Yes, a minimum wage comes with costs, but is it worth it?
After President Obama called for raising the minimum wage to $9.00 in the most recent State of The Union address, a wealth of debate has exploded around the issue. Most Economists agree that basic economics shows how raising the minimum wage leads to increased unemployment. Despite the costs that a higher minimum wage places on employers, an increased minimum wage will nevertheless put more money in the hands of some workers. Even though there is plenty of literature about the negative effects of a minimum wage, there is little on if and when a minimum wage is justified, which under certain economic conditions, it is.
Even though we typically think about the minimum wage as the lowest hourly rate that businesses are allowed to pay their workers, it is also the lowest price workers are allowed to accept for their labor. Thus, a minimum wage effectively prohibits the workers whose labor is worth the least- the poor in society- from freely entering into contracts with employers.
However, economic theory can show us how putting restrictions on employers’ ability to freely contract with employees can be beneficial in the case of a monopsony. The economic tern ‘monopsony’ describes a situation in which one buyer faces many sellers. If a labor market were a monopsony, there would only be one buyer of labor (a firm) and many sellers of labor (individuals). In other words, a monopsony in the labor market would exist if there were one employer and all potential workers didn’t have any other options to work for that employer.
Under a monopsony, because of the lack of competition, the one employer is able to lower wages to the point that his employees are barely better than being self-sufficient. In this situation, where workers have no other option, and where competition for the best labor does not exist (since such competition would require more than one firm) a minimum wage could led to a net increase in welfare since raising the wage rate won’t necessarily lead to more unemployment; the one employer could still find it profitable to keep all his employees even with a minimum wage.
A good free-market-fundamentalist would be quick to point out that a minimum wage may not be necessary under a monopsony because unsatisfied workers could leave the employer and become self employed. One could be self-employed by being an entrepreneur of some sort- investing in an idea or in his own labor. However, where a monopsony exists it is almost undoubtedly the result of a government granting such a business monopoly power on the market because it would be profitable for a rival firm to come into that market, break the monopsony, a pay slightly higher wages to obtain the best labor. Those who live under a government who pass laws allow a monopsony to exist are not likely to be governments that protect property rights very will, which makes entrepreneurial activity and investment very risky if not doomed to fail, so self employment is, in effect, not a viable alternative.
Luckily, in the United States, no labor market can be characterized as a monopsony. Entrepreneurship is taking place constantly and we have a government with hundreds of years of legitimacy that does a better of job a protecting property rights then most countries. Thus, even after considering when a minimum wage could theoretically help, we can conclude that we are still not in a position to benefit from rising, or even maintaining, the minimum wage.
While it would be extremely convenient to be able to improve the lives of the worst off in our society by mandating a higher minimum wage, raising the minimum wage will effectively force employers to reduce the amount of low skilled workers they have.
Many advocates of a minimum wage argue that the increase to $9.00 per hour would greatly help reduce poverty. However, those advocates should instead advocate a minimum wage of $20.00 per hour or even $500.00 per hour since these wages should help the poor even more. Those who concede, and correctly so, that a minimum wage of $20.00 or $500.00 per hour would be economically destructive, cannot deny that a $9.00 minimum wage will cause adverse economic effects without yielding gains for anyone.
Those advocates of the minimum wage need to meet the burden of proving that given all of the costs of such a policy, it is the best way to reduce poverty. There is little evidence to support that. In fact, firms and the poor would be much better off if firms payed an extra a tax on profits that could be directly given to the poor rather than having to work around a policy that directly impacts their business model and prohibits willing and able citizens from being able to enter the workforce.
The, political, benefit to raising the minimum wage is its simplicity- people can understand the concept, but the economic results will certainly be negative. If the price of something rises, people will consume less. Legislation won’t be able to avoid this economic reality- even when it comes to the minimum wage. The minimum wage hurts all actors in an economy- especially the very poorest, marginalized and least skilled, who receive the lowest wages. The minimum wage will make the very people it aims to help worse off; it is the epitome of bad economic policy.