Minimum Wage, Living Wage

Two days ago I sat down with the smartest person that I know, and had about a 40 minute conversation about various things. Amongst the things we talked about were the living wage in this state, and minimum wage theory.

Crossposted on Annapolis Politics

I would be fair in saying that my earlier statement condemning the minimum wage was valid, although Dr. Montgomery would maintain that a net benefit of a small minimum wage increase is slightly more likely than what I would claim.

The classic model of economics dictates that as any product or service becomes more expensive, the demand for that product will be decreased. Labor is no different–if wages are higher, there will be less demand for labor, and unemployment will result.

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Neo-classic economic arguments focus on the elasticity of labor demand, which means how sensitive labor demand is to price fluctuations.

If demand for labor is completely determined by the price of the labor (perfectly elastic: an elasticity of 1), than a raise in the minimum wage of $.01 would cause every minimum wage worker to lose their job. This is clearly not the case. If labor demand was completely insensitive to the price of labor (perfect inelasticity: an elasticity of 0), that would mean that workers were so vital to business operations that you could raise the minimum wage to 13 ka-billion dollars per second and nobody would lose their job.

It is important to know that labor demand is neither perfectly elastic or inelastic. Just how much labor demand is determined by the wage rate is the crux of the debate. More sensitivity to price would argue against raising minimum wages, because it would suggest unemployment. Consenus among economists, however, seems to be that there is relatively little price sensitivity in the demand for low wage workers, which suggests that if the minimum wage was raised, the businesses would simply pay that money to the workers, and there wouldn’t be too much effect on employment.


(if you thought I was going to support minimum wages, you were wrong.)

this is not the whole story. Let’s first talk about the living wage. The living wage is not a small increase in the minimum wage–it’s a big increase! Like a 40% increase! Labor demand is not perfectly inelastic–if you mandate the price of labor to be 40% higher, there WILL be unemployment. No doubt about it. The living wage is a blatantly detrimental market distortion.

Now let’s talk about even a small increase in the minimum wage. Even if demand for low wage labor is relatively insensitive to price increases, businesses are not. If a business makes less money because it has to pay its workers more, there will be consequences. One or more of the following things would happen:

-The business will reduce its capital investment. With less profit, businesses are receiving a lower return on their investment and are less likely to invest in capital for the future. In the long run, this hinders the productivity of the business, and the business would hire fewer people than it otherwise would have. So while 100 people may be making $8 an hour, you could have had 110 people making $7.50 an hour. I would argue that the latter is better.

-The business will close. Small operations that hire mainly low wage workers may decide that they no longer want to deal with the hassle. Perhaps more likely is that the possibility that business owners will shift their operations to deal with higher wage employees so that what they are paying for labor is equal to the value of the labor. (This is exactly what happened with services: as sales taxes increase, business shift their resources to providing services to minimize taxes, and many of the taxable things {cars, happy meal toys, dog food, whatever} are produced in other countries.) In such a case, the very people that you are trying to help would be out of work.

-The business raises the price of what it is selling. In this case, Joe Average is worse off because he has to pay more for this product and has less money to spend on everything else. Furthermore, since the price of the product is going up, some people will decide that they no longer wish to buy this product, the business will make even less money, and these effects will continue.

So my point remains: minimum wages are bad, and living wages are criminal.

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