Guest Post: The downside to minimum wage.

Note from Ben:

I have periodically explored the consequences of government intervention in free markets, which I believe are largely self-defeating and produce unintended long-term consequences.

One of the first posts on this lowly blog explored the way in which government guarantees on deposits via CDIC (Canada) and FDIC (US), while seemingly a good thing, indirectly led to the great credit crisis of 2008-2009.

It’s a topic I enjoy discussing.  Today I present a guest post from M.G. in which he argues against government-imposed minimum wage.

Cheers!

 


The downside to minimum wage.

Most people think of minimum wage as a good thing. Many think that it’s the sign of a healthy economy to have a high minimum wage, or that it’s needed to prevent ‘evil’ businesses from taking advantage of the weak and poor. It would be considered almost blasphemous to say that the occasions of minimum wage helping our economy or the ‘poor’ are significantly outweighed by the downsides. However, that is what I am pointing out today.

First, let’s get on the same page. I think we can all agree that employment opportunities offered by businesses would not exist without invested capital in those businesses. We should also be able to agree that employees are taking advantage of that invested capital in order to gain something for themselves—income.

When we look at minimum wage in detail the negative effects become clear. Example: a  local business man starts a factory that will compete on the global market making widgets. After investing a substantial amount of money, he starts hiring individuals to use his invested capital to produce widgets. The manufacturing is very simple and safe, so he offers minimum wage to his workers. His profit margin on the widgets is small. Let’s say that the factory owner’s cost is $10 per widget and he can sell it on the global market place for $12 per widget.

His costs include his employees wage, utility costs, and any other licencing/permit costs that he must take on. It takes approximately one hour to manufacture a widget at an employee wage of $8 an hour. This factory is just making enough to justify all the invested capital. Now let’s say that minimum wage goes up to $10 an hour. All of a sudden, his unskilled labour is costing him much more and there is no more profit to justify the investment. Because the global economy can produce the widgets at a significantly lower cost due to inexpensive labour, there is no point in competing. The business man loses his capital and the employees lose their jobs.

In a local economy, when minimum wage goes up, it simply creates nominal inflation. The local coffee shop would need to put their prices up to compensate for the extra in payrolls, and then fewer people would buy coffee (which would start a spiral effect) or people would demand more income from their employers to help support their coffee habits (and other higher prices).

There will always be a business where the current minimum wage is just on the edge of making business capital worthless. Examining these extreme cases illustrates my point – that minimum wage decreases a business’ competitive value in a global marketplace, and produces a type of inflation in a local marketplace.

Specific downsides to minimum wage:

Let’s view other downsides of minimum wage, one at a time.

Why finish high school? These days getting a job is difficult, but what is the point of finishing high school if you are already making minimum wage? The only way to make more would be with a college or university degree, an option which is not  for everyone. The income potential between no high school education and having your diploma is minimum and getting smaller each year. So where is the incentive? Salary statistics indicate that minimum wage has decreased the difference in income between having no high school education and having a university degree. Higher wages for people with post-secondary degrees do not increase when minimum wage does. Closing the income gap between blue-collar and white-collar workers lowers the incentive to achieve the payroll clout of higher education in the first place.

 

Why does the government increase minimum wage anyway? Do the people demand it? Yes. For the most part, the ones already making minimum wage are the ones who demand it be increased. Do the businesses encourage it? Yes and no. Let me explain: some businesses, like the ones that already employ workers at more than minimum wage, encourage minimum wages to go up. This might be a sinister move – a ploy to reduce start up competition, but it might simply be because it is thought to be in their best interests for the masses to make more money, and therefore be able to spend more on the business’ wares. Large, economically intelligent businesses may even like minimum wage because they know that jobs will become scarce and thus they will be able to keep their current workforce for less. When jobs are scarce, employees no longer have the bargaining power to hold out for increases in pay. Does minimum wage help the government? Of course it does; they gain more income tax and they persuade more people to believe that the government is benevolent.

 

What happens to all those people who have lost their jobs? Many of them might find another job, but some find themselves on some form of government funding (welfare, unemployment insurance, disability). With less capital investment for businesses and even less for global competition, manufacturing jobs start to get scarce and people start to get desperate.

 

One of the major problems with minimum wage is that the lower class ends up having even less money. If minimum wage didn’t exist, there would be more jobs and less income all around, but other businesses would be able to crop up and cater to these lower earners. In the current state of affairs, these people have no money because they have no jobs (unless they are on a government funded program—and therefore under government control), and there is next to no chance that a new business will be able to start offering services geared to their needs. A small amount of these people end up on the streets.

