Economics Professor: Why the Minimum Wage Is Complete Garbage
With Joe Biden as president, the days of the national minimum wage at its present $7.25 per hour may soon be gone. It will likely be raised to $15 or more and also indexed for inflation, whether it is stuck into a COVID bill or sent to Congress on its own.
But this enactment would be a joblessness bill for “the least, the lost and the last” among us, the very people who suffer the most economic hardship.
The unemployment created by this pernicious legislation always attacks the poor and the unskilled, precisely the people who can least afford it. But it is even more crucial to understand this economic law in the age of pandemic, given present high unemployment rates. Let us, then, more clearly understand the malevolent effects of this unwise legislative enactment.
What determines wages? At what level would wages register were there no laws on the books whatsoever regarding this matter?
The long answer is that discounted marginal revenue product, DMRP, or productivity for short, determines wage levels. What, in turn, is that? Many people talk about productivity, and we all know, roughly, what it means, but what are the exact specifications of this concept? It is all about how much you add to the firm’s bottom line.
If the business receipts rise by $5 for every hour you are on the shop floor, or behind the counter, or pushing a broom, then that is the level of your productivity. We posit, here, that the reason for the increase in sales is solely due to your efforts, all else held constant.
Wages tend to equal precisely that amount. If you are paid only $2 per hour, the employer can earn a profit: $5 – $2 = $3 per hour. But this cannot long last, no matter how much the firm favors this sort of situation.
What will tend to disturb this state of affairs? One source is other businessmen, who would be more than willing to pay you $2.01, or $2.02. They would reason that they would prefer to “exploit” you to the tune of $2.99 or $2.98 rather than have your present employer do so at the rate of $3 per hour. Where will this hypothetical bidding process end up? In the neighborhood of $5, at which point no more profits can be made.
Another source is you, yourself. After hours, you can approach other business firms and offer to work for them for more than your present $2 salary.
You may demand, say, $2.25. If this other company is smart, namely profit-seeking, it will hire you for that amount, since they will still clear $2.75 from your labor.
This process will continue all the way to $5 per hour, in equilibrium, since at that point there is no further room for the wage to rise. But this assumes there are no (transactions) costs of the bidding. If these are low, then there is a tendency for the wage to approach more closely the $5 level.
But suppose this process overshoots, and someone pays you $7 per hour. This, too, is not a stable situation, since any firm foolish enough to do so will lose profits to the tune of $2 per hour; bankruptcy is just around the corner if we generalize from this mistaken hire.
Accurate assessment of employee skills is important for successful employers. If a firm overestimates labor productivity, it will lose money, and if it errs in the opposite direction it will face grave difficulties in attracting a labor force in the first place, and retaining it afterward.
The Jeremy Lin case is a good illustration of the difficulty in measuring productivity. As a basketball player at Harvard, and Taiwanese at a mere 6 feet 3 inches, Lin was severely underestimated by scouts.
But as an undrafted bench rider for the New York Knicks, he was allowed into the game before his usual “garbage time” allotment and did very well in terms of points scored and assists given out to his teammates. This gave rise to the phenomena of “Linsanity.” The point here is that even highly talented assessors of productivity can err. But, when they do, they pay a price for their misassessments.
What boosts productivity? Human capital (skills, education) and physical capital (machines, technology). Mexicans in their own country earn less than equally skilled Americans since they work with the aid of less physical capital.
When they enter the U.S. labor force, their wages rise since they can now work alongside more and better plants and equipment. What determines which nations have the most capital? Adam Smith said it well in his 1776 (that is not a misprint) book, “The Wealth of Nations”: Economic freedom is the key
Try to pluck the golden goose too much and it reduces the egg supply.
What will be the economic effect of a minimum wage of $7.25 (the present federal level stipulated by law) on a worker with productivity of $5?
It is simple. He will have the greatest difficulty in finding a job in the first place (only those who overestimate his productivity will hire him), and he will all too soon be fired if he is lucky enough to be initially hired.
Firms will make a loss of $2.25 from keeping him on the payroll. This analysis is based on the fact that demand curves for labor (and for everything else without exception) are downward-sloping: The higher the price or wage, the less of the offered good or service will be purchased or hired.
It is no accident that the unemployment rate of black teens is quadruple that of white adults. Let me repeat that: quadruple. The former are largely unable to exceed the high bar placed in the way of their first obtaining and then keeping a job.
The minimum wage is not a floor under wages that raises them as it rises. Rather, it constitutes a bar over which the unskilled all too often cannot jump. And the higher it is, the harder it is to hurdle over it into the land of employment.
The reason this cohort of the labor force has recently been doing so well in terms of reduced unemployment (before the advent of the coronavirus) is that inflation has been reducing the real value of the wage mandated by law.
It was set at $7.25 in 2009; in those dollars, it is equivalent nowadays to only about $5.85, given inflation of about 24 percent since that time. Ordinarily, I would not say this, but thank God for inflation, at least in this one regard.
Everyone in his right mind realizes that the higher the price, the less will be purchased. No one doubts this for cars, beans, shoes or music lessons, but when it comes to hiring workers, good sense flies out the window. Those who are pushing the “fight for $15” are not total economic illiterates. But they are suffering from a sort of economic schizophrenia.
When Bernie Sanders and his followers want to reduce the incidence of coal, plastics and gasoline, they know full well to raise their prices usually via taxes. When they want to encourage the use of electric cars, higher education or health care, they act as if they all have a Ph.D. in economics: They favor lowering prices, even to zero.
Why, then, the failure to apply this to the labor market?
Some people think that without this law wages would fall to zero — the only thing that boosts them is this legislation. But federal minimum wages only came into being in 1938. Labor compensation was positive long before then.
If this malignant enactment really increases remuneration, why not raise the mandated level to $1 million per hour? Then, we would all be rich. That is silly. But so is $15 per hour.
Tell that to an unskilled worker with the productivity of $10 per hour who will soon be unemployed. Sophisticates mention “monopsony” in this context, but there are no single buyers or even a few of them (oligopsony) for unskilled workers. If it occurs at all, it applies to nerds, engineers, STEM workers, etc.
Why is this law on the books if it is such a disaster? There are, indeed, beneficiaries. The highly skilled, organized in labor unions, are always and ever in competition with youngsters just starting out. One way to obviate their competition is to price them out of the market. In that way, they can pose as the benefactors of unskilled workers while really stabbing them in the back.
It is no accident that before the advent of the minimum wage law, unemployment rates for all age categories were similar. Afterward, the unemployment rate of youths was double that of middle-aged people and the unemployment rate of black people was double that of white people. This is due to the minimum wage, not to any imaginary white or age “privilege.”
One excellent way to lift barriers to growth for the low-skilled is not to raise the minimum wage level, not to leave it where it is, not merely to lower it, but to eliminate it entirely and to sow salt where once it stood.
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