The Minimum Wage: Washingtons Perennial Myth
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Cato Policy Analysis No. 106 May 23, 1988  The Minimum Wage: Washingtons Perennial Mythby Matthew B. Kibbe Matthew B. Kibbe is a graduate student of economics and a fellow at the Center for the Study of Market Processes, George Mason University.Executive Summary Thanks to the political clout of organized labor, a numberof Washington's lawmakers have once again proposed to substantially raise the minimum wage employers may pay workers.[1]Proposals from Sen. Edward Kennedy (D-Mass.) and Rep. AugustusHawkins (D-Calif.) would raise the present minimum wage, $3.35,by nearly 40 percent, to $4.65, by 1990. An amendment to theHouse version of the bill, sponsored by Rep. Carl Perkins (D-Ky.), is even more generous; it would raise the minimum wage to$5.05 by 1992. Members of Congress who support an increase in theminimum wage have all but monopolized the ethical high ground,using an appeal to simple economic justice as the singleimportant justification for their position. The proponentsargue for a "fair" minimum wage, as though government couldsimply legislate wealth into existence. Kennedy finds it"unacceptable" that the present minimum wage "does not permitfull-time workers to provide the bare necessities for theirfamilies."[2] In reality, full-time employees make up only a smallpercentage of the total number of people earning the minimumwage. The proponents' use of such straw men not only confusesthe issue but also suggests that there are other, less sinceremotivations for supporting an increase in the minimum wage. Minimum-wage legislation is and always has been the resultof special-interest politics. Behind the rhetoric of economicjustice and fairness lie purely self-serving political considerations. A particularly glib admission of this fact wasrecently made by a Democratic House aide, who claimed during acongressional battle over increases in the minimum wage thatDemocratic proponents would "throw numbers out till nobody canhave faith in the numbers, and then political considerationswill win. That's how we do it every time."[3] The simple truth about the issue is that any minimum-wagerate that is forced onto the market will have only negative effects on the distribution of economic justice. Minimum-wagelegislation, by its very nature, benefits some at the expenseof the least experienced, least productive, and poorestworkers. The Determination of Wages in a Market Economy The supply of and demand for particular skills determinethe market price of an individual's labor--that is, his wage.Employers attempt to purchase the specific skills they need atthe lowest available price, while individuals selling theirlabor attempt to find the highest-bidding employer. Every market price, including a wage, is simply theoutward expression of what employers perceive to be consumers'preferences. If consumers do not value a particular good orservice offered on the market, labor, as well as the otherfactors involved in producing the good, will be worth little.Thus, it is the individual--the sovereign consumer--who has thefinal say in determining wages. Aside from a shift in consumers' preferences, there isonly one noncoercive method through which real wages can rise:workers must become more productive. The most obvious way forworkers to enhance their productivity is to increase or improvetheir skills through education, experience, and effort. Wage rates can also be improved if employers increasetheir investment in future production. Increased capitalinvestment renders labor more productive by providing workerswith better tools. A simple example of this principle is thecase of two equally productive workers assigned to clear awooded lot. The first worker is given a shovel and an ax, thesecond, a bulldozer. Obviously, the second worker will be muchmore productive, which illustrates that all the hard work inthe world cannot compete with a high rate of capital investment. To increase wage rates without either an increase inproductivity or a shift in consumer preferences requirescoercion. It is quite possible to raise certain wages byexcluding competing labor from the relevant markets. Thisdistinction between voluntary and coercive methods of increasing wages is essentially a difference between creating wealthand redistributing wealth. Contrary to the claims of many members of Congress,government cannot create wealth by simply passing new laws.Otherwise, Congress would long ago have passed laws prohibiting poverty and establishing a minimum wage of $100, or even$1,000, an hour. In such a world, everyone could be a millionaire. But ours is a world of scarcity, and wealth is a productof the market process, not of legislative fiat. The Economic Effects of Minimum-Wage Laws Simply stated, if the government coercively raises theprice of some good (such as labor) above its market value, thedemand for that good will fall, and some of the supply willbecome "disemployed." Unfortunately, in