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President’s proposal to raise the minimum wage sounds good, but could there be unintended consequences?

A few weeks ago, while many in south Louisiana were celebrating Mardi Gras, President Obama delivered his State of the Union address to the Congress and to the nation.  In it, he not only remarked about where he thought we were as a nation, but also, where he wanted to lead us in several areas.  One policy he mentioned was to increase the federal minimum wage from its current $7.25 to $9.00 per hour over the next three years (listen to a National Public Radio Discussion of the minimum wage proposal here).

While this sounds like a good idea, could there be a downside?

The French economist and writer, Frederick Bastiat, the namesake for this blog, noted in a famous essay of his, “What is seen and what is not seen,”

In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

What is “not seen” are the unintended consequences.

Another way of thinking about this is that we need to be thoughtful and good “positive” economists and not just “normative” economists.

Raising the minimum wage puts a higher floor on wages, raising the price for labor while not raising the value to the employers, the demanders of labor, or reducing the supply of labor.  It changes the price while not changing the values, the demand or the supply.

Employers especially retailers, when faced with a higher minimum wage, cut the hours of their operations as some time periods that used to bring in more money than the cost of those operations in those periods as labor costs rise.  Employers also shift to substitutes for low-skilled workers, such as more productive and better paid workers.  At the same time, a higher minimum wage brings more people into the labor market.   Raising the minimum wage, then, pushes down the amount of labor demanded while it increases the amount of labor supplied, causing a surplus, or a glut of low-skilled, low-educated, and mostly younger workers.  A glut of workers also goes by the name, “unemployment.”

Higher minimum wages also make going to work seem relatively more attractive than staying in a boring high school, leading to more drop outs.  With higher unemployment due to the minimum wage, it is harder to accumulate job experience.  Even though there is a limited “training” minimum  wage, that training minimum wage goes up when the minimum wage goes up.  With it more expensive to train workers, employers do less on-the-job training.  The very things that make a person more in demand as a worker, more education, more job experience and more on-the-job training, are all reduced, so some people may get higher wages, but now they will have greater trouble moving beyond minimum wage.

The minimum wage also increases racial and other discrimination in the workplace.  Suppose there is no minimum wage, or it is below the equilibrium wage.  Then, only the most temporary unemployment exists and the number looking for jobs just matches the number of jobs.  In that case, if a racist employer refuses to hire certain qualified (for the job) workers just because of their race, ethnicity or sexual orientation, he would either have to pay more for his “kind of workers,” or he would have to leave some jobs unfilled, because there just aren’t enough workers applying for his jobs.  So, with no meaningful minimum wage, a racist employer would find that there are high costs consequences to behaving in a racist manner in the job market.

But what happens when the minimum wage is raised above the equilibrium level, when unemployment begins to hit the low-skilled, low-educated, younger workers?  When there are more and more people to pick from for only a few jobs, an employer with racist tendencies can behave like a racist, hiring only his preferred type of worker, reducing the “marginal cost” of racist employment practices, increasing racist hiring.

Racial discrimination in hiring increases in another way as well, in the form of “unintentional discrimination.”  Here is what happens.  When the minimum wage is high enough to cause unemployment in the way described above, young workers with few skills and who have not completed high school find it very difficult to find jobs.  In these cases, the workers with good connections, what some call “social capital,” perhaps parents with friends of employers, find it easier to get a job than those who have few such connections.   “Who you know” becomes more and more valuable.  This also reduces the incentive to acquire as much “what you know,” making increases in pay beyond minimum wage even more difficult.

In the NPR discussion mentioned above, Kevin Hassett suggests that the minimum wage, while a poor way to help the poor, is a way that does not involve raising government spending or reducing taxes.  What we should notice is that there is a somewhat public purpose to raising the minimum wage, but the cost of doing so, higher unemployment of some, higher prices for consumers, lower profits for job creators, are really hidden taxes.

Perhaps, if we want to help the poor, we should do so in a manner that the costs of doing so are transparent and not so hidden.  Hiding the costs of collective action is just not ethical.  There are other ways of helping the poor that might just work better, as Hassett suggested in the NPR discussion above.

-MC

11 Responses to “President’s proposal to raise the minimum wage sounds good, but could there be unintended consequences?”

  1. Maryssa says:

    I definitely do not support the increase in minimum wage. I’ve worked while I’m in college and while it seems like a dream come true, I know that prices will go up and unemployment will rise. My first job was at a pizza company being a pizza maker/insider. Since I did not drive, I made more than most because they were on tipped wage. Even then, the manager of the store, eager for as much profit as she could make, limited my hours down to 8 or 9. This was because it was cheaper to pay the driver his/her minimum tipped wage than it was to keep me in the store at regular minimum wage. This led to me quitting, and I know if the minimum wage was raised even higher, there would be no insiders in that store because she could not even come close to making a profit.

