The False Promise of the Minimum Wage Hike

I. Introduction

Last week, the United States House of Representatives passed legislation raising the Federal minimum wage to $15 per hour by 2025. Contrary to what the Democrats would have you believe, this is less about compassion for low-skilled workers and more about the dearth of economic literacy. If you think a $15 minimum wage is a good idea, why not $1,000 or $2,000? No workers will be hired at that wage, but progressive politicians can claim that but for greedy businesses low-skilled workers would have prospered.  

The decision to raise the minimum wage is a value judgement -- a conscious decision to have fewer working at a higher wage than more working at a market-based wage. This is ironic coming from a party that decries the elitist policies of those on the other side of the aisle. The worst sin of the great many sins perpetuated in Washington is committed by those who worsen the plight of workers on the lower rungs of the economic ladder with false promises that they are doing otherwise.

The nonpartisan Congressional Budget Office (CBO) found that the minimum wage increase would give 17 million workers a raise and move approximately 1.3 million people above the poverty level. It would also cause about 1.3 million Americans to lose their jobs, reduce business income, lower economic growth and raise prices across the economy. Like virtually all public policy decisions, raising the minimum wage entails economic tradeoffs because it creates winners and losers.

II. The Economics

The first observation is that firms in competitive markets are profit-maximizers, which means they are cost-minimizers. Workers compete not only with one another for jobs but with technology (capital) as well. Minimizing costs requires that the last worker hired contribute to revenues an amount that is just equal to its wages. A similar calculus applies to capital. Businesses will naturally seek to insulate themselves from the effects of the increase in the minimum wage. This takes two different forms -- a reduction in the amount of labor that is hired and an increase in the amount of capital that is employed (e.g., robotics). Microsoft cofounder Bill Gates understands automation and he warns that increasing the minimum wage destroys jobs.  

Well, jobs are a great thing. You have to be a bit careful: If you raise the minimum wage, you’re encouraging labor substitution and you’re going to go buy machines and automate things — or cause jobs to appear outside of that jurisdiction. And so within certain limits, you know, it does cause job destruction.

The increase in the minimum wage forces employers to pay a higher wage, but it cannot force them to hire a minimum number of workers or guarantee a minimum number of hours (A lesson learned by Bernie Sanders’ campaign staffers earlier this month). Beware of progressive politicians who proclaim that “If you like your job you can keep your job.” Nor does the minimum-wage hike impose constraints on capital-labor substitution. This explains why labor unions, at least the smart ones, bargain on both wage-benefit packages and employment guarantees.

The second observation is that low-wage jobs are an indispensable training ground for young and unskilled workers that enable them through job tenure and skills acquisition to increase their prospects for higher-paying jobs. Low-skilled jobs are similar to apprenticeships and relatively low wages are to be expected. The objective is not for government fiat to mandate an above-market wage, but to provide workers with strong incentives to acquire the skills and experience that, in concert with economic growth, will naturally command a higher wage. Increasing the minimum wage will force some of these individuals out of the work force and deprive them of the opportunity to acquire the skills that would allow them to move up the economic ladder. These displaced workers are no longer able to participate in the various educational-assistance plans that many companies provide. In this sense, an increase in the minimum wage is the proverbial "sumé killer.” Even if aggregate wage income should rise as a result of the increase in the minimum wage (contrary to what the CBO found), displaced workers still suffer a twofold loss: their job and the opportunity to invest in their human capital through additional education and skills acquisition.

Third, raising the minimum wage will increase the prices of goods and services across the economy as businesses seek to pass along these wage increases through higher prices. The increase in the minimum wage does not equate to a corresponding increase in purchasing power because the nominal wage increase is eroded by inflation. This reduces the effective increase in the minimum wage for those who retain employment and imposes even greater financial burdens on those displaced workers. These higher prices also reduce demand for goods and services and therefore the demand for minimum-wage workers.  

Fourth, the progressive politicians that advocate increasing the minimum wage also tend to support an Open-Borders policy and a dramatic influx of low-skilled labor into the country. Paradoxically, the realization of the American dream may be denied these individuals because the hike in the minimum wage forecloses the very economic prosperity they seek. The end result is an increase in the ranks of the unemployed and a concomitant rise in poverty, crime, and despair. This will necessitate an increase in outlays for various social programs and perpetuate a cycle of government dependence.  

