• Jake

What would a higher Minimum Wage really do?

Updated: Aug 21


What do YOU think a $15 minimum wage would do? The right answer is that no one really knows, at least not completely. The scale of literature on the topic is vast and the number of studies nearly endless. The problem is, doing an empirical study in this area requires holding constant a mess of ever changing variables and loading your study with a set of assumptions and biases from the onset.


Luckily, empirical knowledge is not all there is, nor are such studies always the gold standard. Math is not empirical neither is philosophy. Never do we need to leave the comfort or our armchair to be certain that 2+2=4 or that the principle of sufficient reason holds true.


So scrap the studies, ditch the anecdotes, and for goodness sake stop the naive memes and join me in some armchair economics as we sketch out what impact a higher minimum wage may have.

First observation:

No rational employer would pay more in wages than the employee creates in value. If they did through mandate, charity or accident they would find their firm disappearing since their capital would be constantly drained. Other more cost concise firms would soon out number them through growth, hiring and expansion.


In time we would expect an equilibrium where employers would always want more workers to work more hours if and only if each of those hours of labor created more dollars in value than where paid as dollars in wages.

What happens when a minimum wage is enforced? One answer has become obvious. Lets just rewrite the paragraph above:


Employers would always want more workers to work more hours if and only if each of those hours of labor created more dollars in value than where paid as dollars in wages on the condition that each hour represented the creation of at least $15 dollars of value.


As you can see, it now becomes illegal for a worker to sell their labor for less than $15 per hour. Which means anyone who lacks the skills, health, intelligence or other factors that would have produced that much value per hour is now forcibly ejected from the labor force.

The minimum wage has been described as sawing the bottom rungs off of the economic ladder.


From the perspective of the economy as a whole we are now under producing value for one another in our economy because all tasks that produce $0.01-$14.99 in value per hour have stopped by force of law.

Furthermore, as anyone who has worked anywhere knows, not all working hours are equally productive. This means that all hours that create $15 dollars of value or less will be cut from current workers schedules to the extent that this is feasible.


Summary:

  1. Unemployment for low skilled, partially disabled, and other vulnerable classes of workers will rise because their value output does not meet and arbitrarily set bar. Selling their own labor becomes illegal.

  2. Hours will be cut for workers who do not always meet the arbitrary value limit.

Objection:

Why don’t the employers make their workers more productive so that they can create that extra value per hour? Why do you assume that the result will be unemployment and reduced hours when employers could leverage their labor with technology?


Response:

Great question. Lets address the first part first then deal with technology. Yes, employers can make their workers more productive. This is called making them work faster and harder. Compensation given to a worker comes in many forms. Obviously there are wages. But a nice working environment is valuable so are breaks and time to relax with coworkers without pressure from management to always be working. Fringe benefits, discounts on merchandise, holiday parties, free uniforms, free parking, days off, long lunches, ect….

If one part of that compensation is forced to rise, the other parts will fall in response. So yes, employers can make people more productive but there is a reason that for a given cost to the employers the compensation scheme is set in the ways it is. As a result, the job satisfaction rate is at or near its highest recorded level in the US.


Workers shop for the best total compensation as a result, employers are forced to compete with one another by providing the best compensation package not just the highest wage.


What about technology? Value producing technology is purchased if and only if the the additional value produced as a result of its adoption is greater than the cost of the technology. In other words, if an additional $1 can be generated by the purchase of this equipment when there is a minimum wage, it would have also have been purchased when there is not a minimum wage.


The difference is, when there is a minimum wage in place the company has less value being created with which to purchase this equipment since all of the values from those 0-$14.99 per hour exchanges have been banned. Furthermore, the economy has slightly contracted due to that forfeited value so that there is less ability in total for the economy to invest in upgraded equipment.


More on the relation of capital to labor in the next section…



Second Observation:


Companies that use a higher blend of labor will be harmed by a higher minimum wage and companies that use a higher blend of capital will benefit. This will create economic distortions that harm total value creation in the nation.


Imagine two excavation companies. The first hires low skilled workers to dig holes by hand. The second owns expensive earthmoving equipment to do the same job. If a customer wants a small hole to be dug the hand digging company can do it for cheaper. If the hole is very large, the balance tips and the earthmoving guys get the job.


