The minimum wage is a popular and well-thought-of piece of legislation which many people believe is only helpful - or, may have some drawbacks but is more helpful than not. Fortunately, the minimum wage can be looked at objectively by examining how general economic law works as well as socially, by examining what kind of affects the minimum wage has on real people. This two-part article is designed to look at the minimum wage at a fundamental economic level and then for its broader impacts on society.
Removing Morality
For the first part of this article, a pure economic analysis, we must put aside anecdotes and emotional arguments. For example, “but he’s a waiter and deserves minimum wage!” is not a valid point right now, because we are going to look at pure economic law and effects. If the reader comes into this analysis unwilling to engage the material for what it is, then the reader should be honest with himself and admit that he does not want his preconceptions on the idea to be challenged.
Many times, this results from not taking a moment to remove the subjective morality or “fairness” ideas that one brings with them into an argument. Besides, we will deal with these entirely in part II - so just hold your horses.
Wages as Prices
What is a wage anyway? Often, people don’t make the connection that wages are just another price in the massive global market of good and services. Just like a new bike has several components and interactions on the market that determine it’s price, so to does a person’s time and skills - their labor - fetch a price based on these same phenomena.
We only separate out wages into a special category because in modern society, this price has a significant impact on the seller (the employee is selling his labor; the employer is the buyer of labor) because his livelihood, status and often his access to opportunities are dramatically affected by the price he can fetch on his labor. But those are moral considerations, and you promised not to go there until next time, remember?
We have to understand that a price on a wage is reached when there is mutual consent - the employer wants the labor more than he wants the money from the wage and the employee wants the wage more than he wants his time. So if a price can be reached, then it is because both parties believe that they are better off.
People have to trade this way because there is scarcity - not only are material goods finite, but time is finite as well. So demand and supply can’t shoot up into infinity. If it were so, we could legislate a minimum wage as high as we liked and there would be no consequences. However, because things are finite, there is a limit to how high we can raise a wage through legislation.
How Wage Prices Are Determined
Jobs and wages do not come about by employer generosity (or, on the contrary, greed). That is, companies don’t just provide jobs for kicks and don’t pay wages as charity. They actually have a demand for labor in order to get something done - the end result of which is likely for their profit (either financially or maybe idealistically [they need labor to build a free hospital in Sudan]). If they don’t think this way then they lose money and go out of business (and provide no jobs by the way).
On the other hand, laborers are not slaves by nature - they only want to trade their time if it benefits them. In most cases, this is to seek a wage that provides at least their basic subsistence and usually a little more than that - again this is profit.
These two parties meet somewhere above the employee’s minimum value on their time and somewhere below the employer’s cost for what the labor produces. The price is driven down by the scarcity of demand - the less demand for labor, the lower the price that laborers will have to set for their abilities. The price is driven up by how talented, experienced, educated, hard-working, skilled and so on the laborer is. The more talented the laborer, the more objective value he has in the market.
What a Price Floor Does
If then, a wage is just like any other price, than a price floor (a minimum price allowed) is going to have a universal effect. If we legislate that gas, for example, must be at least $5 a gallon to help those poor oil companies, then a lot of people are going to go without gas, simply because they can’t afford it (other will have to cut back significantly in other areas to pay the increased price). It might elevate all the profits from gas for just a little while, but the customer base is going to shrink a lot more than it normally would. So you may have the average customer paying more for gas, but you will have so few of them that, in time, the gross profit is going to actually be less. Neither of the parties benefits.
Say it’s a price floor on wages now. The minimum wage is $15. It’s not just a matter of everyone currently making $5.15 getting a whopping raise. Rather, many of the employee’s customers (employers) can no longer afford their service. In fact, so many employers would be unable to buy labor at that rate that over time, the net profit on labor is going to go down. In fact, the scarcity of jobs is going to rise so much that those employees still left will make less money because supply and demand have been adjusted against them. There are less laborers to compete, but there are even less jobs, so all parties lose.
Raise the Sea - Float All Boats?
Many think of the minimum wage (and price floors in general) like a sea of water that carries boats with it as the water level rises. But employees are not floating - that would imply that their value is totally subjective. Rather, they have anchors, made of all the talents and skills, which hold them to the bottom. The anchors only get longer as more talents and education (and the like) are gained by the employee.
Realize that each employee is a unique combination of skills, experience, training and talents - no two are alike. They earn a unique price for their labor on the market. We’ve already established that someone working for $8 is not making that because their employers likes them “eight dollars worth” or is generous or mean, but $8 is the price that his labor can fetch on the market. What happens then when the minimum price allowed for labor rises above $8? Objectively, our $8 man is drowned because it’s not like his talents and abilities (which got him the price in the first place) increase along with the wage floor. No, we have raised the water level over his head, and drowned those least able to swim.
Tomorrow we will cover the social aspects of a minimum wage and take into account what kind of effects this has on working people and their families. This is the realm where most of the support for a minimum wage comes from.
Colin said: “We have to understand that a price on a wage is reached when there is mutual consent - the employer wants the labor more than he wants the money from the wage and the employee wants the wage more than he wants his time.”
A perfect market scenario only works when both parties are equally informed, and when neither party has some kind of unfair advantage over the other. Let’s not pretend that employers and workers are on an equal footing. A worker, particularly an uneducated one, often doesn’t know the fair market value of his skills. Even if he knows what he’s worth, he can’t always take advantage of that, because he is geographically limited. Especially in a city where there are only one or two major employers, the employers can collude to drive down wages well below the average market value. Sure, workers could get better wages elsewhere, but they’d have to move to those other places.
What I’m getting at is that employers often have two advantages over workers: better knowledge, and geographical monopoly power. That’s not a recipe for a well-functioning free market. Maybe minimum wages have their place. (Although it would probably be better to establish minimum wages based on education or skills, rather than one blanket minimum wage.)
