Minimum Wage Again? You Must Be Kidding

Below is a reprint of an article that appeared originally in the Austin Business Journal, way back in 1995.  Later, in 2007, I updated the article, because the drums were beating yet again to raise the minimum wage.  Unbelievably, here we are once again with many people pushing an increase in the minimum wage.

Raising the Minimum Wage:  Who Benefits, Who Loses?

by David L. Kendall

January 26, 2007

In 1964 I turned 15 and landed my first real summer job washing dishes in a restaurant.  Somehow, I got the job over several others who also wanted it.  My first wage was 80¢ an hour—45¢ below the $1.25 federal minimum wage that year.

 

It might take an army of lawyers to figure out whether my employer was breaking federal law by not paying me minimum wage.  But legal or not, I was thrilled to work for 80¢ an hour.  That summer I learned a lot about holding a job, personal responsibility, and forgoing summer fun with my friends.  I even got a raise to 90¢ an hour after the first month.  More important, I earned about $385 over the summer, an enormous sum for me at the time.

 

Franklin D. Roosevelt sponsored the first federal minimum wage legislation with the National Industrial Recovery Act of 1937.  The Supreme Court declared that act unconstitutional.  But undeterred, one year later Congress legislated a federal minimum wage of 25¢ an hour in the Fair Labor Standards Act.

 

The 1938 act covered wage earners only in industries involved in interstate commerce.  But over the years, Congress amended the law to increase the federal minimum wage and to extend its reach.  Federal minimum wage law now applies to about 70 percent of the work force. 

The drums are beating again in Washington to raise the federal minimum wage from its current level of $5.15 per hour to $7.25.  With House Speaker, Nancy Pelosi as chief drummer, several legislators and pundits are claiming the moral high ground for wanting to raise the federal minimum wage.  Supporters argue that $5.15 is not a “living wage,” and therefore, the moral, ethical thing to do is raise it.

 

But is raising the minimum wage the moral high ground?  Should those who oppose the minimum wage hang their heads in ethical shame?  Who will benefit and who will lose?  A closer look and a little reasoning may be helpful.

 

Myth Number One—unless forced by law to pay higher wages, businesses will exploit workers, forcing them to accept a low wage.  The truth is that fewer than 7 million workers—about 5 percent of the workforce—received wages below $7.25 in 2005.  Conclusion:  most wage earners receive wages higher than minimum wage, even though no law requires it.

 

Employers are willing to pay more than minimum wage because they are in business to earn profit.  Just as most people are willing to pay costs to earn income—transportation, lunch, and day care expenses, for example—businesses are willing to pay costs to earn income too.  In fact, businesses are willing to pay workers whatever wage will maximize profits. 

But willing or not, employers are not able to pay workers more than they’re worth.  The wage workers are worth per hour in business depends on the value of goods or services they produce, and how much they are able to produce each hour.  Fortunately, a huge majority of workers in America produce goods or services each hour that can be sold for far more than minimum wage.

 

My employer during the summer of 1964 was a good, kind man.  But he was also in business for a living.  Owning and running a restaurant was how he and his family earned their income.  Like any other business—small or large—he had to cover all his costs of doing business, including a profit for his family’s income.  Otherwise, he would soon have been out of business.  He paid me what I was worth that summer.  Had he been forced to pay me minimum wage, the cost to his business would have been about $600 for the summer instead of $385.  Would he have hired me if the law had required him to pay me more than I was worth?  Plain sense suggests no.

Myth Number Two—minimum wage law helps the poorest, least advantaged workers in society.  Belief in this proposition may explain why so many Americans favor raising the minimum wage.  Much closer to the truth is that the minimum wage helps one set of “have nots” at the expense of another set of even poorer “have nots.”  A simple example helps explain why.

Suppose that a company is now paying $5.15 an hour for 400 hours of labor supplied by 10 workers, each working 40 hours per week.  Suppose also that the business is paying 100 other workers various amounts more than minimum wage.  Raising the minimum wage to $7.25 an hour would increase this company’s weekly wage bill for the 10 minimum-wage workers from $2,060 to $2,900, an increase of $840. How will the hypothetical business respond?  Let’s consider several options:  (1) raise prices to consumers, (2) accept lower profits, (3) reduce wages of workers who earn more than minimum wage, or (4) lay off some minimum wage workers. 

