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Loppers Not Ladders

A popular view of minimum wage increases is that they “spiral up.” In other words, when the minimum wage is raised from say $5.15 per hour to $7.25 per hour, employers will increase the wages of low-wage workers, which will then subsequently force the wages of other workers up and wha-la … everyone is richer (except owners, investors, customers and all of those people priced out of a job).

But think about how a minimum wage increase would affect you if you were running a business. Perhaps the way to think about it is to line up current and prospective workers in order of how much value they create for your firm on an hourly basis. Imagine 10 workers and worker A produces $10 per hour worth of valuable things, worker B produces $9 and so on until worker J who can only produce $1 worth of valuable things for you.

If the minimum wage is $5.15, you at best will hire workers A, B, C, D and E paying each what they are worth to your firm. Thus worker A is paid $10, while worker B is paid $9, C is paid $8, D is paid $7 and E is paid $6. You’d like to pay each worker less, but if you do so, your competitors would be able to hire them away at better wages and make profits.

What do you do if the minimum wage is raised to $7.25 per hour? Do you simply raise the wages of worker E by $1.25 and worker D by $0.25? And if you do that, wouldn’t that be unfair to worker D who used to make more than E, but now makes the same? So would you respond by raising worker D’s wage to $8.25, and then C to $9.25 and so on, to maintain the “fairness” in your wage scale? It seems silly to be even asking the question doesn’t it? What you would likely do in the case of a mandated wage increase is to relieve workers E and D from duty (or otherwise reduce the costs of having them by $1.25 for E and $0.25 for D). Why? Because E and D cannot produce $7.25 worth of stuff for you.

I am not playing any fancy games here. If you don’t believe that this is how employers respond to mandated wage increases you would have to explain what forces would systematically keep wages below productivity. Because then and only then could firms sustain wage increases and maintain profitability. However, that is not the point I’d like to make. Suppose you do believe that low-skilled workers are active in markets for their services that are not uber-competitive, and that there is a reason to think that their wages are lower than the value of what they produce for firms (that still may be the proper outcome, as we would need to have a very long discussion on risk, the structure of production and interest/discount rates to get into an academic analysis of this), it cannot follow that all workers are systematically underpaid. That would produce such an enormous profit opportunity for other greedy employers that it is silly to even suggest it.

Thus, if at some point in the wage distribution workers are being paid their productivity, but at lower points in the wage distribution workers are not – then how can mandated wage increases at the lower end ultimately “spiral up?” They can’t … and some evidence for this is that the share of labor and the share of capital in national income has remained remarkably constant for the past 60 or so years. If mandates could alter the distribution of income in any way, then we should have observed times of better worker “treatment” by government to correspond to increasing labor shares and times like the radical free market 1980s through today to see labor’s share falling. But we do not see that.

The point is, mandated wage increases are like a pair of loppers, not the ladders that their promoters so often pronounce.

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2 Responses to “Loppers Not Ladders”

  1. Michael says:

    People tend to forget that capital can substitute for some labor. My case in point is when I go to the grocery store, I see four self-checkout aisles that are ran by one person, no bagger. In my youth, each register would have required at least one person at the register and potentially another one bagging. They also had someone load it in our car, too!

  2. Harry says:

    Yep, Michael.

    I am sure Wintercow and Michael have driven in the country and have seen big round bales of hay, or even bigger rectangular bales. Today, you never see teenagers manhandling smaller bales of hay.

    I’m not saying this is not progress. After all, you never see anyone with rakes and pitchforks loading hay onto a horse-drawn wagon. Thank goodness for the internal combustion engine, the steel-roofed pole barn, and the New Holland round baler. No social security or any other payroll taxes, not to mention workmens’ comp, involved there.

    I am waiting for the next Tax Equalization and Fairness Act for Persecuted Teenagers to be passed, wherein the kid who mows your lawn will fall under the dominion of the state. I believe the present law exempts employers who give these teenagers money from having to pay a fully-loaded $7.25, which of course net out to be a bad deal for the homeowner and the kid, but would be a good deal for the government, which really needs the cash. That is, unless you mow your own lawn and do not have to pay taxes on imputed income, which, if you manage a hedge fund, you might.

    A great metaphor, Wintercow.

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