 

So now let’s flip the coin and see what the benefits of minimum wage are. You may think that the fact that the government can now collect more taxes is a good thing, however, because the government does not use this money to create more capital, my point of view is that this is a bad thing. I will leave this for you to figure out.

 

Does minimum wage help out big, ‘evil’ corporations? First of all, I need to clear something up. Greed cannot be maintained without the presence of violence or duress. A simple example of this is the loan. A loan cannot be greedy, nor have anything in its agreement which is inherently greedy. It may be biased; however, due to the fact that both parties must agree to the terms, neither party can be said to be greedy. If one does not agree, they can simply find someone else to make a loan agreement. The individual providing the loan has the vested interest in making sure the risk is taken into account and that the borrower succeeds so the loan can and will get paid. So no agreement can really be called “greedy” unless one party is forced into it. This works for private loans, the banks, which make money out of nothing, take more risk, but I digress.

 

The same thing applies in employee-employer relationships. If an employer is unfair with their pay rates, people will move on, or another business will offer their employees slightly more pay until a balance is found with what employees want and what businesses can pay. The only time a business can take advantage of employees is when jobs are scarce. This can either happen where there exists a government-forced minimum wage, or an excess of available employees (such as in China).

 

There isn’t really a labour problem in China; their economy is just a reflection of the high population. The businesses there can invest less capital and just pay for more labour hours. You might ask yourself why labour in China gets paid so little. The simple answer is that the available employees are willing to work for less because they can survive on less, and because in a market with a labour surplus, holding out for that higher wage will get you nowhere.

 

In North America, we have experienced the opposite. Too many jobs and not enough people to fill them. This is no longer the case now that we have completely lost our manufacturing bases.

 

Let’s recap…

 

Minimum wage:

–         Decreases the ability to compete in the global market

–         Decreases the number of jobs at the lowest end of the pay scale

–         Lowers the income range between skilled and non-skilled labour, therefore removing incentives to self improve by seeking additional education or training

–         Allows big business to take advantage of job losses by decreasing pay for employees in the upper tier

–         Allows government to become bigger and tax more

 

Before you send me an email, telling me all about the miracle of minimum wage, please answer this. If minimum wage is such a good thing, why don’t we just make it $50 an hour, or even $100? Wouldn’t that just make the economy better? The problems you see with a $50 minimum wage applies in all cases, even a $10 minimum wage.

Advertisements
This entry was posted in Guest Posts and tagged . Bookmark the permalink.

13 Responses to Guest Post: The downside to minimum wage.

  1. Jason says:

    Interesting post. Love the blog, but economics has a serious deficiency when trying to address moral concerns (coming from an economist myself).

    The post also contradicts itself; China perhaps has lower ‘pseudo-‘ minimum wages, however it’s what one can buy with that income that matters. I don’t have the statistics handy, but the poster didn’t either. Can someone provide a comparison of minimum wage and purchasing power parity, in local basket of essential goods? Otherwise we’re just comparing apples to oranges.
    Also, China’s export-based economy isn’t providing enough income for its workers to allow China to move to a local consumption based economy. I don’t think that is something that Canada should be striving for.

    I live in Australia, where the minimum wage is over $14.00. One of the big side benefits? Great local restaurants and pubs. A person can afford to pay for university and live in a home on the salary of a waiter, without the fear of not earning enough tips. As a result, the restaurants here are incredible and not all chain restaurants. Of course, it also means that items such as milk and bread are more expensive, but I think the trade-off is worth it. Individual restaurants instead of bland copy-cat restaurants that cover N. America in every neighbourhood. No thanks!

    Raise the minimum wage in Canada. Your tastebuds will thank you.

    • Marc says:

      Great points Jason.

      Yes the data to show that would be helpful, but I highly doubt that raising minimum wage contributes to more or less chain or fast food establishments. You should take a look at farming subsidies. The government tends to encourage corn and through this action lowers the price of fast food. Corn is used to feed the meat and most fast food burger buns are made with lots of corn. These subsidies contribute more to the fast food industry than the minimum wage would.

      The government can’t create better industries without changing the dynamics so another industry suffers. They only take resources from one place and put it elsewhere. If we were paying the REAL cost for fast food instead of it being subsidized through our taxes, there would be many more restaurants that would serve better food and far less chains.