Fifth, progressive politicians rationalize their policies to increase the minimum wage on the basis of some studies that report little or no adverse employment effects from an increase in the minimum wage. There is no consensus in the economics literature on the effects of increasing the minimum wage. This should not be all that surprising. There is an old adage that “a town too small to support one lawyer can always support two.” The counterpart is that you can always find an economic expert to support the policy directive du jour. Even peer-reviewed studies do not provide dispositive evidence given the liberal bias in academia. The Law of Demand states that the quantity demanded of a good or service varies inversely with its price. This implies that an increase in the minimum wage causes a certain number of low-skilled workers to lose their jobs and reduces the number of hours worked for a substantial percentage of those retaining their jobs.

Finally, the Federal minimum wage is an ill-conceived concept from the outset given the pronounced differences in cost-of-living across the country. Where is the economic logic in mandating the same minimum wage in San Francisco as in Little Rock?

III. Conclusion

In an ideal world, elected officials would practice something akin to the Hippocratic Oath, “First, Do No Harm.” Unfortunately, this is not an ideal world. The most progressive politicians in the U.S. House can be partitioned into two groups. The first group is arguably economically illiterate. Their heart may be in the right place, but their candlepower sheds little light on the problem at hand. The second group understands the economics, but recognizes that there are short-run political benefits to a minimum wage hike despite the harmful, long-run effects. Markets do not adjust instantaneously to an increase in the minimum wage -- the wage benefit is immediate while downsizing the labor force and capital-labor substitution occurs with a substantial lag. By the time their constituency feels the cost of these policies, these politicians have already moved on to their next campaign or promise. True accountability is the Loch Ness Monster of politics because despite much folklore no one has really ever seen it. This is the problem with formulating public policy -- the focus is almost entirely on the short run because this is the only period of time over which politicians have any real culpability.

In the final analysis, it does not really matter whether myopic, minimum-wage policies have their genesis in economic illiteracy or political dishonesty. Because for those workers that suffer profound and enduring economic hardship as a result of these policies, this is a distinction without a difference.

Dennis L. Weisman is Professor of Economics Emeritus, Kansas State University.  

I. Introduction

Last week, the United States House of Representatives passed legislation raising the Federal minimum wage to $15 per hour by 2025. Contrary to what the Democrats would have you believe, this is less about compassion for low-skilled workers and more about the dearth of economic literacy. If you think a $15 minimum wage is a good idea, why not $1,000 or $2,000? No workers will be hired at that wage, but progressive politicians can claim that but for greedy businesses low-skilled workers would have prospered.  

The decision to raise the minimum wage is a value judgement -- a conscious decision to have fewer working at a higher wage than more working at a market-based wage. This is ironic coming from a party that decries the elitist policies of those on the other side of the aisle. The worst sin of the great many sins perpetuated in Washington is committed by those who worsen the plight of workers on the lower rungs of the economic ladder with false promises that they are doing otherwise.

The nonpartisan Congressional Budget Office (CBO) found that the minimum wage increase would give 17 million workers a raise and move approximately 1.3 million people above the poverty level. It would also cause about 1.3 million Americans to lose their jobs, reduce business income, lower economic growth and raise prices across the economy. Like virtually all public policy decisions, raising the minimum wage entails economic tradeoffs because it creates winners and losers.

II. The Economics

The first observation is that firms in competitive markets are profit-maximizers, which means they are cost-minimizers. Workers compete not only with one another for jobs but with technology (capital) as well. Minimizing costs requires that the last worker hired contribute to revenues an amount that is just equal to its wages. A similar calculus applies to capital. Businesses will naturally seek to insulate themselves from the effects of the increase in the minimum wage. This takes two different forms -- a reduction in the amount of labor that is hired and an increase in the amount of capital that is employed (e.g., robotics). Microsoft cofounder Bill Gates understands automation and he warns that increasing the minimum wage destroys jobs.  

Well, jobs are a great thing. You have to be a bit careful: If you raise the minimum wage, you’re encouraging labor substitution and you’re going to go buy machines and automate things — or cause jobs to appear outside of that jurisdiction. And so within certain limits, you know, it does cause job destruction.

