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November 22, 2006

The Minimum Wage, Continued

When the minimum wage goes up, the cost of employees goes up for any business that employs people for the minimum wage, and for many other businesses as well due to union contracts that base wages on the minimum wage and due to wage compression. That money has to come from somewhere, a fact minimum wage advocates often appear to gloss over. If the cost of each worker is now higher, the business has only so many ways it can cover that cost. It could let people go, so that there are fewer workers at higher pay rates. It could raise prices to cover the higher cost of labor. It could go out of business. It can reduce its profit margins to absorb the higher cost of labor. Or it can get more productivity out of its now higher-priced workforce so that the money it is paying out is covered by the productivity of the labor force.

It is becoming an article of faith among minimum wage advocates that a higher minimum wage doesn't cost any jobs. This flies in the face of basic supply and demand, but it's true that studies have had a difficult time showing any significant drops in employment in areas where the minimum wage. I suspect that one factor here is that most businesses paying the minimum wage have very high turnover to begin with (one of the things minimum wage advocates don't like to discuss is that not many people work at minimum wage for long; like the issue of helping people in the bottom 10%, they ignore the fact that in a dynamic economy these aren't the same people from year to year), so the higher cost of labor may not be enough to convince them to start firing people when they already have trouble locating decent help. Some people may also have a reluctance to fire people just because the government raised their pay; firing people isn't a pleasant job, and if you're in a high-turnover industry to begin with, it can be easier to just wait for that person to quit. But, it is important to note that simply because we cannot find solid evidence of employment dropoffs in areas where the minimum wage is raised does not demonstrate that raising the minimum wage is cost free. If businesses aren't letting people go when the minimum wage goes up, they're doing something else to cover those costs.

Businesses may absorb the cost of minimum wage increases by increasing their prices. This is a traditional method for business to cover its costs, after all, particularly those imposed by government. (All those who think taxes on business aren't reflected in prices raise your hand.) This also helps to address one of the issues I raised in my last post, the inflation that a raise in minimum wages can cause. But wait, commenters complained, the total supply of money hasn't increased, so the price of goods shouldn't increase. While it's technically true that the total supply of money doesn't go up when the minimum wage is increased, the amount of money available for the kinds of goods purchased by people making minimum wage has increased, and when demand for a good goes up, prices rise with it. Some commenter with an amazing faith in the marketplace pointed out that if demand goes up, supply will rise as well. This is true in the long term, but it doesn't happen immediately and supply generally rises in response to demand because prices go up and it therefore becomes profitable for more people to generate the goods. This whole process is extremely complex, as it involves so many individual actors, and the end result will certainly not be that we are status quo at the end. People making the minimum wage will be able to afford more of some things, and less of others, so whether or not they'll be better off will depend highly on their individual circumstances.

Businesses can also ramp up the productivity of the jobs they have in order to get more worth from these now-higher prices workers. As Tyler Cowen notes, an employer can always make one's job worse. Whether by requiring higher quotas, reducing break time, eliminating amenities or something else, employers can find ways to get their money's worth out of their employees. Are these minimum wage employees now better off, or worse off? There's more to life than the size of one's paycheck; I know I've worked a job or two that, while it may have paid well, I didn't consider worth the money.

Now, every minimum wage advocate's favorite: business can simply trim its profit margins to absorb the cost of labor. A lot of minimum wage fans hear profit and flinch like Nosferatu confronted with a cross: that's one of those things they'd like to see eliminated. Why should those nasty capitalists get profits from the sweat of their workers, after all? Advocates with a bit more solid grasp of capitalism understand that profits are what drive the economy, however. Going into business isn't easy. Business owners put a great deal of time and effort into their business. There are startup costs, the struggle to find the right workers, advertising, and more, all of which are what help to make most new businesses fail pretty quickly. Schumpeter's creative destruction is good for the economy as a whole, but it leaves a lot of disappointed entrepreneurs along the way. But if it wasn't for those people spending their time and money to create businesses, we wouldn't be creating those minimum wage jobs. And what causes people to go into business? Profit, or the potential for profit. Few people go into business on the assumption they'll lose money. Smart people take a look at the industry they're considering to determine whether or not they've got a reasonable shot at making money there before they actually go into business. And one of the ways they do that is to look at the profit margins of people who are already in business. If the local restaurant businesses are turning an average 10% profit, Joe Entrepreneur may consider that a pretty good bet, as his entry into the market will probably still allow him to take an 8% profit. But if businesses absorb minimum wage increases by trimming their profit margin to 6%, Joe may decide that there's no point in entering the market. Which means those jobs Joe might have created never come into existence. That's an economic impact we can't really quantify, because we never see the loss. But make no mistake, it is a loss, and it is therefore a cost of government interference in the economy.

Sometimes these costs are worthwhile, I should note. All actions we take offer a mix of costs and benefits. The tricky part of life is determining which are higher. But I get very little sense from minimum wage advocates that they even think there are costs to this policy, and that's an opinion I have a difficult time letting slide.