Sorry, Your Minimum Wage Law Is a Nightmare

The minimum wage is an economic nightmare.

Let’s say it one more time, with feeling.

The minimum wage is an economic nightmare.

In the recent elections, voters throughout the U.S. took to the polls to elect their political leaders. Winners and losers were decided, the Republicans took control of the Senate, and pundits eagerly anticipate how the new political landscape will impact the U.S.

Voters also voiced their opinions on several specific issues. Alaska, Oregon, and Washington, D.C. voted to legalize recreational marijuana. Voters in four states, Alaska, Arkansas, Nebraska, and South Dakota voted to raise the minimum wage. Over the coming months, these states will raise workers’ required pay to as much as $9.75 an hour. The city of San Francisco voted to raise their minimum wage to a whopping $15 an hour.

The idea behind raising the minimum wage is simple. Increasing the required payment for low-skilled workers will boost their income. In turn, they will spend more. This spending will fuel the economy, leading firms to hire more workers. Unemployment will go down, output will rise, and everyone will win.

While this idea sounds appealing, it’s based on what can only be described as (really) bad economics.

First, minimum wage jobs make up about 4-5 percent of hourly workers, according to the Labor Department. So already we see a problem with the above logic. Even if the rest of the above reasoning holds true, augmenting these wages is not likely to have the large effect proponents claim.

But there is a more fundamental issue here. In economic principles, we learn a simple but very important concept known as the “first law of demand.” That is, as the price of a good or service falls, people buy more of that good or service. The converse is also true. If the price of a good or service rises, people buy less. Market forces—supply and demand—determine how much is bought and sold and at what price. When we try to manipulate this system by setting an artificial price, we wind up with unwanted shortages, surpluses, and distorted prices. (For an example of this problem on a grand scale, click here.)

Labor services are no different than any other from this perspective. In the case of hiring workers, employers decide how many labor hours to buy from their employees based on the costs and benefits.

Imposing a minimum wage automatically increases the cost of hiring labor without giving workers any new skills (an arbitrary increase of $5 in pay doesn’t magically make a worker more productive). This makes the employers worse off since it now costs more to manufacture and sell their goods and services.

It also harms low-skilled workers. It’s not difficult to see why.

Suppose you are the owner of a fast-food chain. Your employee, Bob, costs  you $8 an hour in wages. Every hour, he makes you $10 worth of revenue. You both win. Bob earns you $2 in profit every hour  ($10 revenue – $8 wage = $2 profit), and Bob makes $8 dollars.

But now a new minimum wage law requires you to pay Bob $15 an hour. This increase in pay is not the result of changes in the supply or demand for labor, but an artificial price. Since Bob hasn’t gained any new skills, he still produces $10 of revenue an hour. However, he now costs $15 an hour to employ. The result is a loss to you, the employer, of $5 every hour Bob works ($10 revenue -$15 wage = -$5 profit).

So what do you do? You fire Bob. Simply stated, he’s not employable at $15 an hour. Now, not only are you worse off as the owner, but Bob is certainly worse off. He was making $8 an hour, but now he earns nothing.

This scenario has played out time and again with minimum wage laws. Take, for example, plans by companies like McDonalds and Panera to move at least a portion of their stores to automated cashiers. As human workers become more expensive, computerized, capital-based options become the most economically sound.

This same scene is playing out once again in San Francisco. One popular book store, despite its customers and dedicated employees, turned a very small profit last year of about $3,000. As the minimum wage increases, these profits will erode. According to the store owner,

 [B]y 2018 we’ll be losing about $25,000 a year [because of the increase in wages].

As a result, the store is shutting its doors in March. Customers will lose a beloved store, an owner will lose his business, and several bookstore employees will be out of work. One such employee stated that the work had allowed him to live while “nourishing his passion for sci-fi and fantasy.” Thanks to the minimum wage hike, this is no longer an option.

Proponents of minimum wage increases claim that such hikes will lead to increases in income. This is true—for the people who are able to keep their jobs. But this ignores the many low-skilled workers who are likely to lose their jobs. These jobs, in addition to providing income, allow many workers to gain skills and experience they need to advance their careers. The result is bad news for employers, workers, and the economy as a whole.

Many are applauding the decision of voters to increase the minimum wage. Economics tells us, however, that these voters may get a higher wage, but they should expect higher unemployment and fewer opportunities for the very workers they’re trying to help.