    With unemployment going higher than ever before due to an increased minimum wage, we may see more and more people go on welfare or unemployment payments. This may cause taxes to go up and the people making the $9 an hour will not see most of it. The people making more than that or on salary will not see the reason why they went to school and tried to better themselves when taxes are increased. As it is right now, with the recent tax hike on our paychecks, my dad is questioning why he is the one harmed and why he wanted to better himself.

  2. DJ says:

    For people who have to live off of minimum wage it would seem like a good idea to have it raised, but it is not. I take exception to what you say about increasing racism, however. First, while there are pockets of stupidity, I don’t believe that widespread racism exists. Second, I believe that for the businessman, capitalism trumps the -isms. If you have to spend more money on fewer people you need the best people for the job regardless of other factors, including nepotism. Employers only have a certain amount of money that they can spend on what they pay their employees, so take home pay will not necessarily increase in accordance with a higher minimum wage. I agree that they may shut down for a time, furlough workers, or cut back on benefits to decrease the amount of money that they spend on employees.

  3. MPC says:

    Increasing the minimum wage from $7.25 to $9.00 brings a lot of consequences to the economy instead of helping it. Everything is like a balance if employees get paid more then prices have to go up or the number of deployment have to increase. Which people with deployment will not have money to buy the expensive products which will bring to a smaller quantity of the population that will not be as much affected by this increase of minimum wage . I can see an increase in debt that will bring for increasing the minimum wage, there are other ways to help the economy and this one is not one of them.

  4. DB says:

    Even though raising the minimum wage may seem like a good idea to most Americans, it is most likely to do more harm than good to the American economy. The politics of this issue are complicated, but what I worry about is that it may be harder for the poor to find a job. Having a higher minimum wage means that businesses will not hire as many workers, since workers will be more costly to retain. I also worry that we will soon be paying more for a gallon of milk at the grocery store since wages will be higher. For someone that cannot afford the higher prices, this could create a big problem with having to afford the bare necessities of life. The minimum wage is only a mechanism that hurts people that need a job the most. I can recall a study in our textbook that looked at whether raising the minimum wage improved the purchasing power of the average American family. From the 1970s to today the minimum wage has gone from around $2.50 to $7.25 . With each increase in the wage, the consumer price index rose, raising the cost of a basket of goods. So, in conclusion, families did not have an improved purchasing power. This is something that should be taken into consideration when deciding the minimum wage. The bottom line is: the market does a good job of setting competitive wages on its own. Although the author of the article presents some good arguments, I do not think a higher minimum wage will be good for the labor force.

  5. Scott says:

    While a raise in minimum wage may sound good to may people in the workforce today, they may be overlooking some very important points to be made before the wage is raised. With a higher minimum wage, the cost of everyday products will go up so that producers can make up the difference. With the cost of these products going up, it will cause the you to spend more of your check to purchase these necessities which will all balance out having the wage law raised. Just think of spending $12 for a humburger at McDonalds for example. This will also cause people to think less about continuing their education and think more about joining the work force. While general labor is needed in the workforce, there will be a surplus of general laborers and not enough of office workers.

  6. Raymond says:

    In rasing minimum wage from $7.25 to $9.00, I forsee a hike up in prices for buisness to keep up with their new cost. This will actually hurt people with experience that are making more then minimum wage if ther wages do not go up the same. The buying power of the experienced woker will drop. I also agree that young people will wonder what is the point of education if they can start out making $9.00 a hour. Being young, a lot of them will not consider the disadvantages like having a harder to find a job.

  7. Rebecca says:

    What this is can be simplified into one phrase: Every action has its consequence. Or, to put it in a Newton’s law of motion form: Every action has an equal and opposite reaction. The reaction and consequence for this action is as you said: unclear to the naked eye. Though it seems to be a good move in the forefront, it actually may just worsen the problem there is with it now. I, for one, agree with you on the point that there are other ways to improve our economy that would be easier to understand for the general public, because the consequences for this action, as you explained, are much heavier than there is an obvious benefit. There has to be some other way to improve, and somewhere out there, I’m sure there is, we just haven’t figured it out yet.