      The problem is that too many people think the government should do something to fix what the government has caused. Most people have not thought about the big picture (like you pointed out in your comment about our chain restaurants) and what is actually causing the problems or discomfort. People’s instinct is to make more laws, force more money here or there, when this has never worked.

      The governments force (or violence if you will) disrupts what is really wanted by the people being forced.

      • Jason says:

        Thanks for the response.
        The restaurant part was anecdotal, and purely for entertainment purposes. Unfortunately, I can’t find the Roy MacGregor article on G&M where he mentioned this, but it was entertaining; but when I ask waiters directly, they respond that it is a good job for just that reason, and it’s actually a position that people hold irrespective of age. That is not my experience in Canada.

        However, I also think it’s too simplistic to think that a ‘free market’ will be the best determinant of optimal scenarios in all cases. Externalities are almost never taken into consideration in standard cost/benefit analysis. The government needs to step in here to protect interests beyond those directly impacted.

        However, as you’ve noted, it goes both ways; subsidies are a perfect example, though I don’t think the end of egg subsidies would vastly increase the cost of an Egg McMuffin. Rather, that would be counter-acted by lower wages.

        Also, there is a delicate assumption that everyone ‘unemployed’ wants to be gainfully employed; however, in many cases, they simply do not want to work for minimum wage. I don’t see how removing minimum wage will suddenly compensate for this those who are ‘priced out’ of the labour market will come flooding in. That’s simply ignoring reality.

        Saying the ‘market’ can determine optimal salaries is also immediately discounted by9 digit CEO incomes, but Teachers who earn less than bartenders.
        The ‘government’ isn’t a vast, troublesome actor. It provides vital services that the private sector cannot do profitably without severely impacting its performance. In many cases (water, gas, transit) the privatization has measurably reduced performance, increased prices, and resulted in greater costs to the government in terms of subsidization. That’s certainly the case in Melbourne anyways, where it has been calculated that privatization of public transit has been a disaster both financially and operationally.

        I only wish we could move to a STV system, then we would get the government we deserve, not one that represents the will of 35% of the population.

  2. jesse says:

    Minimum wage is a form of income equalization, effectively a consumption tax with direct links to those it is trying to aid. What’s not mentioned in the post is what governments will feel compelled to fund in the absence of minimum wage. To wit, BC has the lowest minimum wage and the highest child poverty rate. I don’t think the two are unrelated. The “pro-business” BC Liberal party along with several prominent business organizations supported a recent increase in the province’s minimum wage. It might be worth studying their report on the matter as there were strong hawkish forces lobbying the other way.

  3. jesse says:

    Here’s some interesting data from BC:
    http://www.gov.bc.ca/fortherecord/labour/

    “Only 2.3 per cent of B.C. workers are collecting minimum wage. ”

    How can one argue that minimum wage has such a detrimental impact on the economy when so few workers are actually working for minimum wage?

  4. El Magnifico says:

    Minimum wage:

    “- Decreases the ability to compete in the global market”
    This is not true as you don’t take into account productivity. Indeed, it has been proven that in countries with high minimum wage, the workforce is much more productive. France has one of the highest minimum wage, most generous social system and… one of the best productivity in the world. What is the incentive for a person that can barely make ends meet to work hard? Whereas if you make a decent salary, you’d be more willing to put in the extra effort that will help your company to produce better/faster, etc. and be more competitive. Humans are not machines, that’s the big flaw of your argument here.

    “- Decreases the number of jobs at the lowest end of the pay scale”
    True, but is that really a problem? Coming back to my argument above, if you have a very productive workforce, you might just be better at competing on a global scale with a lower work force. You might also end up with a lower need for low-skilled workers and a larger need for higher skilled job. This is exactly what’s happening in Germany and in France (somehow) too.

