I know that there are plenty of issues floating around just in time for holiday conversations with your politically extreme family members. So in anticipation of this inevitable reality, I have chosen to revive an old topic that has recently lost some of its steam: the minimum wage.
For those of you who don’t remember, there were two serious proposals put forth by the Democrats with regards to the minimum wage. The first idea was to raise the wage to $10.10 an hour, or by about 40 percent. The second was to more than double the wage to $15 dollars an hour. The idea behind this was to help minimum wage workers make it through a rough economy by increasing their take home pay. Well, that all sounds great. However, raising the minimum wage is harmful to both workers and, more often than not, to the small businesses and franchises that employ them. Economically speaking, there are a few similar yet slightly different ways of viewing this issue from both the business’s and the worker’s point of view.
Let’s start with the business’s point of view. There is one assumption I am going to make here that shouldn’t really surprise anybody: businesses want to maximize their profits. So, the minimum wage is raised. Elizabeth Warren (D-MA) cheers as business owners and CFOs scramble to figure out what they are going to do. The basic concept that needs to be grasped is that the value of the marginal product of a worker’s labor (VMPL) will equal the wage rate at the point of optimal employment (when profit is maximized). Also, due to the concept of diminishing marginal returns, VMPL is decreasing as more workers are hired. Therefore, if the wage increases, the new level of optimal employment will reflect a decrease in workers. To put it more simply, workers will get fired. That’s a very microeconomic way of thinking about the minimum wage.
The more macroeconomic description utilizes the tried and true concepts of supply and demand. The minimum wage is what economists call a “price floor.” In other words, it is a legally set lower limit on wages. This lower limit is put in place to stop markets from adjusting to the true equilibrium price, which is almost always below the price-floor. This causes there to be more labor supplied than labor demanded, and therefore there is a surplus of labor.
Yet a third way that businesses could view a raise in the wage is simply as an additional cost of production, which will most likely be passed on to consumers in the form of higher prices. So businesses face a choice: whether to fire workers, increase prices, or take lower profits. Duke University wondered how the business community would react, and in 2014 conducted a poll of CFOs, asking them how they would react to a higher minimum wage. Over 80 percent said they would lay off workers. Moreover, the Congressional Budget Office estimated that a raise in the minimum wage would cost 500,000 jobs. So instead of “giving America a raise,” #raisethewage would give many Americans an effective income of $0. Pair that with our abysmal job market, with labor force participation at a 35-year low and the increased costs to business due to the new healthcare law, and the outlook isn’t stellar.
The drawbacks don’t stop there. A higher minimum wage would disproportionately harm young workers (16-25), especially young minority workers. This is because by raising the minimum wage, the risk towards the business of hiring a younger worker has increased. After the last minimum wage hike in 2007, the Cato Institute found that unemployment in young workers jumped from 15 percent to 25 percent. So for those of you hoping to find a summer job flipping burgers, a wage hike could set those plans on the back burner.
A minimum wage hike would have very different effects in different parts of the country. This is due to differences between regional costs of living. A $10.10 minimum wage would disproportionally hurt workers in areas with lower costs of living, because the VMPL there is less than in areas like New York City. Moreover, if one area — let’s say Seattle — decides to raise their minimum wage to not $10.10 but instead $15 (and the areas around the city don’t), then Seattle is going to see increased unemployment. This is increasingly unfortunate because the workers who got laid off probably can’t afford to commute to the suburbs each day for work. So, how are they better off? They are not. With the macroeconomic climate as uncertain as it is, “giving America a raise” could be detrimental for many businesses that already operate on thin profit margins.
Finally, I know everybody reading this has been thinking, “Well, what about big business?” It’s important to note that according to the Small Business Administration over 99.7 percent of employers are small businesses, and over 64 percent of private-sector job growth comes from small businesses. Even so, the remaining 0.3 percent of employers who allegedly are exploiting their workers need to be addressed. The American Enterprise Institute has done some work on this very subject of CEO-employee pay gap. They decided to use the parent company of Taco Bell, KFC, and Pizza Hut as an example, and found that even if all executives took a 100% pay cut, wages for their 400,000+ workers would only increase by five cents an hour. So would it be better for the board of directors to give all workers a nominal pay raise, or secure the best possible executives to run the company? I’ll let you ponder that one.
