Imagine you are an entrepreneur. As a businessperson, would you start a venture where you were forced to pay workers $100 an hour, a rate which is well beyond what you could earn from them? No — you wouldn’t open a new enterprise if you were guaranteed a loss. Therefore, the only businesses that will thrive under such conditions are those which are sure to recover the cost of labour plus the cost of capital, and also compensate themselves for the enormous risk of opening a business in the first place. This argument, which is persuasive with a $100 per hour wage rate, can be repeated incrementally down the ladder.
Labour economists have devoted much effort to empirically estimating the effects of minimum wage legislation on the employment levels of various age, race and gender groups. It is now widely agreed that increases in minimum wages do reduce employment opportunities, especially among teenagers.
Perversely, the minimum wage ends up hurting those it is supposed to help. It is clear that the poorest and unskilled labourers are the ones who are crowded out of organised job markets when minimum wages are imposed. One textbook example comes from 1980 in Zimbabwe, where a government decision to set a minimum wage of $45 a month backfired dramatically, causing the dismissal of more than 5,000 workers.
Studies on the subject of poverty have found that minimum wage legislation has only a minor effect on the distribution of income. This finding is not surprising, because not all low-wage workers are members of poor families. Many workers on the minimum wage, especially teenagers, are second earners in middle or upper class families. As Des Moorenotes in The Age (5 September 2006), ‘It is plain wrong to characterize the minimum wage as a safety net when more than half the recipients are in the top half of household incomes’.
Even the fiercest minimum wage advocates usually concede there is a point when minimum wages would cost jobs. What most advocates of the minimum wage do not grasp is that there’s no known theoretically established rate which can be rationally fixed as a minimum wage. In other words, there’s no person in the world who has a Ph.D. in market interference, and who knows exactly when and where to interfere with the market. Economists make models, but a model is a simplified version of reality and is not the truth. Predictions of positive economics involve the influence of one variable on another, holding all other variables constant. But real-life labour market experiments are difficult to conduct, and economists generally use proxies to draw conclusions.
So does the minimum wage help anybody at all? In fact, minimum wages do help certain people. In particular they help the members of trade unions, many of whom are already earning wages above the minimum wage. By making it illegal for employers to hire at market rates (the rate that is deemed mutually suitable to both employer and employee) they minimise competition for the jobs of organised labour and keep their salaries higher than would otherwise be the case in an open and free labour market. They also help lawyers, who are kept busy with reams of industrial relations legislation.
This might seem heartless. Surely employees have less bargaining power than employers? Sometimes, they do. Most of the time however, there is competition for labour amongst employers themselves, who use good working conditions and pay as a means of attracting employees. Usually, employees who enter a job at a very low wage rate gain experience that enables them to earn more later. Social interaction with colleagues can prevent depression and provide other personal benefits. With a legally mandated minimum wage however, these options are closed to many looking for work.
The fallacy arises when policymakers conflate issues of social welfare with labour market efficiency (which leads to lower prices for the consumer). Increased unemployment is the visible consequence. Concern for the ‘working poor’ might call for a different solution: better targeted welfare. But it does not call for government interference in voluntary wage contracts entered into by employer and employee.
The minimum wage would not be such an issue if it weren’t for politicians who have capitalised on the perception that wage controls protect the poor from exploitation. If the poor are in trouble, what is required is to upgrade their skills and to shift their supply to sectors where market demand is growing. This is not an instantaneous process. But it is wrong to penalise small businesses by placing on them the burden of making unskilled workers wealthier than the market will support. Why kill the hen (entrepreneur) that lays the golden egg (of jobs)?