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The Minimum Wage is Still a Bad Idea

There’s quite a bit on Congress’s to do list entering this new year, especially with the 2014 midterms looming. Discontent with Democrats continues to grow as implementation of the Affordable Care Act, better known as Obamacare, reveals the entire law to be something akin to a scheme hatched by Wile E. Coyote. With that, Democrats, with the help of some progressive Republicans worried about their own hides, have turned to a good populist ploy: the minimum wage.

Wile E. Coyote

A recent Washington Post-ABC News poll found that a vast majority of Americans, 57 percent, support a hike in the federal minimum wage. While progressive pundits and politicians alike are already using survey results like this and others to proclaim the inevitability of an increase and demand action, popular support doesn’t preordain something as prudent policy. Further, “Should people make more money?” is hardly the type of question that should be used to gauge public opinion on complex economic policy.  So let’s isolate opinion on this issue and relegate the importance of what the pollsters are purveying and take a good hard look at the economics of this issue. From this vantage point, above the clouds of Beltway bickering of the pundits and politicians, it is easy to see that Americans need to strongly reconsider their position on not just the looming proposal to hike the minimum wage, but the efficacy of this federal price control on labor as a whole.

The minimum wage is nothing but another example of the Parable of the Broken Window. For those unfamiliar, the crux of the Parable, first hypothesized by Frédéric Bastiat in 1850, is that liberals and progressives believe that if a shop’s window is broken by a rock cast by some little mischief maker, then the economy will benefit from the shop owner’s purchase of a new window and his payments to a laborer to have it installed. On the other side, conservatives, or classical liberals, realize that, while yes the money spent by the shop owner does technically add to the GDP by the GDP’s most basic definition, the community that the shop is in is now poorer by the equivalent value of one window. For the sake of argument, say that the new window costs $200. That is $200 that the store owner now cannot spend on a new suit, which hurts the local tailor, or on a new employee, which hurts the person that would have had that job, or invest in a new business, which hurts the entire economy. Instead that $200 will be spent to simply recoup the value of a window that had already existed. Further, the total cost of having the value of one window for that shop has now increased from $200 to $400. This applies universally to government price floors like minimum wage. 

So how do the feds figure in? They’re the little jerk with the rock.

Broken Window Fallacy

Consider a fast food restaurant that has an employee flipping burgers. That employee and employer have voluntarily entered into the agreement where that employee flips burgers and the employer pays him a set rate of $8 dollars for each hour he spends flipping burgers. In comes the government telling the employer he must now pay $10 dollars for each hour of burgers flipped through a minimum wage hike. Yet no additional burgers per hour are flipped. There are only three things that can result from such an arrangement: higher inflation, higher unemployment, and slower economic growth. First, the value of what $8 dollars, and the currency as a whole, can purchase has been diminished. Instead of being able to buy a full hour of burgers, $8 can now only by 48 minutes. This is a genesis point for currency inflation.

While the average burger flipper may be initially excited about the few extra bucks, some will be tremendously disappointed with another nasty side-effect of a higher minimum wage. The onset of inflation is generally gradual and over the long term. In the short run however, a price floor of $10 dollar an hour is problematic for those that only produce $8 dollars an hour of worth for their employer. Would you ever trade a $10 bill for 3 singles and a $5? Of course not, and neither will employers. Instead they will seek out those that can produce the equivalent of $10 worth of value each hour and discard employees that cannot. This means that until the entire economy adjusts to the inflationary effects of the new minimum wage, people that can’t produce more $10 an hour worth of value are effectively barred from the legal workforce. And by that time, if they are able to re-enter the labor force, they are in real terms making no additional money.

Minimum Wage and Jobs

Then there is the impact on the employer. Progressives generally don’t understand the inflationary impact of setting higher prices for single units of goods or services, like an hour of work and what it produces for example. They just think that employers will dive a little deeper into their Scrooge McDuck money vault of profits and spread the wealth.

Scrooge McDuck

What they fail to understand is that profits can only be used by employers three ways, each of which are optimal for the broader economy. As mentioned in the Broken Window Parable explanation, if a shop owner has to spend $200 on a new window, he or she cannot then buy a new suit, hire a new employee, or invest that money in a new business venture. In more general terms, profits can only be applied to increasing one’s personal consumption, expanding physical or human capital at one’s enterprise, or granting opportunity for someone else to found and grow their enterprise. In each case, the economy grows just as much, if not more, as it would by spending those additional profits on a new window or giving them to the burger flipper. Employment is sustained or increased where the shop owner increases their personal consumption, at his or her own shop, or in the community where their profits are invested in a new business. The difference is that the entire society, where the employer keeps more profits and doesn’t spend them on a new window or a $2 dollar higher cost of an hour’s worth of burgers, is richer by value the existing window and the value that is retained by existing dollars in the economy.

Defenders of arbitrary minimum wage increases will no doubt point to any number of studies that proclaim to prove that there is no statistically significant relationship between the minimum wage and inflation, unemployment, or economic growth. These excuses should not be taken seriously. These “studies” are simply suffering from a very basic Type Two statistical analysis error. Where a more common error is a false positive, or a Type One error, a Type Two error is a false negative. This occurs when the test does not detect the effect of the policy on the target. This likely occurs with the minimum wage given the incredibly incremental changes in the minimum wage and the small percentage of the population actually working at the minimum wage level. Essentially, the minimum wage is still largely below the average market clearing price for labor. However, this is no excuse to seek out the boundaries of a cliff in the dark. Further, methods used to take the economy’s temperature, such as GDP growth and the current unemployment rate formula, do not capture the unseen effects of having a minimum wage standard. Since the minimum wage is extant policy, we have no counterfactual or control to measure how much more prosperous the economy could be. This is not to say that hints do not exist.

Youth unemployment is staggeringly high and has been growing for decades. The number of Americans participating in the labor force, those even eligible to be counted in the employment and unemployment rate, is at its lowest level in nearly 4 decades and dropping. All due to a rising minimum wage labor price control? Of course not. However this is not an excuse to exacerbate the situation with fundamentally flawed policy.

Economies must be free to set prices on their own, without the heavy hand of government intervention no matter how beneficent it may be. If not, inefficiency will result and at some level, no matter how infinitesimal, and the economy will be worse off than otherwise.

To learn more about the importance of not regulating prices of goods and services at a governmental level, like the minimum wage does, check out this free course at FreedomWorks University by clicking here: Econ101, Understanding Economics

Tara Ruvalcaba

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Robert Boxer

Patrick, thank you for writing such an excellent article. It's unfortunate how little understanding the average American has concerning economics. People just don't feel it's necessary to understand these things. Too bad for the country. A blind voting public.