the case of minimumwages, the disemployed goods are human beings. The worker whois not quite worth the newly imposed price loses out. Typically, the losers include young workers who have too littleexperience to be worth the new minimum and marginal workerswho, for whatever reason, cannot produce very much. First andforemost, minimum-wage legislation hurts the least employableby making them unemployable, in effect pricing them out of themarket. An individual will not be hired at $5.05 an hour if anemployer feels that he is unlikely to produce at least thatmuch value for the firm. This is common business sense. Thus,individuals whom employers perceive to be incapable of producing value at the arbitrarily set minimum rate are not hired atall, and people who could have been employed at market wagesare put on the street. Some opponents of the minimum wage argue that it aggravates inflation by pushing up the costs of individual businesses.[4] Those businesses, unwilling or unable to absorbsuch costs, pass them on to consumers in the form of higherprices. In this view, any artificial increase in labor costscan produce so-called cost-push inflation. There are several problems with the notion of cost-pushinflation. The primary error in this analysis is that itconfuses a shift in the structure of relative prices with ageneral rise in the level of prices. If the labor costs ofbusinesses are increased and they succeed in passing on thecosts to consumers in the form of higher prices, they will havemanaged to change the structure of relative prices at theexpense of businesses that are unable to raise their pricesbecause of more-intense competition. This is quite distinctfrom a general increase in the level of prices, which would bepossible only if the real supply of money was increased. Many firms, however, may be unable to pass on their increased costs to consumers. It is consumers who ultimately determine the price of any good on the market, and they maydecide that a business's product is not worth a higher price.Producers cannot force consumers to buy what they produce, andbusinesses cannot always arbitrarily increase the prices oftheir products simply because the government has arbitrarilyincreased their costs. This fact has important implications. If a businesscannot simply pass along its new labor costs, it must somehowabsorb them--by eliminating workers rendered unproductive bythe new minimum wage, by replacing labor with more-productivemachines, or by cutting back production. Those jobs noteliminated will be more demanding, as employers will use fewerpeople to produce the same amount of work. Teenagers suffer most from the adjustments required by anincrease in the minimum-wage rate. These workers are generally the least experienced, least skilled, and least productive.According to the Bureau of Labor Statistics, the presentunemployment rate for all teenagers actively seeking jobs is16.5 percent, and the unemployment rate for black teenagers is36.9 percent, more than double the overall average.[5] Theexisting minimum wage has contributed significantly to producing these abhorrent levels of unemployment. The damage done to teenagers is twofold. First, they loseincome immediately. Second, because minimum-wage legislationhas rendered them unemployable, teenagers cannot gain the ex-perience and skills that would make them employable at higherwages later. If there were no floor price on labor, teenagerscould offer to work for a lower price until they had gained thetraining, experience, and skills they needed to command ahigher wage. The damage done to minority teenagers is far worse. Byestablishing an arbitrary minimum, government reduces the costsof discrimination. In The State against Blacks, economistWalter Williams described how minimum-wage legislation altersthe incentives of employers:Suppose that an employer has a preferencefor white employees over black employees.And for expository simplicity, assume theemployees from which he chooses are identical in terms of productivity. If there isa law, such as the minimum wage law, thatrequires that employers pay the same wageno matter who is hired, what are his incentives? His incentives are [those] of preference indulgence. He must pay the black $3.35 an hour and he must pay the white$3.35 an hour. He must find some basis forchoice. The minimum wage law says that hischoice will not be based on economic criteria.Therefore, it must be based on noneconomiccriteria. If he wishes, the employer can discriminate against the black worker at zerocost.