Unskilled labor is like crude oil. Before you read the rest of this post, my advice is not to take this as the complete Truth, but rather as an intriguing theoretical explanation of how domestic unskilled labor is priced.
Unskilled labor is a commodity like crude oil. Both are fungible goods. A worker is only non-fungible if he has some sort of skill, which means he’s no longer an unskilled worker.
Because commodities are undifferentiated, they tend to be priced very low. Providers of commodities can only expect to make a very slight profit over the cost of extracting or producing the commodity. Unless there’s a shortage. Before there was a shortage of crude oil, the cost per barrel was in the low to mid twenties, which was the cost of extracting it from a high cost oil field such as an offshore field in the Gulf of Mexico.
What’s the cost of producing a unit of unskilled labor? That would be the cost of keeping the worker alive. So the lowest salary that can exist for workers is the amount the worker needs to spend to remain alive. Otherwise the worker will die off and disappear. (In the U.S. few workers outright die: the worker either moves to another location, collects welfare, or supports himself with crime until he is convicted and then the state pays for his support while he’s in prison.)
The cost of production theory explains why the prevailing wage in New York City is higher than the minimum wage elsewhere. The higher cost of living in New York City requires a higher salary to keep workers alive.
Basically, the cost of an unskilled laborer is no different than the cost of a slave, because the slave owner would have to provide for the slave’s food, clothing and shelter, and also pay the interest on the loan he took out to pay for the slave. If only the Southern plantation owners understood how this worked we wouldn’t have had to fight a Civil War. So when someone says that unskilled workers are being paid slave labor-like wages, this is not a vast exaggeration but actually a very close approximation to the truth!
When there is talk about raising the minimum wage, someone always points out that a large share of minimum wage workers don’t “need” a higher wage because they are teenagers or retired people. This observation confirms the cost of production theory. The teenager and the senior citizen have a lower cost of production because their living expenses are covered by their parents or by Social Security.
Like crude oil, the demand for unskilled labor remains fixed by the amount of capital dedicated to using such labor. For example, the amount of cars in the United States is fixed, so when the price of oil increased from the low twenties to over $70/barrel, we continued to use the same amount of oil because we still had the same number of cars.
When oil was cheap, why didn’t we build massive numbers of cars until the price went up? Because oil is only a small part of the total cost of owning and operating a car. Similarly, unskilled labor is only a small part of the cost of operating the United States economy, so the demand curve for unskilled labor is extremely inelastic.
Unlike oil which is currently in a state of shortage, there is a plentiful supply of unskilled labor. There’s an entire world of unskilled labor, and if the labor can be used in a foreign country it’s even cheaper than using it here because of the lower cost of living in the foreign country. If there is a domestic shortage of labor then wages rise and immigrants come here from foreign countries to take advantage of the higher wages, and this causes the wages to drop back down to the subsistence level.
Of course Congress, if it wanted to, could enforce immigration laws and thereby create a shortage of unskilled labor resulting in wages rising above the slave labor-equivalent level, but Congress chooses not to do this.
There has been a lot of recent talk in the blogosphere about the impact of raising the minimum wage. Raising the minimum wage has the same effect as a group of oil exporting countries forming a cartel in order to enforce higher prices. As a result, the members of the cartel make higher profits and the oil importing countries still use the same amount of oil. Similarly, employers would still use the same amount of unskilled labor. They would just pay the higher wages because such wages represent only a small percent of the employers’ total expenses, just as gasoline represents only a small percent of the total cost of owning and operating a car. (I previously blogged about how a minimum wage doesn’t hurt the worker, but at the time I didn’t fully grasp how similar an unskilled laborer is to a barrel of crude oil.)
Some readers may take the previous paragraph to mean I support an increase in the minimum wage. Actually, I am agnostic about that. Skilled laborers and owners of capital benefit from the slaver labor-like wages paid to the unskilled workers. Who am I to say that the unskilled laborer deservers anything more? It’s a moral question, and this is a blog about discovering the way things work and not about preaching morals to anyone.
But the utilitarian in me might posit that the person living at a subsistence level has a higher marginal utility for money than the affluent. For example, what’s the big deal if some upper middle class people have to spend a few extra dollars a year on fast food and lawn care when people living at a subsistence level would enjoy that money so much more?
However the best way to help unskilled laborers is not to immediately raise the minimum wage. We should first attempt to raise wages by creating a shortage of workers by deporting the illegal aliens living here. If we don’t deport them, raising the minimum wage will create a black market in labor in which unscrupulous employers save money by paying illegal aliens wages below the legal minimum (see my blog post on the economics of cheating).