decrease in demand.

A great example of a good with an extremely price inelastic demand curve is gasoline. Over the last few years, the price has more than doubled (I was paying less than $1/gallon at the end of 2001), yet the quantity of gasoline consumed has probably not decreased at all! This is because with even the current high price of gasoline, the benefit of using a gallon of gasoline far exceeds its cost. Are people going to stop driving to work because gas costs more? No. In fact, there isn’t even any evidence that SUV sales are dropping. The cost of buying and maintaining a car far exceeds the cost of the gasoline used to power it.

The demand for low wage labor is like the demand for gasoline. If the price goes up, employers still demand the same amount. (And even if a tiny fraction of workers are laid off, there is still a net benefit to the class. For example, if the minimum wage increases by 20%, but this causes 1% of minimum wage workers to lose their jobs, there is still a net benefit of 18.8%.)

Whenever there is minimum wage talk in Congress, opponents will inevitably trot out some arch-conservative mom and pop business owner who says that he’d have to let one of his minimum wage employees go if the minimum wage were increased. I find such anecdotes extremely unbelievable. Because every single business owner faces the same salary increases, what happens is that prices are raised slightly and no one gets fired. Chances are that demand for whatever these businesses are selling doesn’t change much when the prices go up.

Minimum wage opponents will also argue that jobs will be exported to low wage countries if we raise the minimum wage. Well first of all, you can’t buy a Big Mac from a guy in China if you’re in Virginia. Secondly, there is already such a huge labor price differential between the United States and China that it’s hopeless to compete against that. For whatever reason it’s deemed necessary to have an employee located in the United States instead of China, the reason still exists if the employee’s wage is increased a little. (But foreign competition is a big problem. It’s one of the first things I ever blogged about.)

Another type of “the minimum wage hurts the worker” argument is that the higher wages cause all prices to increase so the workers don’t gain anything because their salary increase is eaten up by higher prices. This is nonsense. Only a tiny fraction of what we buy is substantially dependent on salaries paid to minimum wage workers. The price of a Big Mac might go up a little, but a McDonald’s faces many costs such as rent, food and franchise fees, so even at McDonald’s, the classic example of a business that relies heavily on minimum wage labor, such labor is only a partial component of the cost of its products.

If the overall price level rises by 1%, but minimum wage workers get a 20% salary increase, then it’s obvious that they have benefited from the salary increase.

In conclusion, we see that an increase in the minimum wage does not hurt low wage workers because the demand for their services is price inelastic, and the increase in the minimum wage worker’s salary more than compensates him for any negative repercussions such as a slight chance of losing his job or slightly higher prices.

Comments

[Scott S]

"Well first of all, you can’t buy a Big Mac from a guy in China if you’re in Virginia."

You need to think outside the box.

http://www.msnbc.msn.com/id/7149812

Any attempt to raise employee cost above what the market will bear will lead to greater unemployment and/or increase product cost. To be cavalier about those people who will lose their job and who won't be able to afford as much as they could without your noble intervention, is the prime mark of a modern liberal.

[Half Sigma]

Thanks for the link to the article, I remember reading about that last month.

But for the attitude that we must never do anything that might cause someone to lose a job--if we had followed that 150 years ago, everyone would still be working on farms.

Our rise to a geat economic power has been based on replacing labor intensive tasks with automation, freeing up people to work on different tasks.

Before the Civil War, Southerners thought they could only make profits by using slave labor, but it turned out that after the slaves were freed, our nation became even more economically powerful.

[Michael A. Clem]

Wow, an actual argument! But Henry Hazlitt said "The art of economics consists in looking not merely at the immediate but at the longer effects of any act of policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."
The simple fact is that the minimum wage is a price control, and raising the minimum wage means paying more money without a corresponding productivity increase. Instant "productivity loss" is created. If labor is as inelastic as you argue, then employers must cut costs elsewhere, increase the costs to their customers and clients, or try to increase productivity somewhere. The decisions they make in dealing with the increase determines where and how the increase is felt, but the effect is there even if you can't see it. Perhaps McDonald's won't lose money, but the local burger joint or steakhouse or grocery store will, instead. If people continue to buy the same amount of gasoline as gas prices increase, they still have to spend less elsewhere in their budgets. Less eating out, less luxuries, less clothes, less *something*. The overall effect to the entire economy is being overlooked.

"If the overall price level rises by 1%, but minimum wage workers get a 20% salary increase, then it’s obvious that they have benefited from the salary increase."

Translate those percentages into dollars and see if that really means a benefit. 1% increase on overall price levels is going to come to a lot more dollars than 20% increase on minimum wage workers' income. People are paying 1% more for *everthing* they buy, or rather, they're cutting back on how much they buy somewhere, causing changes throughout the economy in the availability of goods and services. The minimum wage worker may well find that after the increase, they can buy fewer goods and services than they could before. That's no benefit.
Government interference in the economy creates distortions, not efficiency, and is beyond any morally legitimate function of government.

[Scott S]

"But for the attitude that we must never do anything that might cause someone to lose a job--if we had followed that 150 years ago, everyone would still be working on farms."

The most important word in that sentence is "we". As Tonto might say, what do you mean 'we', white man? Do you see a distinction between voluntary changes implemented in the marketplace, and the dictates of a monopoly that implements its changes by threat of force? If you don't, I'm not sure there's much hope.

"Our rise to a geat economic power has been based on replacing labor intensive tasks with automation, freeing up people to work on different tasks."

I don't know how the application of technological advances in the workplace relates to a government mandating minimum employee wages.

