Demagoguery and the Minimum Wage

[This post was originally published by American Thinker magazine on April 2, 2016.]

On Monday (Mar. 28) California Governor Jerry Brown announced that he would sign a bill to raise the state’s minimum wage to $15/hr.  The increase from the current minimum of $10/hr. would be fully completed by 2022.  Last year, New York passed legislation raising the minimum wage for fast food workers to $15/hr.  At the local level, the city of Seattle has mandated a minimum wage of $15/hr. to be fully phased in by 2021.  In the presidential campaign, Hillary Clinton and Bernie Sanders have proposed raising the federal minimum wage from $7.25 to $12/hr. and to $15/hr. respectively.

Particularly among politicians of the left, raising the minimum wage has long been a staple as a campaign talking point.  Mrs. Clinton and Senator Sanders claim, for example, that raising the wage floor is necessary to help people to move into the middle class.  The argument rests on the idea that if incomes are too low for some people to reach the middle class, a law mandating higher incomes is justified.  Certainly, the argument has strong emotional appeal.  Regrettably, it is also subject to significant demagoguery.

As economists have taught for generations, price controls (wages are prices) never achieve their intended ends.  Simply put, there are irrefutable laws of economics that cannot be repealed by political action.  Demagoguery and emotional appeal may produce short-term political advantage, but ultimately claims based on unsound economics must disappoint those who put faith into those claims.  Minimum wage laws are an exemplar of political action that cannot live up to its claims.

A fundamental law of economics is the law of demand, which states that as the price of something rises, the quantity purchased decreases in a given time period, and vice versa.   The law rests on the fact that, in the real world, resources are scarce, and thus the process of satisfying human wants requires making choices among alternative uses of those scarce resources.  Relative prices determined in free markets facilitate this process by permitting persons to make spending decisions according to the incremental value they obtain per extra dollar spent on a good or service.  The lower the price, the higher is that ratio.  The higher the price, the less is the ratio.  Hence, if the price of something goes up – thus reducing the value per dollar spent – less will be purchased as substitutes become a better bargain.

Artificially controlling specific prices distorts this process and creates inefficiency in resource allocation, as relative prices no longer fully reflect market forces.  Wages are prices.  Hence, if wages for unskilled labor are artificially set above the market wage by means of legislation, less unskilled labor will necessarily be purchased per period of time.  Moreover, the structure of wages throughout labor markets – skilled as well as unskilled – will be distorted, and economic efficiency will be compromised.  These outcomes are givens, and economists have known about them for a long time.

Why then do minimum wage laws persist?  Are not the harmful effects sufficient for voters to reject politicians who push these laws?  The answer, I believe, is that, although the harmful effects are real, they are generally not immediately visible, while the superficial, demagogic appeal of minimum wages is easy to articulate.  For example, both Mrs. Clinton and Senator Sanders claim that raising the minimum wage will help to elevate people – particularly unskilled workers — into the middle class. Senator Sanders further claims that raising the minimum wage will have a desirable redistributive effect that will lessen income inequality.

Neither of these contentions, however, lives up to its full billing.  As for elevating lower income people permanently into the middle class, minimum wage laws are highly inefficient because they focus on symptoms and ignore causes.  In this regard, vast amounts of evidence indicate that rising incomes are best achieved by education, stable families, and cultural factors such as personal discipline and a strong work ethic.  Entry level jobs – even at low wages – help to foster the personal characteristics, especially among young people new to the workforce, necessary to succeed in a work environment and eventually advance into higher paying positions with greater responsibility.  Minimum wage laws that price these persons out of the labor market remove the opportunity to develop these traits.  In addition, in few households is the primary income earner a minimum wage worker. Hence, even for households where jobs are retained, raising the minimum wage will have little impact on household income.  A far better emphasis for public policy directed toward building the middle class would be on augmenting incentives for skills acquisition and maintaining stable families.

Raising the minimum wage is a similarly inefficient means to address income inequality. This is not controversial among economists.  Any income redistribution that raising the minimum wage achieves is likely temporary, as employers adjust to the higher wage rate over time by substituting to other inputs such as labor-saving technology.  In addition, the higher wage rate only raises the income of those who continue to keep their jobs.  For workers who, at the margin, lose their jobs, income falls to zero.  And, finally, the redistribution comes at the expense of distorting relative prices, which can be considerable depending on the size of the wage hike.  There are far better ways to achieve income redistribution (assuming that’s the goal) such as simple cash payouts or a negative income tax.  Either of these measures ensures that the incomes of the entire targeted group increase, and both mitigate against compromising efficiency because of price distortion.

Regrettably, demagoguery on the minimum wage is not limited to political candidates seeking electoral advantage. Minimum wage laws also receive strong support from organized labor under the guise of helping out all workers.  The California legislation, for example, was backed strongly by unions.  At first glance, such support would seem odd as union jobs, after all, are typically at hourly wages much higher than the minimum wage.  Even so, there are at least two reasons why unions can be counted on to advocate for higher minimum wages.  First, many union contracts contain clauses that structure union wages relative to the minimum wage.  That is, the union pay scale is set, in relative terms, to be some percentage above the lowest pay scale.  Hence, when minimum wages are hiked, the union pay scale is similarly adjusted upwards.  Second, even aside from contract terms, it is in the interest of skilled union workers to have the wage rates of unskilled workers continually increase.  The higher the wage of the unskilled worker, the less that worker competes for the same job as the more productive skilled worker.  In the end, despite contrary rhetoric, both of these factors work against greater employment of unskilled workers.  Once again, legislated wage floors produce perverse consequences for those intended to be helped.

To sum up, higher minimum wages cannot be justified in sound economics. Fundamental economic laws simply cannot be overridden by political action.  Unskilled labor in California, New York, and Seattle will, in the end, suffer the most from the economic demagoguery of their elected officials.  Moreover, if Mrs. Clinton or Senator Sanders succeeds in raising the federal minimum wage, the perverse consequences will be spread across the nation.  This result would be unfortunate because it need not be so.

Indeed, higher real wages for all workers (unskilled as well as skilled) and permanent rises in standards of living have been the historical norm in the U.S. The drivers of this experience have been ever-increasing labor productivity and an expanding economy in which competition for labor services remains intense.  The proven recipe to those ends is a vibrant and growing free-market private sector incentivized by low taxes and minimal regulation, and a culture that encourages skills enhancement and personal responsibility.  Demagoguery over the minimum wage is no substitute.