Why raising the minimum wage does not pay for itself

Dan Calabrese

You can't raise the cost of labor without consequences.

On the one hand, this is so elementary, it's hard to believe anyone argues with it. But when you're dealing with ideological true believers, you know they will argue with anything you say if it doesn't line up with the faith. So don't assume you've won the argument just because you point this out: Raising the minimum wage will worsen unemployment because, plain and simple, it raises the cost of labor.

Not only that, but it raises by statute the cost of the least productive laborers out there. There's a reason minimum wage earners get the minimum. Their contribution represents minimal value. An employer who decides to hire such a person is accepting lack of experience, lack of training and lack of maturity, and is deciding to invest some time developing the worker and getting whatever minimal contribution they can make until they see if the investment pays off in the person's improvement. Usually you're not talking about people trying to support a family. Usually you're talking about a 16-year-old kid. If you make it even more expensive than it already is to hire such people, businesses simply will not do it.

So what's the left-wing rejoinder to this seemingly indisputable observation? A liberal friend whom I won't name (because he hasn't given me permission to do so) offered it today via Facebook:

Increasing the demand for goods and services more than balances out the minor increases in costs. At least that is how it has worked since the minimum wage has started. Businesses hire the people they need to meet demand. And if demand is not there, they will not hire, no matter how low the minimum wage is.

One of the best ways to increase demand for goods and services is to put more cash in the hands of people at the low end of the income spectrum. Reagan tried to do that by exempting low-income families from income taxes. But that didn't help very much and low-income people kept falling behind. Gradually raising the minimum wage to match the cost of living would have been a better strategy. Making it easier for low-wage workers to form unions would have been even better.

If low wages were a path to prosperity, then Mexico would be a very rich country. But that's not how economics works. When income distribution becomes too out of whack, then you have too many people who cannot afford to participate in the consumer economy. They can't buy stuff. When people cannot afford to buy stuff, then the economy falters.

Got that? When the government forces businesses to pay more than they want to for labor, everything will be fine because those better-paid workers will now turn around and buy more good with the extra money, and the employers will "more than" make up the extra costs they're being forced to shoulder.

This is a lynchpin of Keynesian thinking. Capital in the hands of consumers creates demand. If only people have more money, they will buy more stuff. And people buying more stuff means businesses make more money, so it's really just an investment in your own profits. This thinking goes all the way back to the dawn of the auto industry, when Henry Ford purportedly raised the wages of his employees so they could afford to buy his cars.

It's the sort of theory that might even make sense until you think about it a little bit. But let's.

Rational economic decisions are based on a value proposition. You don't buy stuff just because you have money. You buy it because the thing you'll be acquiring represents equal or greater value to you than whatever you're going to spend for it. So let's consider the company that gives raises to all their employees so they can afford to buy their products. Everyone comes out better off, yes? No. Why? Because when you raise the cost of labor, you also raise the cost you incur in producing the goods, and consequently you have to raise the price. So your better-compensated employee now has to pay more for the goods.

Spread the same logic across the entire economy. If all laborers are getting paid more — and make no mistake, raising the minimum wage raises the scale for everyone — then all goods are more expensive to produce, and everything costs more. That is especially true when you realize that you have mandated more money be spent to pay for the least productive laborers. These are the people who cause the most discipline problems, have the highest absentee rates, drive your turnover rate higher. That's why you pay them the least. You get less production and more problems from them.

So businesses can react to the imposition of higher costs in one of two ways. One is to raise the prices of their products on the presumption that consumers, having been the beneficiaries of this benevolent redistribution of wealth, will have no trouble paying the higher prices. Another is to hire far fewer minimum wage employees, since the value-to-cost proposition simply isn't there, especially now that you have to spend even more to hire them in the first place.

What do you think they're going to do? And why doesn't someone explain this to President Obama? Probably because he only surrounds himself with economic advisors who embrace the same Keynesian thinking as he does, and as my friend here does. No one really thinks through the big picture and understands that there's no way to impose higher labor costs without creating consequences on the other end.

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