"Before the Civil War, Southerners thought they could only make profits by using slave labor, but it turned out that after the slaves were freed, our nation became even more economically powerful."

I don't know how the abolishment of slavery (itself a violation of individual liberty) relates to government not allowing people to work for less than a set wage.

[Half Sigma]

"Do you see a distinction between voluntary changes implemented in the marketplace"

The U.S. actively encouraged industrialization via government policy. For example, we had tariffs on imported goods to encourage development of domestic industry.

" don't know how the application of technological advances in the workplace relates to a government mandating minimum employee wages."

When labor is too cheap, there's no incentive to develop and invest in labor saving technologies. But it's our accumulated capital that makes us the far greater economic power compared to China, not our cheap labor.

So if wages are too low, it could hurt our economy in the long run.

"I don't know how the abolishment of slavery (itself a violation of individual liberty) relates to government not allowing people to work for less than a set wage."

Certain libertarian capitalists would gladly pay slave labor-like wages to their employees.

[Michael H.]

One problem with the minimum wage is that it hurts another group of relatively low-wage workers: the owners of the less popular fast food places. The average Subway sandwich shop owner typically works there 12 hours a day and ends up making only about minimum wage. If he has to pay his workers more, he makes less. He is not guaranteed the minimum wage by anyone.
If you really think that we need to help the working poor, we should subsidize their wages. That would be expensive, and it would cause some fraud and other distortions in the labor market, but it would help all low-wage workers and not just salaried workers. Just a thought.

[Scott S]

"The U.S. actively encouraged industrialization via government policy. For example, we had tariffs on imported goods to encourage development of domestic industry."

I would think a libertarian would be against any government intervention in the market, including tariffs for the purpose of advancing domestic markets. If the ends do not justify the means, then doing it for the sake of 'progress' isn't enough. One can imagine that our medical technology would advance if the government subsidized medical research and careers to the same amount they currently pump into the defense budget. This would cause people to live longer and with less ills. But should government take people's labor value against their will to do this? I think not.
The road to socialism is paved with good intentions.

"Certain libertarian capitalists would gladly pay slave labor-like wages to their employees."

I'm sure they would, if they found people *willing* to work for that wage. Since there is no right to work, I don't see a problem with that. Also, I'd wager most business owners are far from libertarian.

[Mike]

There is another class of worker who is hurt by minimum wage laws - the marginally productive worker.

Currently, the minimum wage is about $5.50, right? Many of the people making that wage are not terribly productive - their efforts are only providing their employers with something worth slightly more than $5.50.

If the minimum wage is raised to, say, $6.50, these marginally productive workers are in a serious bind - nobody will ever hire somebody who generates less revenue less than their salary. We risk creating a permanently unemployed underclass of people, which grows larger every time the real value of the minimum wage is raised.

[Michael A. Clem]

Everybody is hurt by the loss of productivity caused by minimum wage increases, not just low-wage workers. But not equally so. Not only are marginal workers at greater risk of being unemployed, but marginal consumers (i.e. those who are living from paycheck to paycheck) can less afford price increases than wealthier people.

[steve]

The problem with neo-classical theory is that it often makes conclusions our of context and fails to explain why empirical reality doesn't conform to the theories. Over the past decade and a half labor productivity has increased yet real wages have stagnated or decreased as prices increase. Despite the stagnating real wage levels there is high unemployment and economic stagnation. Many factors account for this like slack demand, reduced investment in the face of weak product markets and high and rising (non-labor)fixed costs, and future uncertainty due to the growing deficit. The factor equilibrium models of neo-classical economics fail to take into account the vast complexity of real world economies and are fixated on a rigid, abstractified behavoirist model of the market.

[Michael A. Clem]

The problem with neo-classical theory is that they often overlook the a priori truths of Austrian economics, and are unable to adequately sort out the vast, complex, empirical and historical data that exists.
While it's true that the economy is vastly complex, if we can control or eliminate other variables, then we can test or make some conclusions about changing one variable.
In this case, raising the minimum wage. Think of it like this: you go to your local fast food place to buy a hamburger, and find out that a new law has been passed that makes the hamburger cost a dollar more than before. Now what happens? Do you pay an extra dollar or get something else instead? Do fast food places offer larger hamburgers or some other bonus (free fries) to make up the difference?
Minimum wage increases are like that. How does the employer make up the difference so they can pay the increase? There are several ways that they could do that (of which firing or not hiring minimum wage workers is only one possibility), but unless they can somehow increase the company's productivity, they all mean cutting back on expenses somewhere, which means a productivity loss to the economy. That's a simple, a priori truth. The fact that the economy is complex and many other factors are in operation won't change that. The fact that most workers already make more than the minimum merely minimizes the harm done by a minimum wage increase, but it doesn't stop the fact that harm is done.

[liberty]

>Over the past decade and a half labor productivity has increased yet real wages have stagnated or decreased as prices increase.

1. Real wage shave risen for many sectors and quintiles of the economy, the rise in real wage of the most productive well outdoes the stagnation of the poorer workers - in other words, wages have increased overall, just unequally.

2. Healthcare costs and other benefits paid for by employers etc mask real wage increases across all income levels.

[Chris S.]

I felt the affects of this today upon going to mcdonalds. I hardly remember a double quarter pounder meal costing 7 dollars. I am in the bracket that makes slightly above minimum wage but don't receive any boost from minimum wage increase. Instead, all the prices around me inflate and I essentially make less money than I was making before due to the inflation.

Inflation due to minimum wage increase effects everyone in the lower bracket including those who should have benefitted from the increase in their pay.