Saturday, January 3, 2009

What’s wrong with a minimum wage law?

What’s wrong with a minimum wage law (MWL)?:
Let me begin by saying that my objection to a MWL is NOT based on a subjective desire to prevent workers from improving their material lot by increasing their earnings. Quite the opposite, in fact, though this may not be clear on the surface. Surely all people of good will towards fellow men will rejoice if everyone’s lot is improved. But a more detailed analysis is required to determine whether a MWL can really do that. Also, one must consider whether such a law is consistent with “the proper role of the state” in a free society.
This law is wrong-headed on a number of levels. At the highest, most general level, it sets the bad precedent that the government should get involved in transactions and interactions between “consenting parties”. This objection to a MWL, stated thus, should appeal to the modern “liberal”, i.e., left-winger”, as it has long been recognized by most people of that camp that the government has no business getting involved in private interactions between consensual parties. This is of course usually argued in a sexual context. And I agree, that it is a valid principal in that context. But it should be carried further and applied to all cases involving mutual consent among citizens. Once it has been established that the government does have such a role to interfere, then it opens the gates for gradual osmosis into other areas. Hence, I maintain that it should not be within the role of the state to regulate wages (or prices).
There are other practical difficulties with any MWL. One is that it tends to render a certain low-income worker unemployed. Why? Well, look at it this way: in a purely free market system, we can imagine that there is a large spread in the perceived value of workers. Some workers are perceived by employers as being “high risk”, in the sense that they are untrained, with a dubious, or at least un-established, level of responsibility and dependability. An employer operating with a very narrow profit margin might be inclined to take a chance with this type of risky worker if the “price is right”. That is, low enough that the employer can still operate in the black. Let us call such a worker X, and the mutually agreed upon (low) rate r. Further suppose that there is a worker Y that is more responsible and with more established performance record. Suppose Y will only work if for rate q, where q > r. Now a MWL is enacted, stipulating that the employer must pay at or above a pay rate p, where p > r but p ~ q. Then the employer will have to choose between the following alternatives:
Paying X at a rate p, which is more than he deems he is worth (possibly having to cut back any other employee fringe benefits or reduce working conditions, and/or raising the prices of his goods and services)
Hiring Y, figuring that if he has to pay the rate p ~ q, then he might at least get an employee that he deems to be worth that rate (but to maintain operating “in the black” he might try to raise the price of his goods or services).
Deciding to close up shop, because he needs the help but cannot afford to pay the rate required by the MWL
Deciding to try to stay in business, but to limp along without a helper

Note that in 3 of these 4 cases, X loses out because he does not get the job. Now if we postulate that the unemployment rate in Y’s category is zero, then the second alternative may not happen, because all of the Y-types are already making their market rate, p ~ y. In practice, the y class is never fully employed. Furthermore, even if it is, alternatives 3 and 4 still involve leaving X unemployed. And we must assume that X would be happier being employed at the rate r that is below the MW than he is unemployed with the MWL in place.
The often-heard argument that “everyone has a right to a living wage” is naive and untenable for several reasons, one of them being the above reason, that the MWL cannot guarantee that worker X in fact has a job. Other reasons come to mind:
There is no constitutional right to “being paid a living wage”. A cursory reading of the “founding fathers” will show that this is not what was meant by the right to the pursuit of happiness…this phrase was penned in an era where slavery and active suppression by violence was a reality in much of the world (as it still is today)
Who, in any case, would determine what a living wage is? Surely this differs from person to person. Living at what level? Subsistence, or at a level where one can afford a TV and a nice car?
Many people that work for wages in the r regime are not, I believe, primary wage earners for a family; rather they are teenagers earning discretionary income, or retirees working just to keep a foot in the goings on of society. Some are, to be sure, and taking a job at rate r is still preferable to no job. They may have to take two jobs at rate r…it’s a tough world, not to sound callous. The job might be a gateway to a higher salary, once they establish that they help the employer’s business flourish. For once proven, they would be attractive to competitor’s, who might hire the employee away at an increased salary, and a raise would be in the offing to prevent that.
A MWL cannot easily prevent an employer from making trade off in employee benefits or working conditions. Any attempt to try to prevent such trade offs would increase the government bureaucracy and associated government overhead even more, thus contributing to inflation, deficit spending, etc. This eventually hurts everyone in the society.
It can further contribute to employers outsourcing jobs overseas, where the MWL cannot be applied.
The legislated increase in wages will tend to be passed on to consumers, who may choose to reduce their patronage of the employer’s business, thus eventually driving the business under, thus resulting in the loss of X’s job.
A MWL will tend to hit smaller “mom and pop” businesses more than it will the large corporations, because the latter can more easily cope by adjusting other factors, such as fringe benefits. The M&P businesses will not be able to do this. Thus the MWL hastens the depressing trend toward chains taking over in all areas of commerce (restaurants, hardware stores, drugstores, etc).
By increasing the level of unemployment of workers of type X, crime is probably encouraged and increased. Gang-related activity is encouraged by the large number of unemployed people (sadly, youth from underprivileged neighborhoods).


efp said...