The increase in the minimum wage forces employers to pay a higher wage, but it cannot force them to hire a minimum number of workers or guarantee a minimum number of hours (A lesson learned by Bernie Sanders’ campaign staffers earlier this month). Beware of progressive politicians who proclaim that “If you like your job you can keep your job.” Nor does the minimum-wage hike impose constraints on capital-labor substitution. This explains why labor unions, at least the smart ones, bargain on both wage-benefit packages and employment guarantees.

The second observation is that low-wage jobs are an indispensable training ground for young and unskilled workers that enable them through job tenure and skills acquisition to increase their prospects for higher-paying jobs. Low-skilled jobs are similar to apprenticeships and relatively low wages are to be expected. The objective is not for government fiat to mandate an above-market wage, but to provide workers with strong incentives to acquire the skills and experience that, in concert with economic growth, will naturally command a higher wage. Increasing the minimum wage will force some of these individuals out of the work force and deprive them of the opportunity to acquire the skills that would allow them to move up the economic ladder. These displaced workers are no longer able to participate in the various educational-assistance plans that many companies provide. In this sense, an increase in the minimum wage is the proverbial "sumé killer.” Even if aggregate wage income should rise as a result of the increase in the minimum wage (contrary to what the CBO found), displaced workers still suffer a twofold loss: their job and the opportunity to invest in their human capital through additional education and skills acquisition.

Third, raising the minimum wage will increase the prices of goods and services across the economy as businesses seek to pass along these wage increases through higher prices. The increase in the minimum wage does not equate to a corresponding increase in purchasing power because the nominal wage increase is eroded by inflation. This reduces the effective increase in the minimum wage for those who retain employment and imposes even greater financial burdens on those displaced workers. These higher prices also reduce demand for goods and services and therefore the demand for minimum-wage workers.  

Fourth, the progressive politicians that advocate increasing the minimum wage also tend to support an Open-Borders policy and a dramatic influx of low-skilled labor into the country. Paradoxically, the realization of the American dream may be denied these individuals because the hike in the minimum wage forecloses the very economic prosperity they seek. The end result is an increase in the ranks of the unemployed and a concomitant rise in poverty, crime, and despair. This will necessitate an increase in outlays for various social programs and perpetuate a cycle of government dependence.  

Fifth, progressive politicians rationalize their policies to increase the minimum wage on the basis of some studies that report little or no adverse employment effects from an increase in the minimum wage. There is no consensus in the economics literature on the effects of increasing the minimum wage. This should not be all that surprising. There is an old adage that “a town too small to support one lawyer can always support two.” The counterpart is that you can always find an economic expert to support the policy directive du jour. Even peer-reviewed studies do not provide dispositive evidence given the liberal bias in academia. The Law of Demand states that the quantity demanded of a good or service varies inversely with its price. This implies that an increase in the minimum wage causes a certain number of low-skilled workers to lose their jobs and reduces the number of hours worked for a substantial percentage of those retaining their jobs.

Finally, the Federal minimum wage is an ill-conceived concept from the outset given the pronounced differences in cost-of-living across the country. Where is the economic logic in mandating the same minimum wage in San Francisco as in Little Rock?

III. Conclusion

In an ideal world, elected officials would practice something akin to the Hippocratic Oath, “First, Do No Harm.” Unfortunately, this is not an ideal world. The most progressive politicians in the U.S. House can be partitioned into two groups. The first group is arguably economically illiterate. Their heart may be in the right place, but their candlepower sheds little light on the problem at hand. The second group understands the economics, but recognizes that there are short-run political benefits to a minimum wage hike despite the harmful, long-run effects. Markets do not adjust instantaneously to an increase in the minimum wage -- the wage benefit is immediate while downsizing the labor force and capital-labor substitution occurs with a substantial lag. By the time their constituency feels the cost of these policies, these politicians have already moved on to their next campaign or promise. True accountability is the Loch Ness Monster of politics because despite much folklore no one has really ever seen it. This is the problem with formulating public policy -- the focus is almost entirely on the short run because this is the only period of time over which politicians have any real culpability.

In the final analysis, it does not really matter whether myopic, minimum-wage policies have their genesis in economic illiteracy or political dishonesty. Because for those workers that suffer profound and enduring economic hardship as a result of these policies, this is a distinction without a difference.

Dennis L. Weisman is Professor of Economics Emeritus, Kansas State University.