    “- Lowers the income range between skilled and non-skilled labour, therefore removing incentives to self improve by seeking additional education or training”
    I doubt about that argument as well. It has been proven many times that an educated person would see his salary, throughout his career, increase faster than a less-educated person. The incentive to train or study is and will always be here…

    “- Allows big business to take advantage of job losses by decreasing pay for employees in the upper tier”
    I don’t think there is any relation between minimum wage and high (upper tier) wages…

    “- Allows government to become bigger and tax more”
    Coming from Europe myself, I always find very funny the very anti-government arguments. People in North America just forget that they get what they pay for, and as far as US and Canada are concerned, they get crappy infrastructure (where are the high speed trains, public transit, great highways, etc…), next to zero social safety net (EI, CPP???), less and less affordable education (Universities are almost free in France and Germany…) and have to worry not to get sick (not so much in Canada though). I can keep on going on and on…

    What is the main difference between a developing/emerging country and a developed country?
    Not the GDP per capita… not the number of billionaires… not even the number of poor people… It’s the size of the middle class…
    The financial crisis has really devastated the middle class in the US. The wealthy are still wealthy, or even wealthier, the poor are still as poor (they had pretty much nothing before the crisis, so they didn’t lose much…). The middle class took the hardest hit. Sadly, the US are on the path to become like Russia, with lots of wealth unequally distributed (lots of billionaires, small(er) middle class, lots of poverty).

    No matter how great the “free market” looks on paper, it doesn’t work as well in reality, for many reasons (asymmetric information is one of them), and that’s why the government needs to step in and create regulations to correct the imbalances. European countries, especially France and Germany, understand it well and that’s why these two countries didn’t get hit as hard as the US, UK or Ireland…

    The deregulation of the financial markets is what put us in this mess. It’s time to put back regulations on this sector and get our common-sense back (why did we allow the banks to privatize their profits and socialize their losses???).

    For your information, I would strongly suggest you to read this book written by Joel Bakan, a law professor at UBC: “The Corporation – The Pathological Pursuit of Profit and Power”. It’s really disturbing and might change your mind (a little).

    Cheers,

    Flo

    • Marc says:

      Hi Flo,

      Thank you for your comments. For brevity sake I will just respond to the parts that I find most dangerous.

      On “seeking additional education or training”, there are variables not accounted for. The people who get higher education might be getting pay raises due to their performance and ability. The unmotivated or simply under-performers are not likely to get higher education, and are not likely to get pay raises throughout their lives. By choice.

      “No matter how great the “free market” looks on paper, it doesn’t work as well in reality” This is simply not true, it has worked in reality in more situations than government has. Look at California at the start of the gold rush before their was any sort of government. Also, you use free market principles to choose what you eat, who you date, how you live your life.

      I have read “The Corporation”, and I did enjoy it. It was actually on the start of this anarcho-capitalist path that I find myself on. Remember that corporations are a government created entity, and the corporations use the government to control the markets. Sometimes they encourage the governments to increase regulations to lower new competitors, and sometimes it much more direct. Without the government, where would corporations be? Do you think the people would allow them to have right as a person? Would you still let corporations have limited liability?

      If you follow the problems of corporations all the way down the rabbit hole, you find the force of government.

      • El Magnifico says:

        Thanks Marc,

        ““No matter how great the “free market” looks on paper, it doesn’t work as well in reality” This is simply not true, it has worked in reality in more situations than government has. Look at California at the start of the gold rush before their was any sort of government. Also, you use free market principles to choose what you eat, who you date, how you live your life.”

        Well, I don’t really remember what happened during the Gold Rush, I was not born :p
        More seriously, and closer to us, if the free market was working perfectly, cases like Enron or Madoff would not happen. Market failures do happen, and that’s why you need a government body to ensure that the competition is free and fair.

        I’m not anti corporations and pro government. I’m just trying to say that there should be a balance of power between corporations(especially financial markets) and governments. I think right now, there is an imbalance in favour of the corporations, and, most often, their economic interests go against the economic interest of the Middle Class in particular. If we don’t put more regulations to control those corporations, we are on a dangerous path to become a poorer and more violent society.

        The goal of a society is to provide better living conditions (richer, healthier, safer, etc.) for the generations to come. Corporations can have a great role at helping doing that, but we should never forget that the ultimate goal of corporations is to generate increasing profits, regardless of the consequences on the society or on the environment.

        Flo

  5. John in Ottawa says:

    Minimum wage is a much more difficult subject than has been presented in this post.

    One of the conditions being imposed on Ireland as part of the bailout of German and UK bankers is a reduction in the minimum wage. With 14% unemployment, perhaps and just perhaps, a reduction in minimum wage will help.

    One problem I have with the argument presented is, Canada doesn’t make widgets any more. It isn’t minimum wages pricing us out of the global widget market. It is the price of safety, the environment, and benefits such as EI and CPP. Those alone remove us from the widget market.

