Minimum Wage, Maximum Insanity

January 2, 2014

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If a teen unemployment rate of 25 percent is not high enough to suit; raise the minimum wage and it will go up. Logic says if you raise the price of anything, including labor, less of it will be taken. There is no good or service that is exempt from this law of economics, especially over time as markets have time to adjust to new prices. In simple terms, raising the price of labor produces an incentive to find ways to operate with less labor (mandatory benefits, restrictions on termination, etc., have the same impact). The tragedy of this is that opportunities for the “first job,” the chance to get “on the job training” and enter the labor force are eliminated.

Why? Because no business can pay a worker more than the value they bring to the firm, e.g. you have to “earn your pay.” A business that pays more than employees are “worth” (the value they create by working) will obviously fail and all jobs will be lost.

So, take a familiar example, a pizza parlor or a restaurant. The firm employs 10 workers that work 2,000 hours a year (two weeks off). Labor costs typically make up 70 to 80 percent of total costs. Assuming 70 percent, total cost of the business if the minimum wage is $7 per hour and all earn the minimum wage is $140,000. This means total costs are $200,000 (rent, utilities, ingredients, etc.). The firm sells about 65 pizzas daily at a price above $10 per pie, the cost of producing it. If the owner makes $2 per pizza (a 20 percent margin) for starting the business and taking the risks, he makes $40,000 per year on his investment in the operation.

It is clear for this firm that every $1 increase in the minimum wage raises labor costs for this owner by $20,000 (half of his profit in this case). An increase in the minimum wage of $2 to $9 per hour raises labor costs by $40,000 and wipes out the owner’s income. What are the options? Closing the firm eliminates 10 jobs (plus the owner). Recovering the $40,000 that was sufficient to keep the owner operating the firm rather than finding another occupation would mean that pizza prices would have to be increased by $2. If consumers didn’t care about the increase in price and bought the same number of pizzas, the firm could continue. But, the law of demand says that fewer pizzas would be purchased, leading the owner to reduce employment by one worker.

So, workers have more to spend, but dollar for dollar, customers in the area have an identically lower amount of money to spend so no “increase in spending” due to the hike in the minimum wage as many argue. Wow! There is no “free lunch”! What a surprise. And, since workers don’t make any more pizzas after the increase in the minimum wage than before and every firm pays the same minimum, the cost must be absorbed by customers and owners, dollar for dollar.

But most importantly, if new workers are to be hired, they must bring a value of $9 per hour to the firm or they won’t be hired. Before, the “hurdle” was only $7 per hour in value. The higher the minimum wage, the higher the hurdle a new or unskilled worker must get over to get their (first) job. So, raising the minimum wages reduces job opportunities for the young and unskilled in the year it is raised and forever after. This is not the way to develop our labor force.

In 1908 the Supreme Court stated: “The right of a person to sell his labor upon such terms as he deems proper is, in its essence, the same as the right of the purchaser of labor to prescribe the conditions upon which he will accept such labor from the person offering to sell. … In all such particulars the employer and the employee have equality of right, and any legislation that disturbs that equality is an arbitrary interference with the liberty of contract which no government can legally justify in a free land.” -Adair v. United States (Justice Harlan)

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