Why Minimum wage hurts the people it is intended to help

Why Minimum wage hurts the people it is intended to help  By Michael Busler

Many people around the country are calling on the federal government to raise the minimum wage from the current level of $7.25 per hour. Some believe the minimum wage should be at least $9 or $10 per hour, while in Washington D.C. the city council believes the minimum, at least for large retailers like Walmart, should be $12.50 per hour. In New York City the workers in the fast food industry believe the minimum should be $14.50. But is raising the minimum wage a good idea? Some argue that a worker being paid the minimum, cannot survive. At current levels, annual income of minimum wage workers would be about $15,000. This is barely above the poverty rate for an individual and far below the poverty rate for a family of four. So don't these people need more?

Although that argument appears valid, the reality is that the minimum wage hurts exactly the people it intends to help. That's because anytime a price (or wage) is set above the market equilibrium, surpluses result. A surplus of labor is called unemployment, which means that raising this wage causes unemployment. Let's look at why this occurs and the numbers that support the claim of higher unemployment.

If there were no minimum, the market would set the wage at the point where the quantity of labor supplied (people seeking jobs) would exactly equal the quantity of labor demanded (the number of jobs available) so that unemployment would be zero (except for some seasonality factors or some factors concerning people between jobs). Suppose the equilibrium wage would be $5 per hour. If that's the case, what happens when we set the minimum at $7.25 or higher?

At $5 let's say 100 people seek jobs and at $5 there are 100 jobs available. If we raise the wage to $7.25, more marginal workers (those who seek jobs but don't necessarily have to, like recent high school grads who could go on for more education) would enter the labor force increasing the quantity supplied to say 120. In addition, at a wage of $7.25 there would be fewer jobs available, say only 80 instead of 100. So that at the $7.25 wage we would have 120 people seeking 80 jobs resulting in a 33% unemployment rate.

There would be fewer jobs available because some workers simply aren't worth $7.25 per hour to the firm. If we look at the latest figures for the unemployment rate, this seems to be true. While it was recently announced that the overall unemployment rate is 7.4%, the rate for teenagers is almost 25%. The rate for minority teenagers in some inner cities is close to 50%. The rate for women entering the work force for the first time is over 20%. The minimum wage is hurting just the people it intends to help by causing very high unemployment rates.

But what about the argument that the workers "need" more? This is not a valid argument in our economy.

To show why this is the case, let's assume we have 100 workers who get together and produce 1000 units of output per day. At the end of the day it must be decided how to divide the output (which becomes the income of the worker). There are basically two ways to do this.

One is we can divide the output evenly so that each of the 100 workers receives 10 units, regardless of their contribution. The logic is that each person should be paid according to their need. And since each person has similar needs, they are paid the same. This system may have some success when the society is concerned with the lower level needs like food, shelter, clothing and safety, but the system fails in the long term since there is no incentive to work harder and produce more. No matter how hard an individual works their pay is the same. This is why the system failed in countries like Russia and China and is failing in countries like Cuba and North Korea, where the standard of living is extremely low

The second way, as we theoretically do in the U.S., is to pay an individual according to their contribution, so that someone who works hard, figures out how to improve the production process and makes a large contribution may earn 40 units of output, while a worker who barely contributes may earn only 2 or 3 units. This is not an equal distribution of output but rather an (arguably) fair distribution. In this system individuals are encouraged to produce more because their earnings will increase. This results in growth in the economy and vast improvements in the standard of living.

So the argument based on a worker needing more is not valid in our system because we are paid according to contribution and not according to need.

The bottom line is that increasing the minimum wage will hurt the people it is trying to help by reducing the number of jobs available, encouraging more people to skip further education and enter the job market and raising prices of products to consumers likely by a large amount, considering the rippling effect that higher minimum wages would cause on the entire wage structure.

The best policy is really to eliminate the minimum wage and let the market decide. Then an individual would know exactly what the value of their output was worth, unemployment would fall dramatically, growth in the economy would accelerate and there would be little wage induced inflation. Everyone would benefit.  - Michael Busler, Ph.D. is a public policy analyst and an Associate professor at Richard Stockton College.