    I would like to talk about China and France, but this comment would be much to long, again. So let me say a little bit about China.

    In many large cities in China, Xian for instance (think Terracotta Warriors), as soon as the kitchen garbage basket fills up, it is taken to the curb and unceremoniously dumped at the edge of the sidewalk. The basket goes back to the kitchen. Within minutes, someone will come along with a broom and sweep that mess up. That’s full employment.

    I had the opportunity to visit one of these families in their home. A sixty year old man (doing the sweeping class job) living with his mother and his aunt in a 10′ x 12′ room. The toilet was a slit in a concrete slab above a cess pool just outside the door. I accepted their tea, but when offered to share a meal I declined. They couldn’t afford their generosity.

    I met two wounded veterans of Mao’s march. They lived together in what we in Canada could only classify as a dog kennel. Not the fancy dog kennel you take your pet to during vacation, but a hovel that our ancestors might have considered fancy 5,000 years ago.

    I sailed down the Yang Tze as it was being filled as a result of the new dam mega project. It was about 80% full at the time. Whole cities were inundated with no regard to the environmental toxins that were going to not leach, but gush into the river. The garbage floating down the river is still clogging the dam today.

    On the boat, women and babies slept in the stairwells. The smell within 15 feet of the washrooms was over powering.

    This was only a few years ago.

    Back in 1975 I visited an American factory in Taiwan. They were making TV tuners. One of the components they made for the TV tuners were diodes, which require a thin silicon wafer not much bigger than a pin head. In one room there were 10 year old kids inspecting the wafers by eye. The American manager explained to me that they could only do this particular job until they were about 12, by which time their eyes were no longer up to the task. Similar things go on in mainland China, and many parts of the world, today. Enjoy that IPod, it was made by true “wage slaves.”

    Being middle class means being able to live and work in relatively safe, clean conditions with a minimum expectation of services, such as electricity and running water, and access to decent health care. What we call a minimum standard of living. Minimum wage isn’t the half of it.

    • El Magnifico says:

      “One of the conditions being imposed on Ireland as part of the bailout of German and UK bankers is a reduction in the minimum wage.”

      The Irish plan include:
      – social expenditures to be decreased by E2,8 billion by 2014
      – 24.750 government jobs will be suppressed
      – minimum hourly wage to be decreased from 8,65 to 7,65 euros
      – VAT (equivalent of HST here) increased from 21% to 23% in 2014

      In the mean time, the corporate tax rate of 12.5% will not be touched (the average in the European Union is 30%…).

      Once again, the middle class will pay the full price for the reckless behavior of these same bankers that put this country into this mess. The Corporations, especially the Banks, can get away with no penalties, no additional taxes, nothing! How frustrating is that? No wonder why the Irish are so angry at their government right now (this government will not survive the winter)…

      The irony of this whole situation is that Ireland is the country that benefited the most from the EU subsidies (3% of its GDP). It used these subsidies to lower corporate taxes, giving itself an unfair competitive advantage against the very same countries that are financing those subsidies… I’m not sure how long Germany and France will accept that situation (people are very angry at Ireland in these two countries right now).

      John, to add to your comment, I would strongly advise you to watch the interview of Sir James Goldsmith in 1994, who predicted exactly what was going to happen after the GATT (General Agreement on Tax and Trades).
      Here is the link of the first part (out of 6): http://www.youtube.com/watch?v=4PQrz8F0dBI&feature=related

      One day, hopefully, people will understand that the economic competition should not be done at the expense of the living conditions of the workers and at the expense of the environment…

  6. Lumpen says:

    I’ll echo the thoughts of the posters above – minimum wage is as much a social construct as an economic one. Yes, it may theoretically reduce the number of low-wage jobs, but as the 2.3% of BC workers are at minimum wage stat from BC, it doesn’t seem that it’s a direct constraint.

    I have to believe that society wants to make it possible for as many people as possible to participate in the productive side. That is, anyone who can hold a job can at a minimum feed, clothe and house themselves. The risk is if this is not possible, vulnerable people may make choices that are dilutive to society, especially the wealthy that make the rules.

    For instance, if it’s necessary to mug people at ATMs, or carjack fine German automobiles to survive, then that’s what people will do. I can’t believe Canada would actively choose to turn itself into a Sao Paulo. A subsistence wage makes sense for all involved – more people can support themselves, and both the middle class and the wealthy are less threatened with crime of all forms.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s