Basic economics: what’s wrong with raising minimum wage rates?

Economist Thomas Sowell
Economist Thomas Sowell

From Investors Business Daily, an article by famous economist Thomas Sowell.

Excerpt:

Political crusades for raising the minimum wage are back again. Advocates of minimum-wage laws often give themselves credit for being more “compassionate” towards “the poor.”

But they seldom bother to check what are the actual consequences of such laws.

One of the simplest and most fundamental economic principles is that people tend to buy more when the price is lower and less when the price is higher.

Yet advocates of minimum-wage laws seem to think that the government can raise the price of labor without reducing the amount of labor that will be hired.

[…]Switzerland is one of the few modern nations without a minimum-wage law. In 2003, the Economist magazine reported: “Switzerland’s unemployment neared a five-year high of 3.9% in February.”

In February of this year, Switzerland’s unemployment rate was 3.1%. A recent issue of the Economist showed Switzerland’s unemployment rate as 2.1%.

Most Americans today have never seen unemployment rates that low. However, there was a time when there was no federal minimum-wage law in the United States.

The last time was during the Coolidge administration, when the annual unemployment rate went as low as 1.8%. When Hong Kong was a British colony, it had no minimum-wage law. In 1991 its unemployment rate was under 2%.

[…]Most people in the lower income brackets are not an enduring class. Most working people in the bottom 20% in income at a given time do not stay there over time. More of them end up in the top 20% than remain behind in the bottom 20%.

There is nothing mysterious about the fact that most people start off in entry-level jobs that pay much less than they will earn after they get some work experience.

But when minimum-wage levels are set without regard to their initial productivity, young people are disproportionately unemployed — priced out of jobs.

In European welfare states where minimum wages, and mandated job benefits to be paid for by employers, are more generous than in the United States, unemployment rates for younger workers are often 20% or higher, even when there is no recession.

Unemployed young people lose not only the pay they could have earned but, at least equally important, the work experience that would enable them to earn higher rates of pay later on.

Minorities, like young people, can also be priced out of jobs. In the United States, the last year in which the black unemployment rate was lower than the white unemployment rate — 1930 — was also the last year when there was no federal minimum-wage law.

Inflation in the 1940s raised the pay of even unskilled workers above the minimum wage set in 1938. Economically, it was the same as if there were no minimum-wage law by the late 1940s.

In 1948 the unemployment rate of black 16-year-old and 17-year-old males was 9.4%. This was a fraction of what it would become in even the most prosperous years from 1958 on, as the minimum wage was raised repeatedly to keep up with inflation.

A survey of American economists found that 90% of them regarded minimum-wage laws as increasing the rate of unemployment among low-skilled workers.

Harvard University economist Greg Mankiw puts the agreement level at 79%. This is not controversial. This is one of the most widely-accepted facts in economics. Generally, if you raise the price of domestic labor, without any increase in worker productivity, then it reduces demand for domestic labor and causes companies to reduce hiring and retention, possibly looking elsewhere for labor. Compassionate-sounding policies actually cause negative results like outsourcing and layoffs. The very people who agitate the most for a “living wage” cause higher unemployment – especially among youth and minorities.

The only sure way to help workers is to give them marketable skills and job experience – that’s what really draws higher salaries and better benefits. And that means advocating for smarter policies: fewer regulations on job creators, lowering the employer portion of payroll taxes, merit pay for teachers, vouchers to encourage competition between schools, making work pay more than collecting welfare for doing nothing. And so on. That would actually solve the problem of people not having work.

7 thoughts on “Basic economics: what’s wrong with raising minimum wage rates?”

  1. A fine and succinct explanation of the non-helpful nature of the minimum wage, though I suspect even as described by Mr. Sowell, it’ll be hard to get through some peoples’ heads. Alas.

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  2. Another key point is that labor is a controllable expense for companies. That is, it is possible to get rid of laborers in order to cut costs. The higher the cost of laborers, the more companies will seek laborers who can do more for the same price (or seek alternatives like mechanization, if possible).

    If I may offer my own opinion related to all of this, it is that we should be concerned that those who work are able to sustain themselves, but we should not always go for what initially looks like the easiest answer.

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  3. I never thought of it this way. But I had worked out that minimum wage is a horrible inflation driver.

    When costs for companies rise, they raise prices to continue enjoying the same profit margins. When minimum wage goes up, price increases automatically follow.

    That means not only does a high minimum wage drive costs of consumer goods up, but the high unemployment rate means no one can buy those goods anyway. It’s a really vicious cycle we’re creating for ourselves here!

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  4. you know, when I first started working twenty years ago or so minimum wage was $4.65. Gas was under $1 per gallon, milk was around $1.50 a gallon, bread was around $.50, rent for a true one bedroom apartment where I live was under $400 and so forth.

    Now with minimum wage at $7.25, almost everything has doubled in price, some things far more than that. My $4.65 went further than $7.25 does now.

    Minimum wage is hardly the only issue contributing to it, but it is a big part. Personally, I think a large issue we have is that we hitched our economy to a usury based model and made it nigh impossible for anyone not in the upper middle class or above to buy much of anything without going into debt. We trumpet debt as a good and useful thing, to the point that the nation as a whole does not seem to care about the trillions of dollars we are in debt; at least not enough to do anything substantive about it.

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  5. yep, i can’t find a job and i would be willing to work for 5 bucks an hour but with min wage near twice that i’m not surprised no ones hiring.

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