In the United States, the federal minimum wage is $7.25/hour. For workers in the state of California, it’s just a little higher at $8.00/hour. But in San Francisco, residents are legally guaranteed an hourly minimum wage of $9.92 an hour, and because the city has been enforcing minimum wage increases to keep up with inflation since 2003, that figure is going to go up just a few cents on New Year’s Day 2012 to the sum of $10.24 an hour.
That will make San Francisco the first city in U.S. history to legally require a minimum wage over $10. Is this a good or bad thing? Does it set San Francisco apart as a city of progress and plenty, or does it hurt the city’s job market by discouraging businesses from hiring? Minimum wage has always been a controversial issue, but I would argue the economics behind it are settled and uncontroversial. Let’s take a look at what minimum wage is and what effects it has on an economy.
Minimum wage is a price floor. In economics, a price floor is a government regulation that prohibits the price of a good from being lower than a certain amount. Anyone buying that good must pay a price above the price floor, but anyone selling that good is also prohibited from agreeing to sell it for less than the price floor, even if they want to in order to outprice a competitor or sell more of their good. A price floor is a handicap on the economic choices of both buyers and sellers for whichever good the price floor applies to.
In the case of minimum wage, the “good” is hourly labor, the “buyer” is an employer that pays for labor, and the “seller” is the laborer. This– by the way– is why employees say “Yes, sir” or “Yes, ma’am” to their employers and treat them politely. While critics of free enterprise see this aspect of the employer/employee relationship as some vestige from feudal times and evidence of exploitation, it is not a sign of subservience, but an example of customer service. Sellers are always polite to their customers– at least the good ones are. That’s why a hotel manager greets a guest with a “Hello, sir!” or “Hello, ma’am!” –not because the manager is inferior to the guests, but because they are paying customers for whose business the manager is grateful. In the labor market, employers are not feudal overlords– they’re the customers.
On the other side of the equation are the laborers who sell their time, work, and skills at an hourly rate to the businesses that employ them. Minimum wage discussions usually center on the right of the worker to charge higher prices for their labor, but a price floor that enforces a higher price doesn’t just limit the employer’s choices on one side, it also limits the laborer’s. A minimum wage codifies the principle that a laborer does not have the right to charge whatever price he or she wants for his or her labor because it prevents them from charging less than the minimum wage. Why on earth would a laborer want to do this? To compete.
Competitive pricing is a strategy that many businesses in other markets use in order to sell more of a good or to snag a customer from another potential seller. What if, out of compassion for wheat farmers, the government created a price floor in their market? We could call it the “minimum price of wheat.” We might imagine this would help the wheat farmers make more money, but customers respond to price changes. All other things being equal, they are likely to buy less wheat and fewer products made with wheat because the price went up. Farmers of potatoes might find their sales going up as their better-priced goods out-compete the hampered wheat farmer. In this case, the well-intentioned “minimum price of wheat” policy just hurt the wheat farmer instead of helping.
The market for labor is not as different as you might think. By setting a price floor in this market, the government’s actions discourage buyers (employers) from buying (hiring) as much of the good (labor) as they would otherwise. Now, another way to put “less hiring” is unemployment. In the instance of the wheat farmer, the farmer wanted to sell more wheat than buyers were willing to buy. In economics, that’s called a surplus. When there is a surplus of labor, it’s called unemployment, and minimum wage policies cause it to happen or make it worse when it’s already happening.
There are two aspects to minimum wage: its directly observable results, and its secondary results that are unseen. It feels good to see a worker earning more and achieving a higher standard of living because of it, and it feels wrong somehow to deprive the worker of that advantage. But what is unseen is the business that hires fewer workers and gives them fewer hours than it otherwise would have without stringent minimum wage laws. Just like the wheat farmer competes with the potato farmer, laborers compete with capital. If they are not free to price their good– their labor– competitively, they will lose their business (i.e. their job) to capital investments that do their job at a lower cost. This is one reason why unemployment remains so high and why your last trip to the grocery store probably involved a self-scan check out. That self-scan machine is a capital investment that beat out the unemployed teenager down the street on price because the government would not let the teen make a choice to outprice the capital market for the employer’s business.
And labor doesn’t just compete with capital. Laborers compete with each other. With price competition hampered at the lower end of the salary spectrum, the least skilled, least educated workers have no way to compete with more skilled labor for jobs. In this way, they are completely barred entry into the labor market. The have-a-littles get to have a little more just so long as the have-nots continue to have not. Where is the compassion of organized labor, of progressives, of socialists, and of welfare statists for these unemployed and “unemployable” aspiring workers? The system perpetuates a sort of economic apartheid that prevents them from ever working. This is why unemployment rates for young black males remain appallingly high.
So what do we do about it? How do we improve standards of living and earnings without unintended consequences that actually harm some workers? That could be the subject of an entire different article, but the economic kind of thinking required for doing the most good and the least harm must start with the understanding that prices are not levers that set value, they are metrics that reflect value… even when we’re talking about the price of something that has been so mystified as labor.