[6] Because no one is allowed to work for less than a setminimum, those who can command only the minimum and arediscriminated against have no way to fight the problem. Ifwages were not fixed at a certain minimum, those who werediscriminated against could compensate by offering their laborat a cheaper price. This would effectively increase the costsof discrimination for those employers who wished to practiceit. Many proponents of higher minimum-wage rates insist thatthe teenager and minority argument is bogus. Minimum-wagelegislation, they claim, is primarily intended to help adultstrying to support a family. The minimum-wage earner trying tomake ends meet with an annual income of $6,968 and three orfour mouths to feed is often used as an example. A cursory study of demographic statistics suggests thatthis example does not accurately reflect the minimum-wage-earning population. According to the Census Bureau's "CurrentPopulation Survey," over 76 percent of all minimum-wage earnersare not heads of households. Furthermore, the Bureau of LaborStatistics found that only 2.2 percent of working adults areearning the minimum waqe. But what about those who are actually struggling to liveon the bottom rung of the economic ladder? Is the governmenthelping them by arbitrarily establishing the minimum livingwage? As noted earlier, government cannot create wealth simplyby passing laws. Such laws succeed only in redistributing theexisting wealth of society. The distortions caused by fixingthe price of labor produce definite losers and winners; it isthe least employable, the truly needy, who lose their jobs, andthe winners either earn wages above the new fixed price or haveprotected jobs. Minimum-wage legislation fosters economic inequalities bycreating a gap in the economic ladder: those on the bottomrung are kicked off, but those on higher rungs climb up. Byno means are such government-created inequalities fair or just. Theory, Statistics, and Econometrics Economic theory demonstrates that minimum-wage legislationwill inevitably create unemployment. It cannot, by its verynature, indicate how much unemployment will be generated in anyparticular instance. However, numerous statistical studies arein rare agreement in their support of a causal relationshipbetween minimum wages and unemployment. For example, the 1983Report to the U.S. Senate Committee on Labor and Human Resources of the General Accounting Officefound virtually total agreement that employment is lower than it would have been if nominimum wage existed. This is the case evenin periods of substantial economic growth.. . . The severity of the employment lossvaries among different age, gender, and racialgroups in the population. Teenage workers,for instance, have greater job losses, relativeto their share of the population or the em-ployed work force, than adults.[7] According to the 1981 Report of the Minimum Waqe StudyCommission, the 46 percent rise in the minimum wage between1977 and 1981 destroyed 644,000 jobs among teenagers alone."The evidence is now in, and the findings of dozens of majoreconomic studies show that the damage done by the minimum wagehas been far more severe than even the critics . . . predicted."[8] A 1983 survey, "Time-Series Evidence of the Effect ofthe Minimum Wage on Youth Employment," found that studiesconducted between 1973 and 1983 generally agreed that a 10percent increase in the minimum wage would result in a 1 to 3percent reduction in teenage employment.[9] Given thesefindings, the proposal to raise the minimum wage by nearly 40percent could result in a 4 to 12 percent drop in the employment of teens. A recent study by Clemson University economists Richard B.McKenzie and Curtis Simon estimated that an increase in theminimum wage to $4.65 by 1990 would cost 764,000 jobs by thatyear and 1.9 million jobs by 1995. The economic output lost in1995 would total $70 billion (in 1982 dollars).[10] Thepolitical embarrassment created by such estimates was graphically illustrated recently when the House Democratic leadershipsuppressed a Congressional Budget Office study that predicted aloss of 250,000 to 500,000 jobs if the minimum wage wasincreased to $5.05. The majority staff of the House Educationand Labor Committee sent the study back and asked for a newversion that lacked any reference to the bill's prospectiveimpact on unemployment and inflation. The majority staff director explained that the CBO had "provided information thatwas not requested."[11] The Senate Republican Policy Committee, citing a GeneralAccounting Office study, estimated that increasing the minimumwage from $3.35 to $4.61, as suggested by AFL-CIO presidentLane Kirkland, would eliminate between 124,000 and 619,000jobs.[12] It is not surprising that AFL-CIO economist John L.Zalusky disputes these findings. He predicts that a $1increase in the minimum wage would eliminate very few jobs, andhis "hunch is that a wage hike would provide a mild stimulus"to economic growth.[13] According to Zalusky's model, createdfor the union by the econometrics firm Data Resources Inc.(DRI), a $1 increase would eliminate 450,000 jobs during thenext eight years. However, Zalusky says, this loss has littleimportance when compared with the 11 million jobs that themodel predicts would be created in the same period.