  8. Paul says:

    Having started working when I was fifteen, I was ecstatic with minimum wage, then $5.15/hr. I was a strong proponent – albeit a young teenager with little knowledge of economics – for the federal minimum wage, convincing myself that it was the government’s job to protect the general populace from an unjust wage. Not only has my opinion on governmental role changed, but as my knowledge of economics has grown, so too has my opinion on MW changed.

    Dr. Coats mentions, “When the minimum wage is high enough to cause unemployment in the way described above, young workers with few skills and who have not completed high school find it very difficult to find jobs.” — As a worker in residential/municipal construction throughout my high school career, I fail to see how this is a bad thing. If high school dropouts are finding it difficult to find jobs with their current skill sets, maybe they will be motivated enough to graduate? As for the “who you know”, this has been an issue in the workforce for many years and will continue to be so. I think it increases the incentive to acquire “what you know”. If someone vying for a position that was given to someone else because their father plays the back 9 with the owner, then I think said someone would be motivated to acquire more actual skills, not more social standing. After all, acquiring actual skill is a permanent thing; social standing can come and go. At any rate, employers quickly notice employees with exceptional skill sets over “who you know”.

  9. Tiffany says:

    Raising minimum wage to $9.00, in my opinion, will not solve our economic problems. By raising minimum wage most jobs will have to lay off their workers because they cannot afford to have as many workers anymore. By doing so, this may lead to unfilled job positions, like you said, and make the product or service provided less efficient. If raising the minimum wage would cause a higher high school drop out rate, I really think it is a bad idea. The last thing the world needs is more high school drop outs. What if a high school student drops out because he or she believes they can get a minimum wage job easily and live off of that and then they find out that it’s not so easy to find a job; they are stuck in a rut. Minimum wage should not be raised.

  10. DDG says:

    An increase in the federal minimum wage sounds like a dream come true to many struggeling families working from pay check to pay check with a poverty label attached to their economic status. I do not know where President Obama’s assertion that “It can be done,” comes from. Is it based on corporate third quarter 2012′s profit earnings alone? Accroding to CNN’s Money report “Corporate Profits Hit Record as Wages get Squeezed,” corporate 2012 third quarter earnings totaled $1.75 trillion, a record 18.6% increase from 2011, while employee wages shrunk during that same period (CNN Money 12/12). The idea of increasing the minimum wage would seem plausible if, and only if, corporations represented the vast majority of businesses in the U.S. Unfortunately, corporations do not, small business’s hold that title representing 99.7% of all employer firms (Small Business Administration Report 2010). Let’s take a more detailed look at the Small Business Administration’s (SBA) report based on the U.S. Census Bureau and the Bureau of Labor Statistics; 64 percent of net new private-sector jobs,
    49.2 percent of private-sector employment,
    42.9 percent of private-sector payroll,
    46 percent of private-sector output,
    43 percent of high-tech employment,
    98 percent of firms exporting goods, and
    33 percent of exporting value, are soley produced by small business acitivity inputs (SBA Report 2010). If President Obama’s plan to increase the federal minimum wage come to fruition, we can clearly see which sector it will have the greatest impact on. Economists help advise our elected officials in areas that relates to the economy. Econmist Robert Brusca states that if one or more factors increase then one or more other factors decrease. For instance, if profits increase then wages decrease (CNN Money 2012). In other words, if President Obama policy is passed, wages would rise, however, employment would decrease, therefore decreasing output and reducing business profits. Despite small businesses out numbering corporations, corporate profits are far much greater. Corportations would be in a better position of handling the proposed policy than would small businesses. The wage increase would cause businesses to hire less or potentially increasing prices to make up for the difference in higher wages. It could possibly force more people into unemployment and increase government spending on unemployment, welfare, food stamps, and other social programs placing more burden on taxpayers. To Nya and Shashee of Brooklyn, NY, raising the federal minimum wage to $9hr, is long overdue. Both are parents earning part-time wages of $8hr. Depsite working, both women receive assistance in the form of welfare and foodstamps to help supplement their income to better provide for themselves and their children. They know that any increase in their wages would put them a little closer to no longer needing public assistance (CNN Money Interview 2012). If the President’s proposal of raising the federal minimum wage to $9hr as “It can be done,” is even possible, despite statistics, then this could change the economy as we know it.

  11. Adriana Love says:

    I agree with Hasset on finding a better way to help the poor. I think raising minimum wages will cause other promblems for the United States. For example: Some people will lose their jobs because the company can’t afford to pay them anymore. Unemployment, one of the things Obama has beening working hard to bring down is going to go right back up. Using minimum wage to balance out one problem is only going to cause multiple problems in the work force. Taxes is starting to make unnecessary problems for the people of the United States.

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