The Minimum Wage and Market Economics
One of the easiest ways to begin to understand the implications of a minimum wage (or an increase in a minimum wage) is by applying basic economics. A minimum wage is a “price floor”. As I discussed above, a price floor has two results: an increase in supply, and a decrease in demand. So how exactly does this apply to labor and the minimum wage?
First, seeing the cost of staff going up, employers will have an incentive to decrease the number of staff (Some would argue that the current number of staff is essential to running the business and will not decrease; I’ll address this later). Second, more individuals who are currently not seeking employment will enter the job market, now willing to work for that higher wage. So, fewer people are employed, and even more people want to be employed. This is a double-whammy for the unemployment rate!
Furthermore, for those who do retain their jobs, the pressure on the employer will be to cut costs elsewhere. One of the first things to go is often training. This means less opportunity for unskilled workers to develop into skilled workers and escape minimum wage, and perhaps poverty. Another item frequently on the chopping block is health care. Some would say this means a zero-sum game for an employee, but the results are far worse. The worker is moved from group health-care to individual health-care programs, where the costs of health care is usually higher to the individual than the employer.
We must also be clear that an artificial price floor may be below the current market rate and have no effect. For example, at one time in my community, gas station attendants were being offered wages of $11.75/hr. An increase in the minimum wage to $7.15/hr would have no effect in this market. On the other hand, in less affluent, more rural, or lower “cost of living” areas (where wages tend to be lower), an increase in the minimum wage will have a greater effect if wages are lower there. The conclusion to be made here is that the effect of minimum wage is directly related to the current wages in a given area, which are related to the overall cost-of-living in an area. Low cost-of-living areas will be affected the most. Also those in jobs that earn the least (typically unskilled workers) will be affected the most.
Having said that the law of supply and demand demonstrates that a higher minimum wage will increase unemployment in poorer areas and for unskilled workers, the simple economic conclusion is that those who are poor and unskilled will be affected by job losses.
One must now ask what happens to all these unemployed workers. Well, they’re out there looking for employment, of course. But they don’t just look for work in the markets covered by the minimum wage. They also look in the job markets that are not covered by the minimum wage. This has the effect of increasing supply in these markets. As we know, this increase in supply results in a decrease in price. That is to say, wages in uncovered markets fall, further hurting the poor and unskilled.
Counter-claims to Market Effects of the Minimum Wage
There are a number of claims that attempt to use empirical evidence or rely on an emotional response to convince us that a minimum wage hike is a good idea. Let’s go over some of these claims.
The lowest unemployment rate in the country is Hawaii’s 2.8 percent, which somehow survives their $6.75 minimum wage.
These figures are accurate and statistics don’t lie (on their own). But some liars can sure use this one to confuse folks. As I mentioned, a minimum wage hike will have an effect in low cost-of-living areas. It so happens that Hawaii has the highest cost of living in the country. The 2nd Quarter 2006 cost of living index for Hawaii was 161.3. That’s 61% higher than the average state, and nearly twice the differential of the next highest state.
Now, let’s adjust Hawaii’s current minimum wage for the cost of living there. $6.75 / 1.613 = $4.18. That’s right, the adjusted minimum wage in Hawaii is much lower than what the average state is paying in adjusted minimum wages. No wonder unemployment is so low – their price floor is almost 20% lower than the average state! If anything, the claim above supports a decrease in the federal minimum wage!
The number of people currently working is required to maintain business operations. As such, businesses cannot decrease employment due to a minimum wage hike without adversely affecting operations.
As we see job cuts due to operational issues on a regular basis, we already know that there is a significant amount that employers can cut due to cost increases. We call this elasticity. But an additional aspect of areas employers can cut jobs is due to substitution. In many cases, the most cost effective way to operate a particular task is with human labor. However, as the cost of human labor rises (i.e., with a minimum wage hike), technologies become more and more available at a cost lower than the rate of labor.
For example, at $5.15 it may be cost effective to have 10 people hand-drying cars at a car wash. Lets say this effectively costs the car wash $139,259 per year for wages and employment taxes (direct costs – we’re ignoring indirect costs like supervision). At a rate of $7.25 the employer must now pay $196,040 – an increase of $56,781. Now let’s say this employer can cut staff in half by using power-assisted drying mechanisms. This equipment, with maintenance, installation, power, and all other expenses factored in, costs $400,000 and has an expected life of 5 years.
At $5.15, cutting half the staff saves $348,147 over 5 years – less than the cost of the equipment, so the power drying equipment isn’t such a good idea. In fact, that’s why we don’t have it at the moment. On the other hand, at $7.25, cutting staff in half saves $490,100, so installing the equipment is a pretty good idea. I guess our employer will be cutting half those jobs in favor of automation!
Essentially, a higher minimum wage encourages the use of automation over labor.