[14]Zalusky claims that such "real world evidence" casts doubt onthe "theoretical constructs" of economics. Zalusky's casual dismissal of theoretical constructsimplies that his model is somehow theory-free and concernedwith only the objective numbers. This is simply not the case.Any statistical or econometric model requires that some theorybe used to determine what data are needed to test it.[15] Infact, two theoretical assumptions of Zalusky's model make itsresults quite deceptive. First, the DRI model ignores potential workers who arenot seeking employment and therefore are not counted in theofficial unemployment statistics. But one of the most destructive aspects of wage fixing is that it discourages a largenumber of potential workers from looking for jobs. A properaccounting would include all unemployed workers, not just thoseseeking employment. An even greater problem with the model is that it ignoresthe increase in employment that might have occurred if aminimum wage had not been imposed in the first place. Agrowing economy creates jobs. It is misleading to claim that aminimum wage does not create a net decrease in the totalnumber of jobs. A net decrease would indicate that theminimum wage had destroyed more jobs than the market processhad been able to create in the same period. Such a scenario,although possible if the minimum was fixed high enough, has notyet occurred. The market has somehow compensated for pastlegislative foolishness. A more accurate accounting wouldcompare the number of jobs created under minimum-wage restrictions with the number of jobs that might have been created intheabsence ofthose restrictions. Such considerations strongly suggest that most studies,including the DRI model, have underestimated the destructiveeffect of minimum-wage legislation on employment. Minimumwages may generate considerably more unemployment than suchstudies estimate. The difficulty of putting numerical valueson what would have happened had the government not interfered,compounded by the proponents' willingness to "throw numbers outtill nobody can have faith in the numbers," indicates that thenumbers have not captured and cannot capture the whole story. Who Benefits from Minimum-Wage Legislation? Labor unions and their members are the most obviousbeneficiaries of government-imposed minimum wages. As theestablished elite of the workforce, union members are on thereceiving end of the minimum wage's redistribution process. Tofully understand how unions gain from minimum-wage legislation,one must consider the essential nature of unions. The success of a union depends on its ability to maintainhigher-than-market wages and provide secure jobs for itsmembers. If it cannot offer the benefit of higher wages, aunion will quickly lose its members. Higher wages can beobtained only by excluding some workers from the relevant labormarkets. As F. A. Hayek has pointed out, "Unions have notachieved their present magnitude and power by merely achievingthe right of association. They have become what they arelargely in consequence of the grant, by legislation andjurisdiction, of unique privileges which no other associationsor individuals enjoy."[16] A labor union's ability to maintain special privilegesfor its members is reflected in the income data of the Bureauof Labor Statistics. According to a 1987 document entitled"Employment and Earnings," the median weekly wage for unionmembers is $439; for nonunion workers, it is $325. Based on a40-hour week, the hourly wage is $10.97 versus $8.12. Unions attempt to fix or limit the supply of labor in aparticular market, which raises the value or price of thelabor available within that market. In this sense, a unionfunctions as a redistributive institution. The winners arethose still included in the labor market, the union members.The losers are those excluded from the market, the unemployed. As would be expected, labor unions are the main politicalforce behind minimum-wage legislation. Although unions alreadyhold privileged positions in labor markets, minimum wagesfurther increase their gains by raising employers' labor costs.As long as union members earn wages above the minimum rate,their positions are made more secure by the government policythat eliminates those who might undercut the union wage.People willing to work for less than the government's minimumare not allowed into the labor market at all. Indeed, unionleader Edward T. Hanley stated in a catering industry employees' publication, "The purpose of the minimum wage is to. . . provide a floor from which we can upgrade your compensation through collective bargaining."[17] A second barrier tends to insulate union members fromthe changes that a minimum-wage increase requires of others.Because union members already enjoy institutionally protectedjobs, there is a good chance that they will be the last firedin any cost-cutting campaign by businesses trying to cope withthe new costs imposed by a higher minimum wage. It is not surprising that the AFL-CIO, representing 90percent of all unions, has lobbied hard for another increase inthe minimum wage. Political pressure from the AFL-CIO is thefactor primarily responsible for breathing new life into thedebate over the minimum wage. "Congressional Democrats, underpressure from organized labor, will try to move forcefully onthe [minimum-wage] issue. Unions played an important role inhelping the party take back the Senate, and labor leaders wantto see progress now that Democrats control both chambers."