President Obama, in his most recent “state of the union” speech, addressed a topic that, though it has been disproven countless times, is so politically popular that future politicians will doubtlessly echo it beyond the lifetime of the present Union:

“Tonight, let’s declare that in the wealthiest nation on Earth, no one who works full-time should have to live in poverty, and raise the federal minimum wage to $9.00 an hour. This single step would raise the incomes of millions of working families.”

We must first understand what a wage truly is.  A wage is a price.  It truly is little else than this; a wage is the price of an individual’s productive efforts.   As with any other voluntary economic transaction, the value of a wage must be such that each party feels that he or she is actively benefiting from it.  If an employee voluntarily accepts a wage of $5 per hour, then he is saying that the money is more valuable to him than the hour of his time and the effort he exerts during that time.  If not, then he would conclude, whether he realized it or not, that his opportunity cost (the value of his next-best alternative) was actually greater than the value of the wage, and would not accept the job.  Similarly, the employer must agree that the value that the employee brings to her company through his productive efforts for one hour is worth more to her than having $5 cash on hand.

Assuming that there is no coercion or threat of force on the part of the employer, the employee will only take the job if he believes he is better off than if he had not taken it.  During a recession, a worker might find that they are more willing to accept a wage far below that which they would have accepted during a highly competitive economic climate.  When people behave according to rational self-interest they cannot accept a wage that would be below their opportunity cost.

A minimum-wage law is a government mandate that prohibits both employers and employees from accepting wage rates that some parties would find both agreeable and preferable to their alternatives.  In other words, it takes all jobs in which the value of an employee’s efforts to a company do not meet the cost of the wage and declares them to be illegal.

The source of the fallacy comes from the confusion of nominal wages and real wealth.  Raising the federal minimum wage will in fact raise incomes for many people, but it will technically raise nominal wages, that is, the precise dollar amount, but real wages, as measured by purchasing power, will not remain higher in the long run.  The prevailing theory is that when wages go up it boosts aggregate demand for goods as people have more disposable income.  This doesn’t work, however, because it also increases costs for many businesses; demand for labor falls at a more-or-less equivalent rate.  An increase in real wages can only follow an increase in production and subsequent increase in real wealth.  Absent that, there is only a fantasy of economic growth and personal fortune.

How Raising the Minimum Wage Causes Unemployment

217px-Supply-demand-equilibrium

The red demand curve in the image above illustrates a fundamental economic principle:  the law of demand.  This law states that raising the price of an economic entity causes a fall in the quantity demanded.  Since wages are a price, it follows that raising wages causes a decrease in demand for labor.  This is especially true during a recession, where already falling demand coupled with raising wages aggravates unemployment.

Economist Murray Rothbard put it thusly:

“In truth, there is only one way to regard a minimum-wage law: it is compulsory unemployment, period. The law says, it is illegal, and therefore criminal, for anyone to hire anyone else below the level of X dollars an hour. This means, plainly and simply, that a large number of free and voluntary wage contracts are now outlawed and hence that there will be a large amount of unemployment. Remember that the minimum-wage law provides no jobs; it only outlaws them; and outlawed jobs are the inevitable result.”

All demand curves are falling, and the demand for hiring labor is no exception. Hence, laws that prohibit employment at any wage that is relevant to the market (a minimum wage of 10 cents an hour would have little-to-no impact) must result in outlawing employment and hence causing unemployment.

This is why politicians never push for a huge increase in wages; they know such a policy would have disastrous consequences.  If the proper minimum-wage rate is the only thing stopping us from eliminating poverty, then to hell with $9/hour; why don’t we raise it to $100/hour?  We don’t, because no new wealth was actually added to the economy.  Business won’t be able to afford it and the ones that don’t go under will have to make significant cuts to staffing.

Raising the minimum wage tomorrow will result in the immediate unemployment of any worker whose productivity does not justify $9/hour.  These will be the marginal workers, typically from already vulnerable sectors of our society:  the unskilled, the disabled, teenagers, and racial minorities.  For those people, the promise of a higher wage rate is of little comfort, as their wage rate will then be zero.

The ability to accept low wages is in many ways empowering for these workers.  Low-skilled workers have a competitive edge when they accept lower wages and the ability to work will then allow them to learn on the job, building up skills that they can use to lobby for a higher-paid position.  Some of the biggest supporters of the minimum wage are labor unions.  But why should they care; most union workers already make higher than minimum wage?  Forcing a wage increase for non-union workers eliminates their competitive edge over union workers.  It is not altruism and camaraderie that inspires the union support, but the desire to forcibly eliminate competition.

