In his State of the Union address, President Obama proposed raising the minimum wage from its current $7.25 per hour to $10.10 per hour, a 40 percent increase. A number of dumb arguments have been made both for and against the increase.
In a recent TV debate that I had with a representative from the N.C. Budget and Tax Center, it was argued that businesses currently paying less than $10.30 per hour would benefit and become more profitable if they paid their workers the newly proposed minimum wage. The argument was that the higher wage would reduce worker turnover. I guess the owners of those businesses are just too dumb to realize this (as opposed to much more business-savvy left-wing policy analysts).
From opponents of the increase, I have heard the argument that the higher wage would lead to the employment of fewer workers (which is true) because businesses have only so much money to allocate to labor, and a wage increase would by definition lead to fewer workers being hired (which is false).
This invokes a wrongheaded and long-discredited explanation of wage determination from the classical economics of the 1700s and 1800s called the “wages fund theory.” Basically, it is the simplistic idea that companies have a fixed “fund” that they tap for labor and that wages are determined by simply dividing the amount in the fund by the number of workers hired.
So, if the wages fund theory doesn’t explain why minimum wage increases cause fewer workers to be hired, what does? The best way to think about the effects of the minimum wage is to think of what wages are really about and how decisions about hiring are conceptualized by employers.
In deciding to hire anyone, an employer must answer a fundamental question: Will the value of the productive output of the potential employee be greater than the cost of hiring him or her? If it will not, the potential employee will not be hired.
It should be made clear that the wage is only one part of this cost. From an employer’s perspective, the cost of a worker’s entire compensation package has to be included when making this decision. Until recently this included, at a minimum, payments into Social Security and Medicare and unemployment insurance.
But the minimum cost of compensation has been bumped up dramatically by Obamacare’s mandate that everyone working over 29 hours a week be provided with employer-subsidized health insurance. The upshot is that anyone whose skills are so low that the value of their productive output is less than the minimum wage plus the costs of these other mandated portions of their compensation package will go unemployed.
If the minimum wage, or the cost of any other part of the compensation package, is increased, the size of this population will grow. In other words, given existing skill levels, more people will fall below the higher cost threshold.
So whose employment prospects will be put in jeopardy by a 40 percent increase in the minimum wage? This will not, of course, affect college graduates, accountants, and skilled manual laborers such as electricians and plumbers. It will instead affect those in society who have little education and little or no job experience, i.e., teenagers, particularly minority teenagers, high school dropouts, etc. In other words, very low-skilled workers who may be entering the labor market for the first time.
It should be pointed out that the current mandated minimum cost of labor is already taking its toll on this group. The unemployment rate for 16- to 19-year-olds is about 21 percent, and the African-American unemployment rate for this group is over 36 percent. The unemployment rate for high school dropouts is over 50 percent.
Empirical estimates by two Duke University economists suggest that for each increase of 10 percent in the minimum wage there will be a 2.9 percent decrease in the likelihood that a low-skilled worker will find employment. This means that the increase in the minimum wage being proposed by Obama and the Democrats implies almost a 12 percent decline in the chances that a low-skilled worker will find employment. For those low-skilled workers who start out severely disadvantaged in the marketplace, this would be just one more obstacle placed in their path.
Advocates of minimum wage laws ignore the economic analysis and the idea that there is any relationship between productivity of the worker and wages paid. They buy into the myth that people’s wages can simply be raised and poverty can be eliminated by government decree, without any change in workers’ productivity.
By assuming that increasingly higher minimum wages will cause no one to be unemployed, they are making one of two assumptions; both are absurd. They are assuming either that there is no one in the labor force whose skills are so low that they cannot command the higher wage or that employers simply ignore worker productivity when considering the cost of hiring a worker.
Low wages define poverty; they do not cause it. Wages, like other prices, reflect underlying realities. In this case, the underlying reality is that there is a large and growing number of people in Obama’s economy whose skills are so low that they cannot command a wage that is higher than even the current minimum wage. The high unemployment rate for low-skilled, disadvantaged groups is the messenger that conveys this reality.
If policy makers are truly concerned about helping those earning the lowest incomes in the country, the first question that should be asked relates not to their wages but to their skill levels. Why are there workers whose skills are so low that they cannot command a “living wage,” to adopt the phrase used by supporters of raising the minimum wage?
The answer to this question is beyond the scope of this column, but clearly the focus should be shifted to issues related to educational reform and how institutions might be rearranged better to facilitate the acquisition of marketable skills and work experience.
To focus on the wage and not the underlying conditions that have given rise to the wage is naive and superficial at best and political demagoguery at worst.
Dr. Roy Cordato (@RoyCordato) is Vice President for Research and Resident Scholar at the John Locke Foundation.