[18] It is Big Labor and its political representatives thatperpetuate the minimum-wage myth. The advocates of minimum-wage laws--shrouded in the rhetoric of fairness and economicjustice--always come back to roost in Washington. As JamesBuchanan pointed out, "People who are damaged by minimum-wagelegislation are not an effective pressure group, whereas thegroups that support minimum wages, namely the labor unioninterests being protected, are much more effective in thepolitical process."[19] Conclusion Regardless of the intentions of its supporters, theproposed minimum-wage legislation cannot achieve their statedgoal of raising the real income of the poor to a more livablelevel. Indeed, it is an extremely shortsighted policy thatcan only breed destruction, by eliminating the jobs of those who need work most: the poor, the young, and those sufferingfrom discrimination. What has been touted as a matter of basic economic justiceturns out to be a self-serving issue for many of its supporters. If the minimum wage is increased, labor unions andtheir influential friends in Congress will make big gains.Unfortunately, everyone else will lose. In the long run, however, such policies will hurt every-one. As unemployment increases, business becomes more and more unproductive, and the overall quality of life declines, all Americans will suffer.FOOTNOTES[1] originally intended to take place in summer 1987, the congressional battle over an increase in the minimum wage was postponed until 1988. Democrats hope to increase their political gains by having the battle take place during an election year. See Forum Notes, Washington Forum, September 4, 1987, p. 1.[2] "Maximizing the Minimum," April 6, 1987, p. 55.[3] "Minimum Wage Getting Maximum Attention," Congressional quarterly, March 7, 1987, p. 406.[4] See, for example, Bruce Bartlett, "How the Minimum WageDestroys Jobs," Heritage Foundation Backgrounder, February 19,1987.[5] Bureau of Labor Statistics, seasonally adjusted figures, March 1988.[6] Walter Williams, The State against Blacks (New York: New Press, McGraw-Hill, 1982), p. 42.[7] General Accounting Office, "Minimum Wage Policy Questions Persist," in Report to the U.S. Senate Committee on Labor and Human Resources (Washington: General Accounting Office, 1983).[8] "Minority Report of Commissioner S. Warne Robinson," in Report of the Minimum Wage Study Commission, vol. 1 (Washington: GPO, 1981), p. 182.[9] Charles Brown, Curtis Gilroy, and Andrew Cohen, "Time-Series Evidence of the Effect of the Minimum Wage on Youth Employment," Journal of Human Resources (Winter 1983).[10] Richard B. McKenzie and Curtis L. Simon, "The Proposed Minimum Wage Increase: Associated Job Loss by State, Region, and Industry" (Washington: National Chamber Foundation, 1988).[11] "Minimum Wage, Maximum Cover-Up," Wall Street Journal, May 3, 1988.[12] Senate Republican Policy Committee, "The Minimum Wage: A Case of Special Interest Politics versus Jobs," March 26, 1987.[13] "Raising the Floor," National Journal, March 21, 1987, p.702.[14] Ibid.[15] In fact, such models usually attempt to represent human action as a series of functional relationships. Models of the market process based on such deterministic assumptions are, at the very least, open to the question of relevance.[16] F. A. Hayek, "Unions, Inflation and Profits," in Studies in Philosoihv. Politics and Economics (New York: Simon and Schuster, 1969), p. 281.[17] Catering Industry EmDlovee, December 1977, p. 3. Cited in Belton M. Fleisher, Minimum Waae Reaulation in the United States (Washington: National Chamber Foundation, 1983), p. 9.[18] "Minimum Wage Getting Maximum Attention," p. 403. [19] "The Budget Chief Talks with the Nobel Laureate," Conser-vative Digest, July-August 1987, p. 31.[19] "The Budget Chief Talks with the Nobel Lauteate," Conservative Digest, July-Auguest 1987, p. 31.© 1988 The Cato InstitutePlease send comments to webmaster/div>Upcoming EventsJuly 23, 2008The FBI Turns 100Cato Policy Forum, 12:00 pmJuly 24, 2008One Man’s America: The Pleasures and Provocations of Our Singular NationCato Book Forum, 12:00 pmJuly 25, 2008Should Congress Lower Tariffs on Imported Shoes?Cato Policy Forum, 12:00 pmJuly 28, 2008Escaping Poverty in Sub-Saharan AfricaCato Capitol Hill Briefing, 12:00 pmJuly 31, 2008The Dirty Dozen: Are They the Worst Supreme Court Cases in the Modern Era?Cato Policy Forum, 12:00 pmSeptember 17, 20087th Annual Constitution DayCato Conference, 10:30 amF.A. Hayek Auditorium, Cato InstituteNovember 19, 200826th Annual Monetary Conference: Lessons from the Sub-Prime CrisisCato Conference, 8:00 amF.A. 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