In 1938, The Fair Labors and Standard Act was passed that established the nations 1st minimum wage at 25 cents/hour, taking inflation into account, this amounts to about $4.00/hour in 2013 dollars. This was one of 121 bills that President Roosevelt signed into legislation on June, 25, 1938 in order to avoid a pocket veto and was an essential part of his New Deal program. Today, the current Federal Minimum Wage is $7.25/hour(individual states may legislate a higher minimum wage) and President Obama would like to raise it to $9.00/hour. There are mainly two groups that want this to occur. Groups/persons with a vested interest, such as labor unions and legislators who want to get re-elected, and “do-gooders” who actually believe that an increase in minimum wage contributes to a better standard of living and lowers the poverty level. In actuality, increases in minimum wage have no positive effect on the poverty level, increases unemployment and force small businesses out of business. In order to explain this, we first need an introductory lesson in economics.
To the economist, life is very simple, benefits and costs. If the benefit of purchasing a good or service is greater than the cost, a rational individual will make the transaction. Taking a simple example, that coffee you bought this morning at Dunkin Donuts that you paid $1.60; would you have paid $1.61? If the answer is yes, then the benefit exceeded the cost. Let’s now extend that example to work. Intrinsic benefit notwithstanding (the joy of work), the benefit you get from work is your hourly pay. What then is the cost? Simply put, foregone leisure. So the rational individual will work as long as the hourly wage is greater than the leisure time he/she is foregoing. If someone is willing to work for say $6/hour, the benefits he's getting outways the cost of foregone leisure. It also has the additional benefit of keeping prices low to the consumer.
Let’s now look at businesses. The rational businessman is not in business to breakeven or incur a loss. He is in business to realize a profit, so he will hire a worker as long as the cost of hiring someone is less than the revenue they are producing. In other words, if it costs me to hire a worker at $7.25/hour, and that person makes $8.00 every hour for the business, I’ll hire him (obviously payroll taxes, workman’s comp etc. have not been considered to simplify the example). The minimum wage now increases to $9.00/hour. What happens to the workers who are producing less than that in revenue, they get laid off and unemployment increases; or if it is a small business that employs primarily minimum wage workers (think landscaping), the business goes out of business. But what else happens when the minimum wage increases, so to does prices, and the costs are passed on to the consumer. This is known as a wage price spiral or cost-push inflation. As a result, the effects of minimum wage have just the opposite effect of those intended by society’s “do-gooders”, an increase in unemployment amongst those it intends to help, the less skilled and uneducated, and no change in the poverty level, or quite possibly, a slight increase in poverty.
To the economist, life is very simple, benefits and costs. If the benefit of purchasing a good or service is greater than the cost, a rational individual will make the transaction. Taking a simple example, that coffee you bought this morning at Dunkin Donuts that you paid $1.60; would you have paid $1.61? If the answer is yes, then the benefit exceeded the cost. Let’s now extend that example to work. Intrinsic benefit notwithstanding (the joy of work), the benefit you get from work is your hourly pay. What then is the cost? Simply put, foregone leisure. So the rational individual will work as long as the hourly wage is greater than the leisure time he/she is foregoing. If someone is willing to work for say $6/hour, the benefits he's getting outways the cost of foregone leisure. It also has the additional benefit of keeping prices low to the consumer.
Let’s now look at businesses. The rational businessman is not in business to breakeven or incur a loss. He is in business to realize a profit, so he will hire a worker as long as the cost of hiring someone is less than the revenue they are producing. In other words, if it costs me to hire a worker at $7.25/hour, and that person makes $8.00 every hour for the business, I’ll hire him (obviously payroll taxes, workman’s comp etc. have not been considered to simplify the example). The minimum wage now increases to $9.00/hour. What happens to the workers who are producing less than that in revenue, they get laid off and unemployment increases; or if it is a small business that employs primarily minimum wage workers (think landscaping), the business goes out of business. But what else happens when the minimum wage increases, so to does prices, and the costs are passed on to the consumer. This is known as a wage price spiral or cost-push inflation. As a result, the effects of minimum wage have just the opposite effect of those intended by society’s “do-gooders”, an increase in unemployment amongst those it intends to help, the less skilled and uneducated, and no change in the poverty level, or quite possibly, a slight increase in poverty.
During the most recent recession, the average United Auto worker made $74/hour with benefits. A function of good negotiating on their part, increases in minimum wages and a perception that Detroit would always be the dominant power in the automobile industry. This is a significant increase from $500/week base pay rate in 1980 (source: sbaer.uca.edu/research/allie...003/organization/new/06.pdf). As a result, Detroit found it cheaper and more profitable to substitute caital for labor, and hence, the decline of the auto worker.
Considering more empirical evidence, if you look at the poverty rate for the past 50 years, you will see that after a dramatic decline in the early 1960’s as a result of Medicare and Medicaid being implemented, the poverty rate has fluctuated in the United States between 11 and 15 percent since the 60’s. It increases during and right after recessions, because this is when unemployment increases and peaks, and gets lower post recessions when the economy is doing well. Simply, the poverty rate in the US is a function of the business cycle and not minimum wage.
But wait. Didn’t I previously imply that increases in minimum wage can increase poverty? If you look at the chart at the left, you will see that most minimum wage increases occur prior to recessions. I am not saying that increases in minimum wage cause recessions, but they can significantly contribute to their severity and length. The 90’s is a very notable exception. Very simply, the 90’s was the best decade economically of the 20th century which was powered by huge technological increases in information technology. Prior and during the most recent “Great Recession,” we had a minimum wage increase of 40% in a three year period. There is no doubt, that this increased unemployment and contributed to the recession’s severity, especially the teenage unemployment rate since it is their group that has the least education and productivity.
We currently have an unemployment rate in the United States of 7.9%, and in his recent address before Congress, FED Chairman Ben Bernanke, predicted that we would not reach a more acceptable unemployment rate of 6% until 2016. A dismal recovery that has been exacerbated by questionable fiscal policies; one specifically being extended unemployment benefits that can last up to 99 weeks. What’s particularly disconcerting is the long term unemployment rate, those people who are unemployed for more than 6 months, is three times more than any other recession and almost twice that of the double dip recession of the early 1980’s. In some states, such as Massachusetts, Maine and RI, to mention a few, these benefits are well in excess of $500/week. Where is the impetus and motivation to go back to work? To give an indication of the severity and longevity of the post recession recovery, we were above 8% unemployment for 43 months. By contrast, after the Reagan stimulus was implemented, the unemployment rate went from 10.8% to 7.2% in 16 months.
If President Obama gets his way and is allowed to increase the minimum wage, someone please explain to me how someone(particularly teenagers) is better off unemployed at $9.00/hour as opposed to being gainfully employed at $7.25/hour.
If I could change 3 laws to help the economy, I would eliminate the minimum wage law, discontinue extended unemployment benefits and do away with Obamacare known as the Affordable care Act(which will be anything but affordable), but that’s for another blog.
The expressed opinions of this blog are mine and mine alone and do not represent the opinions of Bentley University.
If President Obama gets his way and is allowed to increase the minimum wage, someone please explain to me how someone(particularly teenagers) is better off unemployed at $9.00/hour as opposed to being gainfully employed at $7.25/hour.
If I could change 3 laws to help the economy, I would eliminate the minimum wage law, discontinue extended unemployment benefits and do away with Obamacare known as the Affordable care Act(which will be anything but affordable), but that’s for another blog.
The expressed opinions of this blog are mine and mine alone and do not represent the opinions of Bentley University.
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