The Federal Minimum Wage - A Bad Idea Becoming Worse

On January 10, 2007, the U.S. House of Representatives passed a minimum wage increase, raising the federal minimum wage from $5.15 to $7.25 per hour. The bill passed the house by a vote of 315 to 116, reflecting general public opinion. Unfortunately, the passage of this law only adds to an existing problem of the federal government creating and maintaining minimum wage laws. Rather than increasing its meddling in labor markets, the federal government should eliminate all of its minimum wage laws because they are coercive, cause more unemployment, and ultimately hurt the poorest of the poor.





Coercive Nature of Minimum Wage Laws


While it is more than likely most readers are interested in the effect of minimum wage laws on the poor, it is important to first have a brief discussion regarding the coercive nature of minimum wage laws. Essentially the forceful nature of federal minimum wage laws encompasses two areas. First and foremost it forces a business to pay a wage possibly exceeding what the market will tolerate, and secondly by forcing centralized policy upon states which may not be able to bear the policy.


At a micro economic level, one cannot dispute the assertion minimum wage laws force a business (whether large or small) to potentially pay above current market value for labor. When a minimum wage law is passed, the business has no option but to pay a higher labor rate, and implement one or all of the following plans:

• Cutback other benefits (free lunch at a fast food restaurant, eliminate paid breaks, etc.)
• Absorb costs causing a decrease in margins
• Reduce staff

We could spend a great deal of time discussing each of these choices, but clearly none of them is a win-win scenario. Many would argue the absorption of costs is a viable option, but this has a detrimental effect on the business's willingness to make future investments (all else held constant), and we can all agree this has an adverse long term effect on employment and general living standards.

It is certainly important to consider the effects on businesses (large and small) when discussing the minimum wage. Equally important are the general concerns of imposing federal minimum wage laws upon diverse state economies. Few people would disagree the economy of a southern state such as Arkansas is much different than the economy in southern California. While Arkansas is a great state, its people do not tend to have as much money as those in southern California. Understandably, this phenomenon is not necessarily a major issue as prices for real estate and other necessities are much higher in California than in Arkansas.

Considering the preceding paragraph, it seems silly to suggest the federal government should impose a minimum wage upon fifty diverse state economies. Simply put, southern California can probably absorb the increase in labor costs as most jobs (excluding black market jobs) already pay more than the new federal minimum wage level. Unfortunately, as we will see in the next sections, imposing a higher federal minimum wage upon a state whose market rate is lower could prove to be a burden upon the labor market and ultimately the poor.

A Minimum Wage Causes Unemployment

The discussion above regarding the coercive nature of federal minimum wage laws is certainly worth having. However, most people are more concerned with the poor and labor markets rather than a philosophical discussion. Unfortunately, all minimum wage laws (federal or state) cause unemployment if the minimum wage is set above the going market rate.




Before getting into a detailed discussion regarding how the minimum wage law causes unemployment, it is important to have a basic understanding of how people and businesses respond to price changes. As a basic rule of thumb, workers are more likely to want to perform a job as the wage paid increases. Conversely, as a wage increases, the demand for labor by a business decreases. Fortunately, all else held constant, a certain middle ground is obtained where the business is willing to pay for labor and a worker is willing to provide services at this rate. The graph below visualizes this concept by showing the demand for a job by a worker increasing as the price per hour rises, while the demand for labor by a supplier (business) decreases as the price per hour rises. For the sake of this example, assume the market based price is approximately $6.00 per hour, which is indicated by the intersection of the "Demand For Labor By Supplier" and "Demand For Job By Worker" portions of the graph.






While some people may have issues with the market based price, it is a price agreed upon in the marketplace between businesses and workers. The chart below shows what happens when a minimum wage above our $6 market based price is implemented.

As the chart illustrates, the demand for the job by the worker increases due to the minimum wage increase. Unfortunately the demand for labor by business has decreased due to the higher minimum wage. Long story short, there are more workers seeking fewer jobs. Therefore, unemployment has been created due to the implementation of the minimum wage.

When presented with this reasoning, many proponents of minimum wage laws point to statistics suggesting the unemployment rate does not increase when minimum wages are increased, so therefore minimum wage laws do not cause unemployment. While this logic seems valid on the surface, it is actually quite irrelevant. As the example above shows, the increase in the minimum wage causes unemployment in labor markets where the market wage is below the new minimum wage. As the diagram below shows, however, there is no effect on unemployment rates for jobs already paying above the minimum wage.








Essentially, for jobs paying above minimum wage (the vast majority of jobs in the United States), there is no effect on the labor market by increasing the minimum wage. If one insists on analyzing the pros and cons of minimum wage laws by using statistics, the general unemployment rate is simply not valid to consider.


In the above paragraphs, this blog post has demonstrated the effect on unemployment caused by an increase in the minimum wage above the current market price. The above paragraphs also has shown the complete lack of an effect on jobs already paying more than the new minimum wage. With those two statements being said, one must wonder what is the point of a higher minimum wage (aside from political pandering)? Most would agree there is no wisdom in passing a law which is either detrimental (causes unemployment) or ineffective (has no effect). Members of Congress would provide the country a better service by taking a nap.


The Minimum Wage Hurts the Poorest of the Poor

Most people would agree unemployment is not a positive occurrence. Typically people want to work, and earn an honest living. Unfortunately, the unemployment mentioned above hurts the already poor, as it increases unemployment in areas of the economy which can absorb it least.

As explained above, an increase in the minimum wage above the prevailing market rate causes unemployment. Essentially, more middle class teenagers and people trying to make ends meet are chasing after similar jobs due to the increase in the minimum wage. Unfortunately, if forced to pay a higher rate, an employer is likely to choose the more educated workers for the remaining jobs, further marginalizing those who are already on the fringe of society.

As this situation occurs, an already stressed economic situation becomes even more so. An inner city neighborhood or rural town may not be able to support the higher wages, and jobs begin to disappear. It is sad enough when jobs are lost due to regular market impact, but far worse when your own federal government is putting the nail in the coffin.