Minimum Wage – Which World Do We Live In?

Proponents of the minimum wage need to carefully consider what the current state of the world is. Many of the arguments for raising (or even for keeping) the minimum wage are really pretty sloppy. Consider two possible states of the world:

1)      Employers easily have enough money (in the form of profits or something) to pay the higher wages to low-wage workers.

2)      Employers don’t just have the money lying around; they’d have to raise prices. A minimum wage is necessary because all employers have to raise prices together, or else no one will.

Or consider a related pair of mutually exclusive possibilities:

1)      Low-wage employees actually create value much higher than their wage for society, and employers unfairly capture much of that value for themselves.

2)      Low-wage employees earn a wage that is commensurate with the value they create. Legally increasing this wage means forced charity, paid by customers and employers to employees.

Think about the first pair for a moment. If 1) is true, then you should see a large excess profit for businesses that hire a lot of low wage workers. Entire industries that rely on low-wage labor should also have very high profit margins. They don’t. Wal-Mart, that famous bully of low-skilled workers, has a profit margin in the 2-4% range over the past ten years. Look them up. You’ll find similar results for fast food, an industry with a ~2-3% profit margin. (see here). These companies are mostly earning pretty slim profit margins. If they were underpaying for a major expense (probably the largest or second largestsingle expense), you’d expect them to be making a killing. If they are underpaying their workers, it’s by a tiny amount. To pay the higher wages, you’d have to do some combination of raising prices, laying off workers, making the remaining workers more productive (“cracking the whip” more, so to speak), and removing workplace amenities that make life on the job tolerable. It is sometimes suggested that raising prices is a no-brainer, but I seriously doubt this argument. If prices rise to pay for a higher minimum wage, then low-wage workers will see some of their higher wages eaten up by higher prices. We have to be a little more precise than that; perhaps you can work it out so that low-wage workers benefit on net and higher-wage workers subsidize their increased pay. Perhaps the proportion of living expenses going towards goods produced by low-skilled labor is so small that the wage increase will be much larger than the living expense increase. But you have to do this with an explicit model and actual data, not simple hand-waving, which is what I usually see in this track.

Now think about the second pair. Suppose 1) is correct. If low-wage employees are capable of creating value that is tremendously higher than their wage, they should be able to do without their employers and sell their labor on the open market. You should ask why you don’t see much of this, or why you don’t see massive improvements in earnings for the rare individuals who try it. Alternatively, these workers should be able to form a competing company that takes all the good workers by offering a slightly higher wage. The stock owners and highly-paid management, who are supposedly capturing this excess of value added minus wages, should be willing to earn slightly less than a competitor earning the full excess value, and another competitor’s leadership slightly less still, and so on until the excess profits are competed away. Any opportunity to earn excess profits should be competed away as competitors try to grab a slice of it. If this doesn’t happen, it’s at least a mystery that needs to be expounded upon.

Perhaps it’s not the stockholders and executives who are capturing the excess value, but rather the customers. This view would be more consistent with the claim that we can “simply raise prices” to cover the higher minimum wage, and it’s consistent with the low profit margins *actually* experienced by employers of low-wage works. However, there is still a mystery here, because something is being sold for well below what it’s worth in a deep market with lots of participants. You could make some weird “we’re stuck in a bad equilibrium” argument, but that makes little sense because such an equilibrium would not be stable. If workers are capable of generating $15 worth of value an hour and are only getting paid $7.25 in some industry, they should leave that industry for better paying ones, and the low-balling industry should raise its wage until it attracts back the workers it needs. Markets abhor a mispriced commodity just as nature abhors a vacuum. You have to somehow explain why a vacuum isn’t getting filled in, and your explanation has to be consistent with real-world observations.

So in the second pair of possible states of the world, if 1) is implausible then 2) must be the case. The case for a minimum wage is still salvageable, but it really undercuts the moral case for the minimum wage when you admit that you’re forcing someone to pay charity to someone else. It at least implies that we need to stop haranguing the employers of low-skilled workers; it’s not them but their customers who are capturing that (supposed) excess value. It’s harder to bluster that “The worker is getting screwed by the big players!” when you admit that they are basically earning the equivalent of the value they create for their employers. In this world, where employers *aren’t* earning a big surplus on their low-wage workers, the higher wages must be paid by customers. Keep in mind that higher prices means customers will buy less (of whatever commodity we’re talking about), and the result will be less demand for the workers in that industry. If minimum wages are forced charity, let’s admit that they are forced charity, and let’s consider fairer and more efficient ways to redistribute money to low-wage workers. Maybe an enhancement of the earned income tax credit, or a direct subsidy of low-wage labor, or a minimum income guarantee. Whatever we’re doing to help the poor, it should be on-budget and be paid for by everyone, not just by customers (or employers) in a few industries. We ought to stop dicking with the labor market and address distributional issues directly.

My own view is that wages are mostly fair, for low wage workers and for those much-reviled highly paid executives. Employers of low-wage workers actually enhance their (the workers’) earning power by supplementing their labor with enormous amounts of capital. This capital includes machinery, buildings, shelves for stocking consumer goods, vehicles, and less tangible things like brand quality and market expertise. Highly paid executives actually *increase* the wages of low-wage workers by making them more productive; a company that failed to shell out for talented management would go out of business or slog along inefficiently. Those claims that high executive pay comes at the expense of the workers have it backwards; those workers wouldn’t earn as much without those highly-paid executives. We aren’t stuck in some weird equilibrium where workers are underpaid and employers or customers are capturing the excess value, because such an equilibrium would be extremely unstable. Profit margins are pretty slim, so it’s hard to make the case that employers are profiting from exploiting these laborers. You can take or leave some of these observations, but whatever policy you favor for helping poor laborers needs to keep these things in mind. We could have a much more vibrant and active market in low-skilled labor. I think it would be possible for someone to make a living doing a lot of one-off tasks for less than the current minimum wage. Many people who are on the margins of society could be better off than they are now; picking up $20 today doing some menial tasks is better than being completely unemployed and earning nothing. That option has been legally forbidden for many people.

There are tasks worth doing that don’t return $7.25 in value for each hour of labor spent doing them. Minimum wage laws serve to ensure that no coordinated effort to do them will ever happen. It's a shame, because there are a lot of these low-value tasks and a lot of unemployed low-skilled labor in the world. If only we could bring them together somehow.