Minimum wage laws have become a hot topic in recent years, with a constant call for their increase, especially around election time. Increasing minimum wage is an excellent platform to run on, as a candidate, as it is very popular with most people. I mean, who would be against getting more money in the pockets of those struggling to make ends meet? At the surface, it would appear that everyone should be in favor of minimum wage laws, and anyone who is against them must be a greedy, heartless individual. This is the kind of thinking that can make minimum wage laws exceptionally dangerous. As with any governmental policy that looks to put its hand into the labor market, there are unintended consequences that arise. The goal of this article is to bring those consequences to light. It is supremely important to look at potential, negative outcomes when considering policy, but they often seem to be overlooked.
The Greedy Business Myth
The idea that businesses are withholding money from employees in order to line their own pockets is the greatest misconception that drives the demand for minimum wage laws. To the uninformed, this idea is fact and easily observable; however, businesses have to walk a fine line in order to stay in business, due to the highly competitive nature of a free market. Are there exceptions? Always, but for the vast majority of businesses, this is true.
I first want to address the function of profit. To the uninformed public, profit is simply extra money that goes into the pockets of the business owner. While this has the potential to be true, it would not be in the best interest of the business. Each month, a business has money coming in from sales and money going out through expenses (rent, bills, wages, cost to buy supplies, etc.). If a company functioned on a break-even policy where sales and expenses are equal (no profit), they would quickly run into trouble. Buildings and equipment, for example, wear out over time and need to be replaced. This is one of the primary functions of profit; to be set aside for investment in a new building or new equipment or potential expansions. Without using profit for this function, a business will eventually go out of business, as the building and machinery break down around them.
A second function of profit is to improve the services or goods that a business provides. In order to remain in business in a competitive and free market, it is important for a business to continually improve its services or products to set itself above the competition. If a car company, for example, continues to make the same exact car for years, eventually, the competition will come out with newer, better cars with, for example, superior fuel efficiency or better safety ratings, etc. Without profit to invest in research and development, the company will quickly go out of business. In another example, a company may choose to invest in new equipment that allows them to provide services at a quicker rate than the competition. If you know you can get your oil changed in 15mins at a local mechanic, you would have no reason to go to the other mechanic that takes 30mins, assuming prices are the same. In this example, one company could use the extra profits to buy new equipment to improve service time. Conversely, another company could choose to sacrifice some profits in order to lower their prices instead. If they did not have any profits to work with, they would quickly go bankrupt.
There are plenty more ways that profit can be used effectively, however, that is not the point of this article. The main takeaway from this section is that most businesses walk a fine line balancing sales, expenses, and profit. If the government comes in and demands an increase in wages to its employees, the business will need to make cuts in other areas to make up for the increased wage expense. The idea that increasing wages simply means that the greedy business owner gets a smaller paycheck is a dangerous notion. Next, we are going to look at the options a business owner has when a mandated increase in wage expense hits his operations.
Cut Employee Headcount
This is one of the most common responses to higher minimum wage laws. A notion that many people do not like to hear is that not all jobs are worth the minimum wage. A business, for example, may have a position that has an employee returning carts to the front of a store at $5/hr. This doesn’t seem like much, but the position does not require any skill or training. The position is not meant to be for a head of household that is supporting an entire family, but rather for a high school kid that wants to make a few easy bucks for spending money. When minimum wage laws demand that this position be paid at least $12/hr, most companies would cut that position altogether, not because they are heartless, but because they simply cannot afford to pay that kind of wage for low-skill work. The resulting pay increases, however, will look great to those that manage to stay employed, but those that are now unemployed are clearly worse off.
Some employers may take the apparent high road and, instead of cutting positions, may choose to increase prices on their goods or services in order to compensate for the increased wage expense. Again, this looks good at surface level, however, we need to consider some long term effects of such a decision. In a highly competitive, free market, prices of goods and services can make or break a company. If a local grocery store is priced 10% higher than another, people will slowly, but surely, begin to migrate to the store with lower prices. The store with the high prices will see a drop in sales as well as profits. That store will, again, be faced with a difficult decision, and may very well have to cut down on employees. They simply cannot maintain the new wage expenses at current profit levels.
Cut Down on Quality
A third option may be to cut down on quality. A company may, for example, be forced to find a cheaper supplier for some of its materials, however, it will quickly become apparent to the consumers that the item they purchased is now breaking more frequently, or not doing as good of a job as it used to. Some companies may be able to get away with cutting quality longer than others, but, eventually, consumers may realize that they can get a better quality good or service for the same price somewhere else. A company may also choose to spend less on maintaining their current building and equipment. Nothing scares away customers more than a run-down building. Also, if machines continue to break, how will a business be able to support customer demands? A business may be able to stave off bankruptcy a little longer this way, but eventually they will have to close their doors. The employees may have enjoyed that initial pay increase, but now they are faced with unemployment. If all business are facing the same issue, they will be hard-pressed to find new work.
Unemployment – The Dangerous Consequence
While an increase in minimum wage truly has good intentions, no one is arguing that, the ramifications of such policy can have serious repercussions in the labor market. In summary, businesses cannot maintain increased wages for positions that cannot justify the cost. Those positions will be reduced or eliminated accordingly, and unemployment will rear its ugly head. Minimum wage laws, essentially, price low-skill workers out of the market. The business will only keep those positions that can justify the cost. Based on what was discussed above, this is not because the business owner wants to keep his pockets lined with cash, but rather, he wishes to keep his doors open. It is important to allow the labor market to manage its own wages. If the demand for workers is higher than those seeking jobs, a business will be forced to raise their wages to attract workers that may wish to go somewhere else that pays better. Conversely, if there are more workers than jobs available, a business can offer lower wages, but will be able to hire more workers at that price. If the government, however, enforced a minimum wage, the business may only be able to hire one worker, if any. A lower than expected wage is far greater than no wage.
A business needs to be able to set its own wages to remain competitive. If they cannot maintain the higher wage expense, they will be forced to close their doors. In a free market, with no minimum wage, a business will need to keep wages at a level that is enticing to those seeking work, or else they will not have the necessary work force to remain in business. If businesses try to increase their bottom lines but cutting wages or positions, increasing prices, or reducing the quality of their product or services, like was mentioned above, they will not stay in business long. It is in their best interest to offer competitive wages or else run the risk of closing its doors. It does not need the government to enforce it. The labor market can manage itself far better than any government policy. It is a mistake to think the government is knowledgeable enough to manage markets on its own. You don’t have to take my word for it, feel free to do your own research as to the effectiveness of government intervention in the market, but remember to look at ALL consequences, not just the surface level results.