A worker, particularly an uneducated one, often doesn’t know the fair market value of his skills. Even if he knows what he’s worth, he can’t always take advantage of that, because he is geographically limited. Especially in a city where there are only one or two major employers, the employers can collude to drive down wages well below the average market value. Sure, workers could get better wages elsewhere, but they’d have to move to those other places.
His lack of knowledge is a market phenomenon. Any price (labor or otherwise) isn’t determined because both parties have perfect knowledge. In fact, this is why the market has supported education - especially business-type education, which improves people’s ability to negotiate and demand a higher wage. The wage price is the best that each party can do - both the employer and the employee have equally fair shots to educate themselves to earn a better price. The place in-between that, where a lower wage will cause a move, and a higher wage will lose money, in a very natural (and I would argue “fair”) place for a wage to rest.
The geographic limitation of workers is, again, a natural phenomenon. To artificially floor the wage to “compensate” for this takes away a legitimate market advantage that local employers have. Besides, it is in these employers best interest to keep the geographic disparity (but it should cost something just like any convenience) low because they face competition from larger firms who will pay for good employees to move.
The point is that, of course, there are other factors pushing the wage down, but we have to remember that geography and knowledge work both ways. Most people feel they benefit from a $4 pay raise, they may have been worth $10 more, but rather than spend all the time and work to educate themselves, they’ll give the $6 to their employer and keep the $4 and be perfectly benefited. Also, at some point an employee talks to someone four states over and sees that he’s making twice the money he is for the same job. If a local employer tries to negotiate the price too low then he must face the threat of moving.
Remember local markets aren’t in a vacuum.
Although it would probably be better to establish minimum wages based on education or skills
How is this even feasible? Does a government agency need to be created to certify all the minutia of skills and abilities? Why would any non-market mechanism need to do this when a price does it already?
“If a local employer tries to negotiate the price too low then he must face the threat of moving.”
Yes, but how long does that take? If a local employer forces the wages down to rock bottom, eventually people will move, and the market forces will cause the employer to raise wages. How long does that process take? A year? Five years? Ten? That’s neither efficient nor humane. Maybe we can do better by using laws to avoid the whole messy process completely.
“If a local employer forces the wages down to rock bottom, eventually people will move, and the market forces will cause the employer to raise wages. How long does that process take? A year? Five years? Ten? That’s neither efficient nor ***CENSORED***.”
Great article, Colin! I agree completely. Stossel is very good at fighting the minimum wage myths.
Jew said, “(Although it would probably be better to establish minimum wages based on education or skills, rather than one blanket minimum wage.)”
Maybe we could add to that mix experience and attitude.
I like the idea of no or low minimum wage for 13-17 year olds(while limiting the number of hours allowed to work). If employers representing non-skilled labor were allowed to hire teenagers for cheap, it might provide more opportunities for many kids to develop a decent work ethic, to help them to understand the relationship between money and time, and it might give them something useful to do during the summer. I’m thinking the good from this scheme is almost all in the area of getting experience and very little in the area of getting money–but they are, after all, still supported by their parents.
Some kids go through high school and college and then graduate and have never had any kind of job. They are educated and maybe even skilled, but inexperienced. Then they can’t find a job because they have no experience and employers won’t hire them for unskilled jobs because they are “overqualified.”
OK, Colin, if that comment was too emotional, immoral or unfair, then just cut and paste it into tomorrow’s comments!
Yes, but how long does that take? If a local employer forces the wages down to rock bottom, eventually people will move, and the market forces will cause the employer to raise wages. How long does that process take? A year? Five years? Ten? That’s neither efficient nor humane. Maybe we can do better by using laws to avoid the whole messy process completely.
But that process is not good for the employer either. Most employees won’t stand not gradually making more money, let alone cuts in their wages. The place would have a strike on their hand or worse. Maybe the second or third in command takes his knowledge and starts a different company doing the same thing, knowing that he can get profit and pay wages only slightly higher than the latest drop by the local employer.
If the employer is even remotely smart, he isn’t going to risk this at all, especially when he’s making a good profit already. The risk of alienating employees/strikes/defections are far to great to just start “forcing” wages down.
The “messy process” is already avoided by market mechanisms and the risk inherent in the process. It is in both parties best interest to preserve a cooperative environment.
If employers representing non-skilled labor were allowed to hire teenagers for cheap, it might provide more opportunities for many kids to develop a decent work ethic, to help them to understand the relationship between money and time, and it might give them something useful to do during the summer. I’m thinking the good from this scheme is almost all in the area of getting experience and very little in the area of getting money–but they are, after all, still supported by their parents.
Some kids go through high school and college and then graduate and have never had any kind of job. They are educated and maybe even skilled, but inexperienced. Then they can’t find a job because they have no experience and employers won’t hire them for unskilled jobs because they are “overqualified.”
You have partly touched on what I am working on for tomorrow. The reason these kids can’t find a job (and also the reason many areas have exceptions to minimum wage for teens) is because they aren’t worth minimum wage. They have no training, experience or education. Teenagers were one of the early casualties of minimum wage. We’ll talk about this tomorrow with the “high jump bar” effect that increasing minimum wages does.
So I agree with you entirely - these kids need on-the-job training, experience and skills - and they are being robbed of that by the minimum wage.
Regarding this group that Thainamu was talking about-
“Some kids go through high school and college and then graduate and have never had any kind of job. They are educated and maybe even skilled, but inexperienced. Then they can’t find a job because they have no experience and employers won’t hire them for unskilled jobs because they are “overqualified.””
My friend the Pizza Hut manager said that places like his were afraid to hire people with degrees because they don’t think they will stay for long.