Wednesday, February 8, 2012

Do minimum wage laws work?

So Mitt Romney and Barack Obama both support the idea of increasing the minimum wage.  Romney has recently said he'd like to see minimum wages increase with inflation.  Yet is this really a good idea, or is it simply a feel good policy simply to buy votes.  Let's investigate.

Henry Hazlitt, in his book "Economics in one lesson," explains that wages do not exist in a vacuum.  If you raise wages of workers you will have to make up for this in some way.  The employer will have to:

  1. Raise prices 
  2. Do nothing and absorb the cost
  3. Go out of business
  4. Not hire more workers
  5. Layoff workers
Of course there are advantages to raising wages.  One is that your workers will be happier and will be able to spend more money on your products.  By letting the market set its own prices, any owner who has enough money will choose to raise the minimum wage.  He will then do nothing and simply absorb the cost.

Yet when the economy isn't doing so well he will choose not to raise the minimum wage in order to stay in business.  This is the natural process of wage controls.  However, when the government forces a boss to raise the minimum wage by making laws, it forces businesses to make decisions as noted above to make up for the increased expense.

So, what if a boss decided to raise prices to shift the cost to consumers.  Hazlitt explains that one of the following will happen:
  1. Consumers will be forced to stop buying your product (especially if it's a luxury product)
  2. Consumers will be forced to buy less of your product (like 2 loaves of bread instead of 4)
  3. Consumers will be forced to buy from your competitor who has lower prices
So if prices go up, then the value of the dollar goes down.  Say, for example, before the wage hike a loaf of bread is $1. So $1 buys 1 loaf of bread.  Now say wages are increased by $1.  A loaf is now $2.  Now $2 pays for 1 loaf of bread.  You see, the value of $2 is now the same as the value of $1 before the wage hike.  

The end result of any of these is loss in revenue.  So if the boss has to choose to not hire or to layoff workers, this minimum wage hike will most surely result in loss of jobs and an increase in unemployment.

So a minimum wage hike is like a tax hike; it is a tax hike.  So in order to avoid it bosses will be forced to quit hiring, and they may even be forced to lay people off.  This increases unemployment.  So when unemployment goes up revenue to the government goes down.  This is yet another example of how a tax hike does not always increase revenue to the government.

This is exactly what has happened recently.  Most states have increased minimum wages.  As we follow teenage unemployment numbers, they have historically been about 15%.  Yet since bosses have been forced by law to keep minimum wages high, the teenage unemployment rate is now 25%.  That means 25% of teenagers that are willing to work are also not paying income taxes.  

So Hazlitt, and any one who understands the economy, will not tinker with prices and wages.  Instead they will create an economic environment for businesses for prices to naturally go up and down.   As an example, politicians and lawmakers can lower taxes on electronics, machines and building supplies.  This will encourage expansion and the need to hire more workers.  

He also explains that the government should encourage inventions, improvements in the way things are made, and training and education.  All of these things will result in a more profitable businesses that will have the money, and the incentive, to hire and raise wages to keep workers happy.  

As Hazlitt explains, "Real wages come out of production, not out of government decrees."

Check out:  Do minimum wage laws work:  part II

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