Then the minimum wage increases to $15 dollars per hour and something very strange happens. The earthmoving company starts digging holes that are too small for them to be digging. Why? Well lets take an example here is a quote for digging a foundation for a small house:


Hand diggers:

8 men * 30 hours * $10 per hour + $50 in overhead = $2450

The company wants to make some profit so it charges 50% over cost. The quote is $3675

Profit $1270


Earth movers:

1 man * 4 hours * 30 per hour + 2500 in overhead = $2620

The company wants to make some profit so it charges 50% over cost. The quote is $3930

Profit $1310


Looks like the hand diggers get the job. Here is what happens when the minimum wage rises:

Hand diggers:

8 men * 30 hours * $15 per hour + $50 in overhead = $3650

The company wants to make some profit so it charges 50% over cost. The quote is $5475 and they don’t get the job

If they try to make the same dollar value in profit the quote will be: $4920 but they still won’t get the job.


If they try to match the price of the earth movers at $3930 they might get the job but their profit falls from $1270 down to $280. If we imagine that the overall profit is cut in half across all of the jobs and transferred to the pocket of the earth movers then assuming a valuation for the company of 7x yearly profit the values of the companies could move in the following way:


No minimum wage:

Hand digging LLC yearly profit 1,000,000 *7 = 7 million dollar value

Earthmoving LLC yearly profit 1,000,000 *7 = 7 million dollar value


Minimum wage:

Hand digging LLC yearly profit 500,000 *7 = 3.5million dollar value

Earthmoving LLC yearly profit 1,500,000 *7 = 10.5 million dollar value


Earthmoving LLC is now 300% more valuable than Handdigging LLC


Of course this is a very simplified example. It is true that the scale of the change is unknown but the vector is plain as day.


Summary:

  1. Capital intensive companies will do jobs that wouldn’t have made economic sense previously. The proverbial Earthmovers will be digging holes that ought to be dug by a shovel and would be a waste of resources to bring in such equipment to dig. The same will be true with the introduction of ordering kiosks vs people or mechanized retail like Amazon vs Walmart. These distortions mean that less value is created in our nation.

  2. Companies with lots of workers will see the value of their companies drop. Similar companies that use a higher blend of capital resources will see their profits and subsequently their market value grow. But this is not based on their contribution of value to others, but instead by manipulation of prices by edict of the state

  3. Companies that would have been major employers of labor will be out competed by newly more valuable companies that now have both higher earnings and increased market share.

  4. A contraction in these companies means a contraction in the demand for laborers. This normally would mean the price of labor would drop. This drop in labor will make the companies competitive again and the market would return to equilibrium. Instead with a mandatory minimum wage the price cannot drop so the market cannot balance in the same way. Opportunities for laborers will be lost completely instead of priced at a lower rate.


Objection:

Sounds to me like the minimum wage will be increasing our investments in equipment and resources. Sure the first few years might not be as profitable but over time these types of investments will pay dividends as every worker works with a greater leverage of capital amplifying their labor. In your own example the worker running the earthmoving equipment is far more productive than the diggers. One of the goals of minimum wage is to speed the transition to an economy that has less people doing unproductive menial labor and more people producing value through technology and skill.


Response:

What you are describing is a greater leveraging of labor economy wide through greater total investment. The problem is with each individual market that gets distorted in the ways described in both section above the total value produced by the economy decreases.


If consumption remains static that means that less value is left over for investment in the productive equipment you are imagining since total value creation dropped. If consumption increase as predicted in much minimum wage literature, this actually cuts into the savings rate to make room for the increased consumption. If consumption falls, this would be from the actual contraction in our economy due to the reduced total value creation. Again the savings and thus investment rates at best don’t rise and at worst fall.


A higher minimum wages will almost certainly hurt the savings rate in the following ways, lower retained earnings for companies, higher government debts as a result of greater unemployment support crowding out capital markets, transfers away from the saving classes, and increase consumption.


If all that wasn't enough, there is still the most damning problem of all for this objection. Quite simply, I could tell the same labor vs capital distortion story that manifestly reduces value creation when discussing the creation of the equipment production itself.


For instance, production of earthmoving equipment involves a blend of labor and capital. One could imagine two factories, one that is fully mechanized to create excavators and the other that occupies the shoveler strategy where people manually create the machines. Then I could push it back another step and ask how the machines that created the machines where made. Again this is a blend of labor and capital that gets distorted with arbitrary wage increases. I could go back again and again all the way to raw materials. At every level up and down the supply chain the metaphorical holes of the wrong size would be dug and each time this represents a waste of resources when compared to market equilibrium. If you imagine that with this kind of inefficiency gumming up the works of the economy would produce more equipment to leverage labor and somehow produce more value in the economy they you are off your economic rocker!