During his address to Congress in February, President Obama proposed increasing the minimum wage by 24%, from $7.25 an hour to $9.00 an hour. The White House went on to claim that the increase would benefit some 15 million low-income workers. This proposal would bring the minimum wage to $9 an hour by 2015 and index the minimum wage to inflation thereafter.
The proposal drew instant acclaim from Democrats, unions and other labor organizations; and drew jeers from Republicans and business owners. Democrats and labor advocates argue that the increase in minimum wage would reduce poverty and increase the buying power of the lower economic classes. Conservatives and business owners argue that an artificial, non-market driven increase in the minimum wage would negatively impact the demand for low-income labor and hurt the very group the measure is intended to help. Economists are split on the matter, with some economists citing evidence that an increased minimum wage increases economic activity, while others claiming that the wage increase will have a devastating effect on employment prospects for the low wage earners.
So let’s take a look at how an increase in the minimum wage is likely to impact you, the consumer. Many minimum wage paying jobs, although not all, involve teenagers, college students, or low-skilled workers who work part time. Let’s assume that most business owners who employ minimum wage employees earn reasonable (not excessive) profit margins, and that these profits are what the business owner and his or her family lives on. This can be any type of business like restaurants, grocery stores, or retail stores that rely on low wage earning employees for a portion of its workforce. When a business cost increase occurs, the owner of the business has three basic choices to make: 1) eat the increased cost and decrease the profit margins of the business, 2) pass the cost on to the customers of the business, or 3) offset the increased cost by reducing costs somewhere else to keep things profit margin neutral. Let’s examine each of the three choices further.
Choice 1 involves the business owner taking on the additional costs and reducing the profit extracted from the business, and having less money to provide for the owner’s family. Since the business owner is taking on the most risk in the business enterprise (capital, liabilities, credit, etc.) the business owner should be entitled to the lion’s share of the business’ profits. Some businesses operate with wide profit margins, and some operate on slim 2 or 3% profit margins. Regardless of the profit margin, most business owners will be unwilling to take a potential 24% reduction in profits brought on by a 24% increase in labor costs brought on by the proposed minimum wage. (Remember, not only will minimum wage employees get a 24% wage increase, all employees who were previously earning above the minimum wage will expect a commensurate increase in their wages too, since they will assume they are more valuable than the minimum wage employees.) It is unlikely that many business owners will be willing to reduce their own profits (which is their income), by such a large percentage, and it is unreasonable to expect them to do so, as well since they are taking all of the economic risk for running the business. Let’s look at choice 2.
Choice 2 involves passing the additional labor costs along to customers. In today’s tough economic environment, many competitive industries simply cannot pass on a 24%, let alone a 10% cost increase onto their customers, especially if the demand for that product or service is elastic (i.e. – it is not a necessity). Pizza parlors and fast food restaurants, for example, will see the demand for their food diminish if costs are passed along to consumers because consumers do not need pizza or fast food to live. Because of this, many business owners may be able to pass along a small amount of the higher cost of doing business, but it will certainly not be a 24% increase. For our purposes let’s assume that the business owner can raise prices by 5% without impacting demand for his or her product or service too drastically. Where will the remaining 19% of increased labor cost come from?
Choice 3 involves offsetting the increased cost of labor to keep profit margins neutral. Assuming that the business is already operating efficiently (which in today’s tight economic conditions is very likely), there are no cost savings to be realized anywhere else except for the cost of labor. Because there is no “low-hanging fruit,” the business owner must keep his/her labor costs the same today (with the increase in the minimum wage) as it was yesterday (before the minimum wage increase). This means that since the labor rate has gone up, the number of hours worked by employees must necessarily decrease proportionately. And that translates into fewer employees overall, or fewer hours worked by employees.
Whichever outcome occurs from choice 3: fewer employees overall or fewer hours worked by existing employees, the end result is the same. The condition of the economic class that the minimum wage initiative was designed to improve is overall worse than before. Some of the people in the minimum wage working class will benefit from the increased wages, but some of the minimum wage earners will lose their jobs or have their income cut from reduced employment hours. And any economic gains realized by the higher minimum wage earners will eventually be offset by the increased costs of products and services the minimum wage earners will need to purchase.
So what is the likely end result if President Obama’s projected 24% increase in the minimum wage occurs? For starters, we are likely to see higher costsfor products and services because of higher wages. Now in the Federal Government’s eyes this may not be a bad thing, because the ensuing inflation ensures that the $16+ Trillion debt the Government has incurred will be repaid with cheaper dollars. We are also likely to see a larger number of unemployed teenagers and college students who rely on part-time, minimum wage earning jobs to put themselves through school. In 2009 when the minimum wage was raised 10.6%, nearly 600,000 teens saw their jobs disappear. Imagine how many minimum wage jobs will likely disappear with a 24% increase, even though the economy has improved slightly from the conditions in 2009!
President Obama’s minimum wage proposal in February was met with a lot of excitement and fanfare, and many Americans polled after the announcement viewed the proposed wage increase favorably. But past history and basic economic principles have shown that raising the minimum wage does not yield the desired results often, and ends up hurting a considerable portion of the economic group that it intends to help. If reducing poverty is the goal of the Obama administration, other policies or initiatives should be devised. As our examples illustrate, raising the minimum wage does little to help low wage earners and has the potential to harm the middle-class and stifle economic recovery through increased inflation.
Sources: Wall Street Journal, Forbes, The Economist