There is certainly a disemployment effect of a MWL, assuming the other option is no wage controls whatsoever. However, a quick google search shows me that those few countries without a MWL, there are effective minimum wages set by collective bargaining agreements. Which of these arrangements is more efficient? I don't know.

Let's not forget that wages for jobs are competing against other methods of making a living: crime, welfare, etc. The lower wages go, the more incentive there is to pursue these alternates, which are generally a drag on the 'official' economy.

Of course, the higher wages go, the more of the economy is pushed into unofficial (untaxed, unregulated) transactions. And the dismeployment effect also pushes people into alternative revenue streams.

So, it's not so obvious to me that MWL = bad. I think that eliminating the MWL, in isolation, would not produce the desired results. It interacts, in complex ways, with all the other labor laws. I wonder if there is a country that had a MWL, and dropped it? I'd like to see the result. The fact is, nobody understands economics, least of all, economists.

Tom said...

I certainly agree that it is a complicated interaction in the present jumbled, quasi-regulated US economy. Indeed, as commenter "efp" in effect says, whether MWL's work or not is really an empirical question. My first order analysis was just intended to show how MWL's might increase misery overall, in contrast to what people really want them to do (to ensure everyone of a "fair" wage). It might very plausibly cause increased unemployemnt of the marginally employable, and might casue business failures of marginally profitable small businesses, for example.
Wages paid by an employer are really at bottom the price of a service. In a free society people should be allowed to trade goods and services at a mutually agreed upon level without interference from an outside party (in the case of MWL's that 3rd party is the state).
As I also noted at the start of this post, whether a law or institution "works" is not really the right criteria for having it. It has to pass the moral criteria of being within the proper role for the state. To take an extreme example, there were, I think, many people in the mid 1850's that argued that "slavery could not abolished lest the economy of the US collapse". Even had that been true, obviously slavery should have been abolished on moral grounds, i.e., as a violation of human rights th estate is supposed to protect. My point is that if it is not the business of the state to interfer in setting wages, then it doesn't matter if it works or not. My thinking here is similar to what I think about why drugs should be legalized (across the board)...I suspect it will reduce gang-crime (and here we have some applicable empirical evidence from the"prohibition era" crime wave, oddly ignored by most people it seems), but I can't prove it. The real reason the drug war should be ended is that the state has no business telling its citizens what products they may or may not use, and making it a "crime" if they do choose to use them.
The point about crime and welfare being an alternative to pursuing a paying job is a good one, but I think it not a telling one. Consider prices of goods. Do we cap what a business can charge for its product arguing that if it goes too high people will simply steal the product? Another point to consider here has to do with the directness of the hike in wages from a MWL. The business owner pays any MW increase directly out of his revenue, whereas the cost of crime and welfare is distributed over all of society.

efp said...

We definitely agree here in spirit. You said "As I also noted at the start of this post, whether a law or institution "works" is not really the right criteria for having it." Certainly not, but I think it must be a necessary criteria for keeping it. I've often thought that every law should be constitutionally mandated to include:

1. A clear statement as to what the law is intended to accomplish. This is where it is held up to standards of the proper role of government.

2. A rationale for how the law will accomplish said goals.

3. A timeline with a concrete criterion to determine whether or not the law has worked. If it can't be demonstrated to be effective, it should expire.

In other words, we need lawmakers to think and act as engineers. Build me a legal system that can deliver a subpoena on the moon.

In the light of current events, I think it's fair to say one valid role of government is to stabilize the economy. Beyond the basic institutions which make a market economy possible (property rights, contract law, etc.) it's clear that macro-economies have various instabilities.

One obvious one is a type of positive feedback which results in scarcity power (monopolies). i.e., the larger a company gets, the more of a competitive advantage is usually has, so it gets even bigger. Monopolies thwart the functioning of the market, so some intervention is required. (This is I also think a sound rationale for progressive taxation and other forms of "wealth redistribution," it's a matter of countering the tendency of positive feedback.)

I won't pretend to have much grasp on the instabilities of the financial sector, but clearly it's in the public interest that the sector doesn't go through extreme swings of boom and bust, which seem to be its natural tendency, when left entirely alone. But that is a very different topic.

I agree, on the surface, the MWL seems unnecessary, and is often skirted anyway--practically every vegetable in every supermarket was picked by migrant workers making less than the federal minimum. When a law makes a very large segment of your population criminals, methinks it needs to be revisited (see: drug laws, immigration laws, etc.)

However, seeing that the common alternative is CBA's, perhaps the MWL's real function is to make labor unions weaker. Unions can also distort the value of wages, and reduce productivity in many creative ways.

Tom said...

I like your 3 rules that should be mandated for any law. It is interesting to apply those to the "drug war" laws. Not only does the drug war violate the rights of a person to ingest what he/she chooses, but the whole mess is obviously not working. And rules 1 and 2, if applied, might make people and the state realize it's a bad idea.