Most employers have no ability to “pass it on” to consumers.  If businesses could raise their product prices anytime they wished, why wouldn’t they already have used their hypothetical market power to increase profits?  Raising price to consumers, other things unchanged, has a predictable outcome—a drop in sales. Our hypothetical business can ill afford to lose sales.  After all, its weekly costs of doing business are up $840, due to the increase in minimum wage. 

What about accepting lower profits?  This option seems reasonable to some—particularly to people who think “profit” is a four-letter word.  But keep in mind that profit is someone’s income.  Is it any more reasonable to expect employers to accept lower incomes by decree of law than it would be for you or me to accept lower wages or salaries? 

Which brings us to the third option, reducing wages of workers who already earn more than the new $7.25 minimum wage.  Are you and I ready to be one of those workers?  Paying some workers less than they’re worth to allow paying other workers more than they’re worth isn’t really much of an option.  Remember, what a worker is worth has nothing to do with the worker as a human; only that worker’s worth as a producer of goods or services.

 

That leaves option four.  Our hypothetical company can keep its weekly wage bill from rising by reducing its use of minimum-wage labor by about 116 hours per week.  Which workers would lose their jobs if the company chooses this option?  They will likely be the least skilled, least productive workers.  Arguably, they will also be the poorest, least educated, least advantaged people—those most in need of even a low-paying job—whether it’s a “living wage” or not.  If low income is bad, no income is worse.

 

How will real companies all across the nation respond to a higher minimum wage?  Companies who can do so will raise prices to consumers, but competition at home and abroad will severely limit that option.  In the short run, business owners may absorb the increased wage bill through profit reductions.  But in the long run, stockholders and entrepreneurs must earn a normal profit or they move their capital resources elsewhere.  In the long run, higher labor costs will not be paid for with reduced profits. 

Wages of workers already earning more than minimum wage will certainly not decline.  Oddly as it may seem, raising the minimum wage tends in the long run to increase wages of skilled, experienced workers.  Faced with a higher minimum wage for unskilled labor, companies demand even more skilled labor.  It’s really just sensible economics.  A higher minimum wage for unskilled labor makes skilled labor relatively cheaper, other things unchanged.  Savvy business owners always want to use more of a productive input that becomes relatively cheaper—and less of inputs that become relatively more expensive.

 

In the end, once business firms make long-run adjustments to a higher minimum wage, workers who aren’t worth the higher minimum wage to their employers will lose their jobs.  Minimum wage legislation does not and cannot force employers to hire workers who are not worth the legal minimum wage.

 

Who gains and who loses if Congress raises the minimum wage to $7.25 and hour?  Supporters in Congress clearly gain by doing what appears to be a highly visible “good.”  Some voters like the idea of guaranteeing higher incomes to low income earners.  But the good comes at the expense of others in the labor force who earn even lower incomes.  The losers are generally willing, hardworking people with the poorest educations, the lowest skill levels, and the least ability to help themselves.  Fortunately for Congress, the harm done is evidently out of sight to most Americans.  Better still for Congress, the losers don’t make campaign contributions, and many of them seldom vote.

Workers who lose jobs or cannot find jobs that pay the higher minimum wage will have even poorer choices than they had before the increase.  They may retreat to the welfare rolls, or they may find a job that can legally pay them less than minimum wage.  Most will choose a job—or perhaps two jobs—that pay less than minimum wage, because most are self-respecting, hard working people.  But if unskilled, inexperienced workers cannot get in on the ground floor, it’s even less likely that they will make it to the second floor.

 

If a higher minimum wage could somehow transfer income from wealthy “haves” to disadvantaged “have nots,” then raising the minimum wage might be defensible on moral, ethical grounds.  At least it would be debatable.  But to use the force of law to take from really poor “have nots” to benefit slightly better off “have nots” may not be what most people would call ethical behavior.  It no doubt depends on how you look at it, but perhaps there is no moral high ground available to supporters of a higher minimum wage.