Assessing the Minimum Wage

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Issues surrounding
poverty and inequality tend to be the most polemic of any social
or economic issues. However, the almost universal relevance of these
issues for economic actors requires that they receive as much calm
and rational discussion as possible. To this end, I embark upon
an examination of one of the more obvious attempts to solve the
problem of poverty: the minimum wage. I will argue in this paper
that the minimum wage not only cannot do what it is intended to
do, i.e., alleviate poverty, but that it actually exacerbates poverty
in various ways.

There are effectively
two aspects of any economic policy decision: the practical and the
ethical. Before any ethical discussion may be undertaken however,
it must be shown that the practical arguments regarding implementation
are sound, that is, it must be first shown that the policy can actually
achieve its intended results. Second, it must be demonstrated that
any unintended results are negligible when compared to the intended
ones. Without sufficient demonstration that the above two conditions
are satisfactorily met by any policy, ethical argumentation is not
particularly meaningful, and with this in mind, this paper will
focus primarily upon practical considerations. The minimum wage
is designed to help those most likely to be affected by poverty,
namely, young workers (especially minorities), the unskilled, and
the uneducated. It is therefore sensible to evaluate the effects
of the minimum wage upon these groups.

We must begin
with some general observations regarding the nature of wages in
a market economy. The first principle to note is the tendency for
wages to equal Marginal Revenue of Product (MRP), or in other words,
the individual workers' wage tends to equal his or her productivity.
We can deduce this logically if we consider the other two possibilities:
either that wages paid are greater than MRP, or also that wages
paid are less than MRP. To take the first possibility: if a worker
earns more than he or she produces, the employer loses money and
thus cannot continue to employ the worker. The second possibility,
that the worker makes less than his or her productivity, is also
prevented by the market process. In this case, the market bids up
the wage rate until W=MRP. It can do this in two ways which are
really two different sides of the same economic coin. First, the
employee can search for other employment at a higher wage rate,
but second, employers can also search for labor in an attempt to
both maximize its own productivity and keep highly productive labor
away from the competition. With this is mind it becomes clear that
even geographic immobility on the part of the prospective employee
is not necessarily a hindrance when evaluating employment opportunities.

It should be
noted that the above tendency only holds with any certainty in the
long run, because the above process cannot take place instantaneously,
but only over time. There is a necessary period wherein productivity
and wage rates must be measured and then evaluated by employer and
employee both. However, we must also note that although the tendency
only emerges with any certainty in the long-run, this does not necessarily
mean that it cannot exist in the short run as well. Short-run
emergence of the principle is certainly possible, especially in
industries in which the amount and quality of labor is relatively
uniform, and it is worth observing that many unskilled jobs fall
into this category. Outside of this limited observation however,
we cannot make any meaningful predictions about whether or not the
above principle will hold true in the short run.

In order to
be effective, a minimum wage must necessarily artificially hold
wages higher than they would otherwise be on the free market (that
is, hold wages higher than MRP). If a minimum wage is introduced
then, employment must fall, because otherwise employers incur (essentially
hourly) losses. Professor Walter Block sums up this problem by stating:

If the law
requires that a low-skilled person be paid, say, $4 per hour,
and his productivity is only $3 per hour, all the firm need do
is take on several highly skilled employees (and some sophisticated
machinery) instead, and avoid like the plague the unskilled workers
it would have otherwise hired.

So by requiring
minimum wage rates which are over the level of productivity of the
employees, minimum wage legislation causes unemployment. The above
quote hints at another aspect of the minimum wage problem, discrimination,
which will be discussed further below. First, however, we must recognize
that an employers' profitability — and thus, his ability to employ
— depends upon his ability to pay workers wages equal to their productivity.
Without this ability, the employer does not merely reap lower profits,
he necessarily incurs losses.

Regardless
of our sympathies for young, unskilled, and uneducated workers,
it almost absurd to argue that unemployment is better than employment
at a low wage rate. This is especially true when employees wish
to work at a certain wage rate and find themselves unemployable
due to the minimum wage.

