How Raising the Minimum Wage Often Does More Harm than Good

The national debate over raising the minimum wage is a reminder that some of the principles of economics resemble the laws of physics. That is, in the economy, each action causes a reaction of some kind – in fact, a series of reactions often popularly described as “ripple effects.”

Of these effects, only the first is highly visible and, thus, immediately evident. The other effects unfold in succession, but they are less visible and, in the public consciousness, far less linked to the action that caused these subsequent effects, which are often harmful.

It can be argued that the difference between a good and bad economist is the ability to foresee all of the ripple effects of a particular action, not just the immediate impact. Whereas the bad economist takes account of an action’s highly visible immediate effect, the other takes account of all of the effects – both those that are seen, of course, but also of those that can be foreseen.

Now this difference is enormously important because it is almost always true that when an action’s immediate effect is favorable, the subsequent effects can be quite different and, in fact, are sometimes quite harmful.

Thus, as economist Frederic Bastiat has posited, it follows that the bad economist often pursues a small good in the present time that will be followed by a great evil to come while the true economist pursues a greater good to come, at the risk of a small present evil.

Minimum wage laws illustrate this. They are often viewed as moral imperatives. Proponents say they protect unskilled workers from “capitalist exploitation” and guarantee a better quality of life for society’s poorest workers.

Some advocates support an ever-rising minimum wage with a seemingly cogent economic rationale tailored to appeal to small-government conservatives: that it provides added income to workers who might otherwise rely heavily on taxpayer funded government programs.

But this theory is ably discredited by Bastiat, the renowned French political and classical liberal economist. He provides a fuller picture of such well-meaning policies in his essay, “That Which is Seen and Which is not Seen.”

In that essay, he explains the unintended consequences of a minimum wage: that arbitrary wage increases have the effect of increasing unemployment while lowering employer profits – a hit to both sides of the labor equation.

Florida’s state Constitution has a nice-sounding minimum wage provision. It states: “All working Floridians are entitled to be paid a minimum wage that is sufficient to provide a decent and healthy life for them and their families, that protects their employers from unfair low-wage competition, and that does not force them to rely on taxpayers-funded public services in order to avoid economic hardship.”

But public policies based on sentiment often defy economic logic. As Milton Friedman noted, “The real tragedy of minimum wage laws is that they are supported by well-meaning groups who want to reduce poverty. But the people who are hurt the most by higher minimums are the most poverty stricken”

The Florida Constitution’s minimum wage provision came about in 2004, when voters approved a union-sponsored amendment providing for a state minimum wage that even includes a feature not included in the federal minimum wage: automatic annual increases.

Florida’s annual recalculation of its minimum wage is based on changes in the Consumer Price Index. As a result of inflation, the state’s minimum wage for 2013 is $7.79 per hour, which is 11 percent higher than federal minimum wage.

This is price fixing. After all, wages are the literal price that employers are willing to pay for a certain amount of labor. Under an arbitrary system such as a minimum wage, if the benefits to the workers eventually exceed the benefits to the employer, it undermines a healthy financial balance.

As a result, employers are forced to move back toward economic equilibrium. How do they do this? An obvious choice is to use other means to control payroll costs. If there is a floor under the wages, the only alternative for an employer to achieve this is to reduce the size of the workforce.

As one employer after another reaches a similar conclusion, the frequent consequence is that unemployment increases. Business owners will be paying higher wages to their remaining employees while receiving the same amount of labor, the same production rates, and a decrease in profits.

To maintain profitability when the wage floor rises, employers usually respond by eliminating jobs, scaling back hiring, reducing employees’ hours, and reducing benefits. These steps will especially affect young and unskilled workers, who often work in low paying jobs to gain the experience they’ll need to advance in the labor market.

Employers who want to stay in business cannot for long afford hire workers who will not produce enough in value to offset what it costs to employ them. In a market economy, salaries are ostensibly based on the value the workers produce.

For those productive workers whose pay is already above the minimum wage, increasing the minimum wage will have little or no benefit; those workers could, however, suffer the consequences of the arbitrary increase if their employers are forced to trim payroll costs by laying off some of them.

Another of the less immediate and, thus, less visible repercussions of raising the minimum wage is an increase in the cost of producing the same goods and services. This occurs as the ripple effects of the wage increase have an impact on the price of raw materials and other supplies.

Each successive link in the production chain will be forced to transfer the new cost (minimum wage increase) to the next link in the production chain, with the consumer ultimately bearing the brunt of the prices increases – again, paying more for the same products and services.

Rather than legislate policies based on well-meaning sentiments that have harmful economic effects, policymakers should direct their efforts toward improving real economic growth. There are many ways to do this. One of the best ways is to improve labor productivity through education reforms that provide training relevant to the job market.

Understandably, minimum wage increases are always welcomed by their beneficiaries in the labor force. This is mainly because of what of what Bastiat says is the easily “seen” benefit. But often the unseen effects are more tragically compelling in the long run, proving what Harry Hazlitt famously said:  “Real wages comes out of production, not out of government decrees.”