During the last several years,
Americans have seen their pay stagnate as a weak economic recovery, weak labor
market, increased regulation and increased immigration have combined to stall
wages. During all this time, the federal
minimum wage has remained at $7.25 per hour.
Honestly, no one can make an honest living today earning just $7.25 per
hour. Proponents of the higher minimum
wage believe that increasing it to $15 per hour will provide all full-time
working adults with what they describe as a “living wage.” Unfortunately, their analysis is not thorough
enough, and therefore, their idea will not deliver the promised benefit. I do not believe that a living wage can be achieved through legislation.
We have to look deeper into the
thought process behind this proposal.
Like I mentioned above, the idea is to provide a living wage to all
full-time working adults. I am with them
on this. I am all for everyone making
more money. However, I am even more in
favor of everyone enjoying a higher standard of living and this is where the
proposal falls short. The weakness in
the living wage argument is the assumption that in lifting wages up to the $15
per hour level, nothing else in the economy will change. You have to make the assumption that nothing
else in the economy will change in order to make the argument work. The problem is that everything else in the
economy will change.
To begin understanding why
everything else will change, one needs a basic understanding of the labor
market, then an understanding of how this will impact company income
statements. I will begin by giving a
very basic primer on how labor markets work.
We begin by noting three basic levels of labor: 1) unskilled, 2) skilled, 3) skilled
union. The unskilled worker is at the
low end of the totem pole, and this is primarily your workers in such areas as
retail, fast food service, tourism, etc…
This is where many teenagers get their first jobs and acquire the basic
skills of work, such as showing up on time, providing good customer service,
working as a team, communicating with your boss, customers and co-workers. Skilled workers have learned a trade, such as
metal working, wood working, plumbing, electrical, machining, welding,
etc. And of course, union workers are
also skilled, but belong to a union that negotiates wages, working conditions
and grievance procedures for the workers, which is typically a large set.
Just a basic anecdotal knowledge
of the labor market today leads me to conclude that the prevailing wage for
unskilled workers is approximately $10 per hour. A wage scale for skilled and union workers
typically is based off the wage for unskilled workers. Currently, the wage scale for skilled workers
is typically in the $16-$22 per hour range, and the wage for union workers is
typically in the $28-$35 per hour range.
Of course, this will vary, with some higher and some lower. This is important to note because as the minimum
wage gets pushed up, skilled laborers and union workers will also see an
increase in their wages. As you might
expect, unions are typically in favor of minimum wage hikes, because it gives
the union added leverage to ask for higher wages in negotiations for their
workers. Plus, as the wage scale gets
pushed up, wages for skilled workers will push their way up. After all, if an unskilled worker is worth
$15 per hour, is the skilled worker only worth $20 per hour? No, the skilled workers’ wages will be pushed
up largely because his work is worth considerably more than the labor of the
unskilled laborer.
In order for companies to pay for
these higher wages, from the unskilled worker all the way up through the union
worker, prices will be forced up, and we will all be paying more for the goods
and services we consume to pay for the higher wages. So the unskilled worker, for whom the $15 per
hour minimum wage is designed to benefit, will see very little, if any, actual
benefit after prices are increased.
Plus, you have to remember that with every company paying the higher
wages, all companies will have to raise prices.
This is where the effect on the income statement comes in. It is not just the wages component of the
expense line that increases. All the
inputs, from the raw materials and intermediate goods that a company purchases,
will cost more. Rents will be pushed up.
The cost of power will go up.
This problem is complicated even
further by the economics concept known as the substitution effect (see the picture above). The
substitution effect simply states that as the cost of a good or service (in
this case, labor) goes higher, the consumers (employers) will seek cheaper
alternatives. The fast food industry is
a good example of this. Most fast food
chains have started experimenting in laboratories with robots that can entirely
run the restaurant, from food prep and cooking to interfacing with the
customer. While one bemoans the lack of
personal service, let’s face it, no one goes to McDonald’s for the
service. Efforts like this could price
many unskilled workers out of the labor market.
As
the cost of unskilled and skilled labor goes up, the cost of professional,
managerial, and executive labor will also go up to adjust for price
increases. So the cost of all labor, and
ultimately, the cost of all goods and services will be forced up. What this means is that the unskilled laborer
will wind up in the same position as he is today, even with the $15 per hour
minimum wage. He will be making more
money, but will still be far short of a living wage. A basic fundamental tenant of economics is
that you cannot legislate a higher standard of living.
Cost of
inputs do not necessarily determine the magnitude of price increases. Elasticity of demand is also a major
determinant. Products with relatively
stable demand such as food or personal care products are said to have inelastic
demand. Products that have highly
variable demand such as washers, dryers or cars are said to have elastic
demand. Obviously, in a higher
cost/higher price economy, those products with inelastic demand will be able to
pass along price increases more easily than those with elastic demand.
So, what drives living standards
higher? Two things off the top of my
head: 1) education, and 2) productivity.
People who pursue a higher education do so in order to learn a skill, a
trade or a profession. And once you
start on education, you learn that you never really stop. Education will get you the next step beyond
unskilled. And further education will
help land you managerial positions. But
the real key is productivity.
Productivity is simply a unit of output per hour. The worker who can produce more units in an
hour is more productive, his work is more valuable, and chances are he will be
paid a higher wage for his increased work.
For both the laborer and the professional, machines often enhance
productivity. Another hidden asset for
both is experience, which intuitively teaches faster, more efficient ways of
working. It is interesting to note that as wages have stagnated during this economic recovery, productivity has only increased at a 0.6% average rate over the last six years. This article is an excellent explanation of how higher productivity drives
wages higher.
So, would I favor a higher
minimum wage? Believe it or not, yes I
would. Just not all the way to $15 per
hour. The trick is to keep the minimum
wage below the prevailing wage for unskilled labor. That way, the disruptive effects (i.e. jobs)
would be minimal, while everyone would make a little more money. The current federal minimum wage has been in
place since 2009. Raising the wage to
$8.50 or $9.00 per hour would be warranted, keeping the minimum wage below the
prevailing wage, and letting those at the very bottom enjoy more income.
A couple of other readings of
interest on this comes from a study conducted by the University of Washington
into the Seattle law mandating a $15 per hour minimum wage by 2017:
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