A Realistic Look at Minimum Wage

minimumwage11There has been a lot of vitriol on both sides of the aisle over the idea of raising the minimum wage.  Ultimately the camps come down on two sides, and I’ll name and number the arguments as the following:

  1. Minimum Wage hasn’t changed in so long, it is behind the times.  Corporations are greedy and there is no evidence that raising the minimum wage will increase prices or cost people jobs.  The minimum wage should be raised immediately to a higher wage, because over 30% of American children are living in poverty.
  2. Minimum Wage shouldn’t be touched!  Minimum wage is already too high and low income workers are being paid for what they are worth.  They get paid for the productivity they bring to the market.  If they can’t live on minimum wage, get another job.  Besides, raising the minimum wage will only increase prices and ever inflate the need of the minimum wage.  Additionally, if you raise the minimum wage, more jobs will be lost to alternatives.

As usual, both these arguments have grains of truth and both these arguments are laced with lies.  And since I’m a blogger, and therefore always right, I’ll set them all straight and tell them what needs to happen.

Let’s take the second position first, and deal why we shouldn’t raise the minimum wage.  The first argument that is of importance is that raising the minimum wage will raise the the costs of goods and services.  To a certain extent, in the absence of all other factors, this is fundamentally true.  A business makes money by selling it’s goods or services at a higher cost than it takes to produce them.  A perfect example is when I was a contractor and working for the government.  I got paid a specific salary, and I charged my customer my salary plus my overhead plus my costs.  So while I worked for $20 an hour, I charged $32 an hour.  I made money, my company made money, and the government contract ensured that the cost was kept low and nothing was overly inflated.  If I suddenly jumped to $25 and hour, the rate I charged would go up as well.  This was all heavily controlled by contracts, because once the contract was established it effectively eliminated all other market forces.  At least until the contract was up for bid again.

However, in the real world (trust me, government contracting is NOT the real world) there are far more market forces at work and such a simple formula fails.  To simplify the economics, let’s say the product or service that we have on offer can sell for $2.  Doesn’t really matter what the product or service is, or the unit of the sale.  The unit cost is $2.  Notice I didn’t say the company set the price at $2.  Companies don’t set the price, the market does, in most cases.  There are some markets where this fails, but in most places in the economy, the price of goods and services are set by the market and not by the company, so for simplicity let’s ignore those markets that don’t follow that.

So if the cost of the good is $2, then the profit of the company is based on how much you can actually produce the good for.  There are lots of things that go into your cost, and some of those things can change the perceived value and let you charge more for the product than what the market dictates, some you can’t.

For example, a decent quarter pound hamburger costs around $4.  At McDonalds, using economies of scale and cheap labor, McD’s may make more at that price point than a local mom and pop.  Then again, the local mom and pop, with a homey, non-corporate appeal and fresh, local ingredients, may make the same profit because of the perceived higher value of the burger, selling it at $5.  Employees are only one part of the equation, and raising the minimum wage may or may not have an impact on the cost of the product.  With McD’s employed at their corporate levels, it may reduce profits a bit.  The mom and pop is more likely already paying their cook more than minimum wage, so it may not effect them at all.  The mom and pop is far more reliant on the skill of the cook so paying him a wage that retains him is far more important to the mom and pop than it is to a chain like McD.

But wage isn’t the only factor.  If the value of the burger is $4 in the market, it doesn’t really matter if McD’s loses profit on the deal, they can’t raise the price by much or they will suffer from a loss of sales.  So with all the other factors, it won’t raise the price to raise the wage.  It can’t, because McD’s has to sell a certain level of burgers to make money.  If the price at McD’s goes up too much, buyers will got to Burger King, or Wendy’s or the mom and pop for a fresher burger.  So factors other than wage are setting the price.

This assumes a modest increase in minimum wage.  A rapid increase of minimum wage will force all the players to raise their prices overwhelming the other factors in the cost of production.  To fast, and the factors are all overwhelmed in the chain leading to the retail are also inflated and the cost of everything does go up.  So it’s a double edged sword.  Raise the minimum wage too rapidly, and the cost of everything will go up.  Raise it slowly, and prices may or may not change, with other factors driving the price to remain at or near the same level.

