Less is More: Why Economists Oppose The Minimum Wage

Justin Ong

Justin Ong

Justin Ong is an active contributor to the Adam Smith Center. His latest work is a series of introductory-level articles spanning various topics of politics, economics and philosophy. He is also an incoming student of philosophy with Nanyang Technological University.

Minimum wage policy and its perpetual debate

The Fight for $15′ minimim wage movement has gone viral in the United States. One of its ardent supporters is Senator Bernie Sanders, who calls the present federal minimum wage of $7.25 ‘starvation pay’. In October 2018, he wrote to McDonald’s CEO Steve Easterbrook, urging him to join Amazon, Whole Foods and Walt Disney Co. in hiking the minimum wage to $15. As of January 2018, 18 states began the year with higher minimum wages, with states such as California and Massachusetts aiming to hit $15 incrementally in the coming years.

Advocates of minimum wage are alarmed by Marxist fears that greedy business owners would perpetually depress wages to maximise their profit margins. To these proponents, the minimum wage is a ‘Robin Hood’ redistribution of wealth from business owners to low wage workers, uplifting the livelihoods of poor families and stimulating consumer spending.

 

No free lunch

The extra income low wage workers receive from minimum wage hikes must come from somewhere. James Sherk of the Heritage Foundation argues that ‘somewhere’ comes from consumers, not business owners.

Many employers of low wage workers are humble small businesses, such as fast food restaurants and ‘Mom and Pop’ stores that operate in highly competitive markets. These businesses earn barely enough to cover expenses, let alone pay workers extra even if they wanted to. For example, the typical fast food restaurant has a razor thin profit margin of between 3 to 6 cents of profit per dollar of sales.

Employers of low wage workers include fast food restaurants that operate on razor thin profits, limiting their capacity to pay their workers extra without raising prices. Image credit: The Times

Businesses generally refrain from raising prices to preserve their consumer base. However, since minimum wage costs broadly affect every firm, firms would collectively raise prices. For each 10% increase in minimum wage, research found that overall restaurant prices rose by approximately 0.7% and about twice as much at 1.5% for fast food restaurants where more minimum wage workers are hired.

A few percentage points of price increase may appear trivial but it carries significant weight on the sales volume of businesses. Fast food restaurants still lose customers even if they collectively hike prices as fast food consumers are particularly price sensitive.

A declining sales volume amplifies the worries for a business owner to cover fixed costs such as rent and utilities, pressurising him to increase prices by more than costs imposed by minimum wage. In addition, business owners must boost pay for mid to high pay grade positions proportionately with the minimum wage retain capable staff – also known as the ‘wage ripple’ effect.

An average of various studies suggest that overall, fast food restaurants would suffer a sales decline of 9.5% for each 10% rise in its prices.

An average of various studies suggest that fast food restaurants would suffer a 9.5% sales decline for each 10% rise in its prices. To put it in perspective, a jump from $7.25 to $15 in minimum wage would overall cause fast food restaurants to suffer a 15.6% decline in sales. While large businesses shift operations elsewhere or invest in automation, small businesses would make irrecoverable losses and that is bad news for poor families too.

Consumers from poorer families spend more than wealthy families on goods and services produced by low wage workers of small businesses. Economist Thomas MaCurdy examined families by consumption quantiles (many economist believe that consumption measures living standards better than income) and revealed that prices for the poorest consumption quintile by 0.63 percent, while only rising by 0.52 percent in the top consumption quintile.

 

Minimum employment

It is clear that the outcome of minimum wage is minimum employment. The Congressional Budget Office, a non-partisan federal agency that supplies economic information to Congress, estimates that a $9 minimum wage would eliminate as many as 100,000 workers from the workforce.

By compelling wages to be paid above market rates, labour supply exceeds demand from businesses, inevitably producing unemployment. Especially with higher operating costs, businesses would simply not hire anyone without a labour output equivalent to minimum wage. Without these employment opportunities, teenagers and unskilled workers would never receive on-the-job training crucial in boosting their future employability or attain promotions to a pay grade above minimum wage.

Working hours and overtime entitlements could also cut so on the whole, workers could receive less despite the elevated pay per hour. The work scope could become more challenging as workplaces operate with a smaller workforce and employers would demand more output per hour.

The minimum wage has created a black market of car washers who could not be hired at market rates anymore. Image credit: Carwash

In its magazine article, the Reason Foundation, highlights how minimum wage laws have turned desperate car washers into black marketers in New York. After making it illegal to be hired at minimum wage, many workers could no longer be employed and have resorted to washing cars out of their own vans parked on the street. Workers lack alternatives either as many car washes have closed or fully automated.

Even for low skilled workers that are employed, the impact of poor families collecting a larger pay check is very much exaggerated. Thomas MaCurdy finds that minimum wage workers live across the income distribution – just only above 20% of the poorest fifth of families include a minimum wage worker. If only a handful of families actually receive the significant boost of real income intended by minimum wage policies, the majority of poor families would actually face a net loss due to the inflation in the prices of goods and services.

 

An assault on market freedom

Walter Williams once described the minimum wage as not only discriminating ‘against low-skilled workers but also is one of the most effective tool of racists everywhere’. The early history of minimum wage policy – the Davis-Bacon Act – had the same intention to exploit low skilled non-White workers by indirectly making them unemployable in industries such as construction.

Essentially, minimum wage is an assault on market freedom as it hijacks the free and voluntary negotiation of wages between workers and employers. In the absence of the minimum wage, poor workers enjoy the competitive advantage of pricing their labour below more skilled workers and daily necessities from small businesses remain affordable for poor families. Minimum wage ironically hurts the poorer communities it wishes to serve. Perhaps, it is time to retire minimum wage from our workplaces.

 

Resources

Sherk, James. $15 Minimum Wages Will Substantially Raise Prices. The Heritage Foundation, 2017

 

Featured image from Sanders.

Posted in
Justin Ong

Justin Ong

Justin Ong is an active contributor to the Adam Smith Center. His latest work is a series of introductory-level articles spanning various topics of politics, economics and philosophy. He is also an incoming student of philosophy with Nanyang Technological University.