Three Bad Arguments For The Minimum Wage

Authored by Gor Mkrtchian via The Mises Institute,

The case for market wages is simple. If employers and employees voluntarily agree to a certain wage, then that exchange will necessarily be mutually beneficial, otherwise it wouldn’t have happened. Creating a minimum wage will simply disemploy the lowest-skilled among us, whose productivity is below the legal minimum wage. Why would a business hire a worker if the business has to pay the worker more than the worker can contribute to its revenue?

Supporters of the minimum wage respond that the minimum wage can actually raise wages while also increasing employment, because:

1. Higher wages will speed up the economy by putting money in the hands of workers who will spend it.

2. Higher wages boost worker morale and productivity.

3. Studies have shown that the minimum wage doesn’t always reduce employment in actuality.

All of these arguments are wrong. Let’s look at each claim.

One: Stimulating Demand

The first argument for the minimum wage is that it will put more money in the hands of workers and that this will stimulate the economy, because low-income earners spend a greater proportion of their income than high-income earners.

The argument immediately hits a road bump, even on its own terms. If the minimum wage is raised, it’s true that the remaining workers will necessarily earn at least the new minimum wage, but all of the workers who are less productive than the minimum wage will have lost their jobs, so worker spending won’t necessarily increase.

Dr. Robert Murphy explains, “Now the employer is going to hire fewer workers, other things equal, so it’s not obvious that the total wage bill is going to be higher.” Shuffling wages from a larger pool of workers each earning less to a smaller pool of workers each earning more won’t necessarily increase the aggregate amount of spending money in the hands of workers.

One can counter that it takes time for employers to adjust to the minimum wage and fire workers, and that in the meantime there will be increased spending.

If it’s true that in the short term businesses can’t react to the minimum wage by firing workers, then in the face of these suddenly increased labor costs and with an inability to flexibly react, a portion of businesses will simply close, their workers will lose their jobs, the supply of goods and services will fall, and prices will rise.

And for those businesses that survive, the increased spending will be no boon. The extra money that workers get to spend in this scenario comes out of the pockets of the businesses themselves in the form of increased labor costs. If workers then go and spend all of this money, this will be a wash for the businesses collectively at best, because they’ll simply be recouping all of the money they lost in the form of increased labor costs.

Quickly circulating money is like a game of hot potato and does not create wealth.

In fact, if the minimum wage succeeds in redistributing money from those more likely to invest it (the businesses) to those more likely to consume it (the workers), this modifies the capital structure of the economy.

With more resources catering to present consumption, fewer resources will be geared toward the capital maintenance and accumulation that allow for future consumption. Other things equal, future productivity will be lower, prices will be higher, and the standard of living will decline.

Two: Increased Worker Productivity

The second argument is that raising the minimum wage will increase worker morale and productivity, decrease turnover, and so can benefit the businesses affected.

However, who has a greater incentive and better access to the relevant information to find the optimal balance between wages and worker productivity than the employer? It’s dubious that politicians have better information about the profit-maximizing wage for millions of businesses across the country than each business will have about their own particular enterprise.

But suppose bureaucrats have studied the business model of Machlup’s Pizzeria and have determined that Machlup can increase his profits by raising the wages he pays. If this is the case, no violently enforced minimum wage will be necessary.

As Dr. Murphy points outs, business owners can simply be informed that they’re missing out on additional profits. If Machlup is told that he can increase the profitability of his business with wage increases, he will gladly do so. No law is needed where an email will do.

Another practical issue is that when a government-enforced minimum wage is set, it’s not set at the level of an individual business. It’s set at the scale of entire cities, states, or even the entire country.

In such ham-handed applications, the minimum wage can’t possibly be tailored to the concrete data of each particular business to optimally balance morale and wages.

Three: “Studies Say So”

The third argument is that various observational studies conducted in areas where the minimum wage took effect showed positive results, such as little reduced employment or even increased employment, as well as higher wages.1

This appeal fails because in the social sciences observational studies can only establish correlations, not causal relationships. In order to establish causal relationships, a controlled experiment is necessary.

In a controlled experiment, a control group and a treatment group are created. The control group is the baseline for comparison. The treatment group holds all independent variables (inputs) constant except for one (the treatment), whose effect on the outputs (dependent variables) we want to learn about.

Controlled experiments are feasible when it comes to the natural sciences, such as chemistry, where the subjects are inanimate chemicals mechanically reacting to one another and the relevant factors of their environment can be precisely held constant in a laboratory setting. But the complex world in which human decisions are made can’t be replicated in a lab.

In the case of the minimum wage, a controlled experiment would mean creating a counterfactual universe where all factors other than the minimum wage change are held equal: other economic legislation, trends in consumer preferences, the weather, the geopolitical situation, and every other potentially confounding variable. Then, the counterfactual universe with the higher minimum wage would be compared to our universe with the older, lower minimum wage.

Clearly, constructing this controlled social experiment is impossible, but controlled experiments are the only empirical way to avoid the post hoc, ergo propter hoc fallacy, the only way to parse correlation from causation.

An observational study can show that a higher minimum wage was passed and then employment increased by 1 percent. But was this because of the minimum wage or because of changes in consumer preferences, or some other confounding variable? Did it occur thanks to or despite the minimum wage?

Controlled experiments are impossible in the social sciences, and observational studies can never prove the effects of an economic policy, because they can’t distinguish correlation from causation. Only the deductive logic of economic theory can do that.

Ultimately, the majority of people who support the minimum wage probably don’t think about the three arguments above, or about any argument at all. Their thought process is simply: if the government passes a law saying the minimum wage has to be higher, then people will be paid more. There’s no consideration of opportunity costs or unintended consequences.

Free marketeers must instill a few basic principles of economic thinking such as opportunity costs and unintended consequences into the public, so that people can reason clearly about the minimum wage, and economic issues generally.