In the same argument, those opposed say workers will lose jobs and that’s certainly a possibility.  But it assumes that low wage workers are both unproductive and easily replaceable with automation.  We’ve seen automation replace workers over the past century, and as a result it is a very real possibility.  But the problem is, low wage workers tend not to be specialized anymore.  If you go to McD’s and watch the jobs that a worker performs during a lunch rush it becomes clear that what automation is already used in the production is there to increase the productivity of the worker.  In some way, automation in fast food as made the worker more secure in their position rather than less.  The worker is expected to perform more and more tasks and the automation lets it happen.

Typically, we see medium to high end productivity workers get replaced with automation, and not low end workers.  Skilled labor on production lines have been replaced with robots.  Skilled welders have been replaced with automated welders.  Low skilled workers are expensive to replace with automation.  For example, instead of replacing floor washers with automation, they have been aided with floor washing machines.  The step from a human driven machine to an automated machine is more costly than the provided value.  Besides, the human driven machine has significantly increased the productivity of the worker, so the automated machine can’t just match, but must exceed the human significantly to make it worthwhile.  Therefore, if raising the minimum wage might threaten anyone’s jobs, it isn’t to the low wage worker but to their higher skilled coworkers above them.

There are exceptions.  Some chains, when they opened, had all of their produce delivered fresh.  New hires started out chopping and slicing the produce into the cuts and styles required by the shop.  But as wages rose in the 80’s, most of those chains moved from fresh whole produce to fresh pre sliced and prepared produce.  It was less about automation or wage cost as it was about scale.  Produce suppliers using automation and scale managed to lower the cost of prepared produce to nearly the same as whole.  And with less waste and time, it made sense to move to prepared.  But nevertheless, jobs were lost.  But you can’t blame minimum wage for it, as much as I did when it happened to me.  Instead, the market forces changed.

Now for the problems with the pro minimum wage arguments, the first is the often claimed children in poverty argument.  I don’t want children to live in poverty any more than any other human being.  The often quoted statistic of how the United States is 34 out of the 35 richest nations for Children in Poverty.  The study was provided by UNICEF, and for what it claims is absolutely true.  But what it claims isn’t about poverty but relative poverty, and that’s a horse of a different color.  Under the definition of poverty used by UNICEF, almost every child in China is in poverty, and relative to China, almost no child in America is in poverty.  It’s the relative part that is the problem.  Relative poverty is any child living in a household that is less than half the median income of the nation.  So any child in the United States that lives in a household of around $15,000 is in “poverty.”  Now, living in America on $15,000 a year isn’t living the high life by any stretch of the imagination, but it isn’t living on the streets of Bangladesh, and country as prosperous as America should be ashamed that 20% of her children live with so little.  But to use images of kids on the street as the standard of American poverty is just as disingenuous.

Most economist agree, a modest raise in minimum wage will not impact prices, jobs or much of anything else.  The only impact is generally expected to be a boost to the economy.  The problem is most minimum wage proponents aren’t proposing a modest wage, but instead are thinking of a quite significant wage increase.  Even raising minimum wage to $10, which is were it should be had wages kept up with the economy, is more than modest.  That’s nearly a 40% (37.9%) increase.  The most common (and currently successful) minimum wage proposal is $11, which is over 50%.

So what do I think is the right idea?  First off, the minimum wage should be raised.  But it needs to be done incrementally, so as to have the smallest negative impact possible, but steady, so as to have the quickest release possible.  I would propose a $.75 increase now, and a year later a $1 increase every 18 months until it reaches $12.  Then a required review of productivity verse wage that would guide when a new increase is needed.  That gives us a significant increase over the next 7 years, but without breaking the bank by suggesting a big initial jump.  I think a 65% increase in 7 years is modest while also being significant.

I also think we need to offer incentives to companies for raising wages faster.  Every year, offer a company a tax break to companies based on the percentage of employees they move from making minimum wage to more than minimum.  And increase the break for employers for every employee they move from minimum to above the $12 rate.  Combine this with the minimum wage, and I think you’d see something pretty powerful and significant.

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3 thoughts on “A Realistic Look at Minimum Wage

  1. Part of the problem is that businesses, perhaps especially big businesses with money to spare, will pay their staff the least they can get away with. For the low-skilled, that means minimum wage – even those who need skills which can be learned on the job and which it would take time to train their replacements and cost in productivity.

    • Which, assuming is true, is the reason behind incentives to pay more. I’m working out the math on an incentive scheme I’ll post about later.

  2. Pingback: Incentivizing Wage Increases | Running Wolf

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