Minimum Wage Myths

Paul Boyce – June 25, 2019

The minimum wage is an idea that has lasted centuries. As humans, we naturally crave justice and fairness — moral values that have underpinned the debate for the minimum wage for decades. However, what is truly fair and just?

The first minimum wage laws were introduced in 1894 by New Zealand, followed shortly after by Australia in 1896. The US joined the party later in 1938 when Franklin D. Roosevelt introduced the nation’s first federal minimum wage. The policy has grown in popularity over time. The negative consequences have not always been as dramatic as some economists have predicted. While there is evidence to suggest it causes unemployment, there is some evidence* that suggests the negative consequences have been exaggerated. So which is right and which is off the mark?

Government Gets Its Share

A higher minimum wage would give workers a pay raise and therefore greater levels of income. That may be the case, but government also takes its share. If those on the minimum wage are struggling in poverty, then why does the government insist on continuing to tax them? For example, a worker earning the federal minimum wage of $7.25 would pay roughly $1,500 per year to the government in taxes.

If the minimum wage is raised to $15, this will take yearly income to $31,000. Of this, the government takes $4,500. It is somewhat contradictory for government officials to bemoan the hard fortunes of such workers yet take from the same individuals.

Big Businesses Aren’t Exploitative, They Just Follow Supply and Demand

The argument, of course, is that this would just be a subsidy so big businesses can pay employees less. However, this is simply not true. Alabama, for example, has no state minimum wage and is therefore bound by the federal legislated $7.25. We would expect big companies like Wal-Mart to pay the minimum $7.25, right?

In 2016, Wal-Mart was actually paying its employees (including those in Alabama) a minimum wage of $10 an hour — not exactly the $15 proposed but far from being “exploitative.” Target also pays its employees above the federal minimum wage. It increased worker pay to $13 in 2019. This was achieved without the coercive force of government. In part, the tightening labor market has encouraged such companies to increase pay. The supply of laborers is much smaller, and a higher salary is therefore used to attract what laborers are available.

This is simple supply and demand. When the supply of minimum-wage workers is low, the salary offered will be high. When the supply of such workers is high, the salary offered will be low. This does not make businesses exploitative. Rather, it follows the rules of supply and demand.

Higher Wage, Lower Benefits

A fairly simple explanation is that companies pay more, and employees receive more. In part, this is true. However, this doesn’t necessarily improve the living standards of those employees. Amazon announced in 2018 that it would pay employees a minimum wage of $15 an hour. The cost was that employees lost bonuses, and the company cut its stock unit program. Many are now actually worse off as a result. An employee interviewed by Wired said they would be $1,400 out of pocket.

The argument that the minimum wage doesn’t cause unemployment can be valid. However, that doesn’t mean that there are no negative effects. While an employee may receive $8 in wages, they may also receive $4 in additional benefits. This may cover health care, child care, pension payments, or bonus payments. If the minimum wage increases to $10, these additional benefits reduce to $2, cutting many of them. In many cases, the workers are actually worse off as a result.

In 2016, the UK introduced a “National Living Wage” to improve living standards and bring workers out of poverty. Businesses reacted by withdrawing certain benefits. Sunday pay rates were reduced, and food outlets removed free lunches for staff. As companies reform their “pay and reward” structures to offset the costs, many workers are actually left worse off.

Impact on Investment

Most private businesses are not charities and are limited by profit and loss. If an employee is bringing in less than their added value, there is less of an incentive to have them employed. For example, few people would pay someone $1,000 to mow their lawn. Why? Because there is no value in such a transaction. The output is not worth the cost.

The situation is somewhat different for employers who are reliant on minimum-wage employees. In retail, for example, they require labor to function. They still require individuals to stack the shelves and serve customers. By increasing the minimum wage, employers have no choice but to accept. The minimum wage, therefore, gives employees a monopoly over employers.

Employers have to pay the minimum wage somehow or go out of business. They have done this by lowering benefits, increasing prices, cutting workers’ hours, or increasing unemployment. Evidence from the UK suggests that a number of companies take a hit to their profits instead. Effectively, this is a redistribution of income from businesses to minimum-wage workers. The consequence is that the amount available for investment declines.

The effect will, in part, depend on the difference between the minimum wage and its true market value. As the minimum wage increases above and beyond the market value, the level of investment will equally decline. In the UK, for example, between the introduction of the minimum wage in 1998 and 2008, investment averaged 17.6 percent of GDP. In the 10 years prior to this, investment stood at 19.9 percent of GDP.

It is highly unlikely that the minimum wage was the sole determinant in this decline. However, it is a factor. There are also studies that confirm the minimum wage’s impact on investment. A study on the Indonesian minimum wage increase concluded that for every ten percent increase in the wage, investment declined by five percent. When wages are higher, there is less capital available for companies to invest.

Increases in Productivity?

This would partially offset the productivity gains achieved from other forms of investment. However, what happens when the workforce becomes accustomed to the new wage level? A higher wage can increase productivity if there is a competitive environment. If a cashier at Wal-Mart is earning $13 an hour, their productivity may increase if the alternative is to work at another retailer for $9 an hour. Competition creates long-term productivity gains.

The minimum wage creates short-term spurts in productivity but inevitably fails in the long-term. A waiter/waitress may put in extra effort, but how long does this last? Will their output consistently be at 120 percent? These are human beings, not robots. Once they see no benefit of their extra efforts, standards will fall.

Capital investment helps achieve long-term and sustainable productivity that is not variable based on the whims of human nature. The minimum wage is just a short-term solution, but it creates a drag on long-term growth.

*This article was updated to more accurately describe the consequences of minimum wage laws.

This article was originally published at Fee.org.

[Photo by Steven Cleghorn on Unsplash]

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