It is simple
to demonstrate the validity of this principle if we look at an exaggerated
example: suppose that the minimum wage was 25 or even 100 dollars
per hour, how then would employment be effected? The answer is obvious:
employment would cease as we know it, because very few employers
would be able to afford such wages. It is vital to understand that
the same principle applies to low-wage earners as well, and that
the above argument is not merely empty or abstract reasoning. Empirically,
we see the principle illustrated in numerous cases. Especially,
we may observe a close correlation between rises in the minimum
wage rate and higher unemployment among younger workers, minorities,
and the unskilled labor force.

Another
major problem with the minimum wage, from the standpoint of the
economically disadvantaged, is that it creates disincentives for
employers to hire unskilled or inexperienced workers. If an employer
must hire a worker at a wage which is higher than the potential
productivity of the job in question, he has an incentive to hire
the most-qualified worker he can find, as opposed to a worker who
could merely have been productive at a lower wage rate.

For instance,
let us imagine an employer who must hire an additional employee
at the minimum wage level of $7/hour, as opposed to the $5/hour
the employer would otherwise pay. The employer faces two negative
incentives. The first involves hiring practices. In any such scenario,
the incentive is to always discriminate against those who are less
qualified to hold the job — that is, those who are uneducated or
have limited work experience who, absent the minimum wage, could
perform the required job adequately at a lower wage rate. If, for
example, an employer has a choice between a college undergraduate
seeking student employment and an uneducated manual laborer, his
incentive – when the minimum wage is in effect – is always to hire
the undergraduate, because he will tend to have more potential for
overly-productive work than the laborer.

However, this
incentive does not exist in an economy where wages rates are adjusted
through the interaction of the supply and demand for labor. In such
a case, the employer only requires an employee who can do the required
amount of work at the desired wage, because he has no wage-productivity
gap to fill. The minimum wage, like all attempts to alleviate poverty,
is aimed, not at the educated or those who compete for middle- or
upper-class jobs, but at the relatively uneducated and those who
cannot compete for better-paying jobs. And yet, we see in the above
an incentive to discriminate against the uneducated and less-qualified
in favor of the less-needy and more qualified, an incentive which
clearly runs counter to the intended goals of the minimum wage.

Another negative
incentive which employers face is to work all employees harder than
normally required, in order to raise productivity as much as possible
to offset the loss taken from wages. In other words, any business
has a minimum amount of work which must be done, and thus cannot
lose staff beyond the number required to perform this minimum (although,
as noted above, an employer can merely higher fewer, yet more productive,
workers). If he wishes to stay in business, an employer will have
to keep a certain amount of staff, although at wage rates which
he knows are too high. An employer must then search for other methods
of deferring the additional cost of paying workers wages higher
than their productivity. One obvious way to do this is to demand
an increase in productivity from all employees, beyond what is expected
of them under conditions of free wages. This could take the form
of demanding more labor per hour, or perhaps requiring a higher
degree of quality in the labor performed from the employee.

Since it is
often claimed that there are ethical reasons for desiring a minimum
wage, it is relevant to mention one argument advanced against this
view. Murray Rothbard pointed out that absent minimum wage laws,
employer and employee may choose to contract with each other at
an agreed-upon price. However, with the minimum wage in effect,
both parties are coerced into abstaining from a mutually agreeable
arrangement which would otherwise have taken place. The law requires
that no contract be made below the required minimum. Thus, even
if a worker wishes — or desperately needs — to work, he or she is
prohibited from doing so.

Through the
previous arguments, we have seen that all parties incur costs when
confronted by the minimum wage. Those who the minimum wage is designed
to help are priced out of the labor market, and thus slide further
into poverty. The economically disadvantaged also face the problem
of discrimination when compared to relatively more-skilled workers,
thus further decreasing their likelihood of finding employment.
Next, the employee who does secure a job must work harder than otherwise
necessary in order to keep it, and also to keep his employer's business
profitable. Finally, employers are put at a disadvantage through
having to pay higher wages and thus reap lower profits, which in
turn makes business success more difficult, and thus endangers the
jobs of the employees.

There is not
a single discernable group that benefits from minimum wage legislation.
It is quite simply the case that the minimum wage law cannot achieve
its intended goal, because it prevents those who need extra income
from working at all. It should be clear for anyone who wishes
to arrest the growth of poverty that the first sensible course of
action which must be taken is the immediate repeal of the minimum
wage laws.

April
29, 2008

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