As the competition for union work has been historically offered by low-skilled racial minorities, minimum-wage laws have been, and continue to be, as Walter Williams describes, “…one of the most effective tools in the arsenal of racists everywhere around the world.”  Williams describes how the Davis-Bacon Act of 1931, for example, was used to price blacks out of the labor market on federally financed or assisted construction projects.  Similarly, minimum-wage laws have been used to discriminate against the employment of blacks in South Africa.  A report from the South African Economic and Wage Commission of 1925 stated that:

“…while definite exclusion of the Natives from the more remunerative fields of employment by law has not been urged upon us, the same result would follow a certain use of the powers of the Wage Board under the Wage Act of 1925, or of other wage-fixing legislation. The method would be to fix a minimum rate for an occupation or craft so high that no Native would be likely to be employed.”

More recently, we see that the unemployment rate of blacks in the United States is still much higher than it is for whites:  in 2012 it was 13.8% vs. 7.2%.  One might argue that a minimum wage should be established to prevent racist employers from paying their black workers a lower wage than their white ones, but intentions count for very little when the outcome is that the black workers don’t have a job to speak of.

Aha!  But minimum wage has gone up in the past without raising unemployment!

This is more-or-less the argument that economist Paul Krugman has been making, most recently citing a study by John Schmitt.  But the main reason why unemployment might not increase after price-fixing wage rates does not put one’s mind at ease.

Bureaucrats understand that raising labor costs will lower demand.  If firms are going to keep hiring, they are going to need more money with which to do so.  In fact, more money is precisely what causes firms to voluntarily raise wages in the first place; wage rates rise naturally due to greater productivity and increased capital investment.  In the absence of real savings, the federal government plays a trick to make us think there is more capital by expanding credit.  This is done, of course, by asking the Federal Reserve Bank to print more currency.  As Ludwig von Mises explained, the credit expansion does nothing to increase the wealth of capital goods, but the belief persists, erroneously, that wealth has been increased for use in new projects, creating an artificial boom.

This causes inflation.  The only way to increase wages without increasing unemployment is to decrease the purchasing power of the currency.  So while nominal wages are rising, real wages remain stagnant, or even decrease.  As workers realize that their money doesn’t buy what it used to, they petition to raise the minimum wage again, and just as before, the government inflates the currency to combat unemployment.  And so spins the protracted-inflation-merry-go-round for eternity.

The Moral Argument Against the Minimum Wage

One of the fundamental tenets of libertarianism is the idea of voluntarism:  that parties should be free to engage in contracts between each other without requiring permission from a third party.  This is a natural outgrowth of the non-aggression principle, which states that the initiation of force or violence is inherently immoral.  When a third party prohibits all or part of a contractual agreement that does not concern that party, they are initiating force against the contract’s participants.

As was explained previously in the article, parties will only engage in contractual agreements or transactions in which both parties believe they are better off.  If we assume that neither party is threatening or defrauding the other, then while there may be unknown alternative transactions that would be preferred by one party or the other, there can be nothing immoral about the transaction.

Minimum-wage laws constitute political cronyism on the part of the workers who are unwilling to work below a certain wage-rate while infringing upon the natural rights of workers who would be willing, and perhaps even happy, to accept a lower rate.  The law says it is illegal to offer or accept certain jobs and subsequently confers punishment if individuals consent to voluntarily transact them.  This is immoral.

Workers should enter the labor force expecting to climb the proverbial ladder of success.  It would be wrong-headed to suggest that the lowest-wage, entry-level position should be enough to sustain all of a worker’s life pursuits.  Income mobility still exists.  A study by the University of Michigan found that 75% of individuals in the lowest income quintile in 1975 were in the top 40% of income earners 16 years later.  The U.S. Treasury department provides more recent data here.

Minimum-wage laws prevent workers from getting the low-skilled, low-paying jobs that are critical for building the skills needed to move up to higher-paying jobs.  The data show that less than 3% of workers earn the minimum wage or less, not including tips, and that the median age of a minimum-wage earner is 24.  It is clear that the unintended harmful consequences of these laws far outweigh any of their alleged benefits and as such they should be repealed immediately.

Further Inquiry

In this video, economists Walter Williams and Thomas Sowell discuss the problems with minimum wage, including its effect on discouraging the employment of young people (particularly from poor or minority backgrounds) through which they can develop the skills and work habits to promote future success, and also how these laws have been used as a tool of institutional racism.

In this article, economist Murray Rothbard dismantles the most common arguments for the minimum wage with his characteristic sardonic tone.

Here, Jeffrey Tucker tells a personal anecdote of how minimum-wage laws directly injured his disabled friend and coworker.

In this article, Sheldon Richman emphasizes how minimum-wage laws hurt the most vulnerable, and are therefore indefensible from a humanitarian perspective.