I know I’m late to the party, but I would like to provide my views on Obama’s State of the Union, or more specifically, his latest idea which he introduced in his SOTU adress: Raising the minimum wage from $7.25 to $9.

Here’s something you should all understand about economists: We agree on 95 % of all issues. We all agree on the law of supply and demand for example, and the Axiom(s) of revealed preferences are generally accepted. However, there are a few issues were we disagree – and naturally you hear more about our disagreements than our agreements.

The minimum wage is one of those issues. Would raising the minimum wage actually create jobs? It sounds counterintuitive, doesn’t it? And as it turns out, in this case, the intuition is correct: Raising the minimum wage would destroy jobs and lead to overall happiness (“utility” to use the economics term) being reduced.

First, why would it destroy jobs? This is pretty standard economics: Raising the price will, all other things held constant, reduce demand (in this case, for labor).

How can anyone argue with this, it all sounds like economics 101, right? I’m going to play “Devil’s advocate” and explain the standard left-winged response to this reasoning:

“Sure, raising the price will reduce demand all other things held constant – but all other things are not held constant: If the minimum wage were to be raised, the quality of the labor would go up, as workers would be able to afford health insurance and the number of sick days would be reduced, which would benefit the employer. Also, workers’ motivation would go up, so the product/service would be better and generate bigger profits. Plus, consumer demand would go up, boosting the economy”

Let’s have a look at these three arguments, one at a time:

1) Would workers be able to afford health insurance if the minimum wage was raised to $9/hour? Perhaps a few more would. However, a few things needs to be remembered: If it was in fact profitable for the employer to offer health insurance, or offer a salary that allowed an employee to afford it, chances are the employer would already have done so. The government isn’t very good when it comes to telling companies how to make a profit – would you take financial advice from someone who’s “company” is currently losing $1 trillion/year? Secondly, it’s far from certain that the money would be spent that way – if you give someone a raise, you never know whether they’ll spend it on health insurance or booze, whether they’ll use the money to get an education, or head to the casino. Of course, that’s none of the employer’s business really (I wouldn’t like working for an employer who told me how to spend my paycheque). However, it means that the argument that we should raise the minimum wage so that the minimum wage workers can afford health insurance and thus become more efficient workers is rather thin, as not that many would spend their money that way. You may still make this argument from an ethical point of view (saying we have an ethical obligation to give people on minimum wage a chance to buy health insurance) – but economically, raising the minimum wage will no doubt mean a loss for the employer.

2) Is motivation really determined by pay? I dare to say 90 % of economists would say No (a plurality of economists actually want to get rid of the minimum wage altogether). And we have to remember that the minimum wage is a FLAT wage: It’s not based on performance. Performance-based pay has been found to increase performance (though not by as much as you might think), but raising someone’s base salary won’t do a lot to motivate them really. Raising the minimum wage just means that the workers will be paid more, without putting in any additional effort. So why would they be more motivated? As a final nail in the coffin for this argument, we need to consider the type of jobs that pay minimum wage: Most of them are in fast food, retail or similar. These jobs don’t really require a lot of motivation – as long as you show up and do the (usually few, usually repetitive) tasks that you are asked to do, the quality of the “output” from your work will be the same. If your job is to make a Big Mac, you just follow the steps in the manual, serve the burger, and that’s it. Also, your work effort is directly observable by your supervisor who (if you’re in fast food) is watching your every move, making sure you’re not slacking off. In jobs were effort is not observable, performance-related pay is a must to motivate employees to work hard. But like I said, most minimum wage jobs don’t belong in that category.

3) What about the additional demand? This argument really shows the fallacy of left-winged economics: They assume that the employers are leprechauns, magical creatures with hidden pots of gold. If an employer – say, someone who owns a restaurant – suddenly needs to give his employers a 24 % raise (that’s what Obama is suggesting), he can simply take the money out of the pot of gold that he is hiding at the end of the rainbow. All employers are secretly rich, hoarding cash that should belong to the proletarian masses – this is standard leftist rhetoric. However, in the world described by conservative economists – otherwise known as “reality” – every dollar has to come from somewhere. Increasing one expenditure means decreasing another – and most likely, the companies will afford it by freezing other salaries (ie, refusing to give pay hikes to non-minimum wage employees) and by cutting staff. Raising prices is another option, which will actually hurt the poor the most. Most liberals are too rich to understand this, but this will actually hurt the poor – ALL poor. Consider a low income family, who’s only option if they want to eat out is to go to McDonald’s. If the minimum wage goes up, prices will go up – meaning that a $4 Big Mac may suddenly cost $4.50. That may not be a big deal for a rich Washington DC liberal who only pretends to care about the poor, but for a low-income household, such a relatively small price increase may mean the whole family has to stay home and feast on Ramen noodles instead.

The big problem however with Obama’s proposal is that it isn’t really based on economics; he wants to raise the minimum wage for purely ideological reasons. If it was based on some kind of economic calculation, that would have been a lot better: At least then, employers might feel reasonably certain that this increase was a one-time incident. But, liberals never get tired of being generous with others people’s money: The same ideological arguments that can be used to argue for a raise of the minimum wage to $9/hour can also be used to argue for a minimum wage of $11, $13 and $15/hour. This means that employers won’t know how much they’ll have to pay their employees in the future, which will create insecurity that will put them off hiring.

Oh, and if you don’t think that raising the minimum wage will lead to higher fast food prices – google the Big Mac Index and look at the Scandinavian countries (our minimum wage in Sweden is close to $15/hour).


What do you mean it will reduce overall happiness? How would you know?

I mentioned early in this post that raising the minimum wage would reduce overall happiness. I realize that’s a pretty bold statement, and I understand I may never be able to prove it definitely, but anyway, here’s why I think it will:

How happy you are with your salary doesn’t really depend on how high it is. It depends on how high it is, compared to everyone else. This is called “anchoring” in behavioral economics. This is why a Wall street trader may feel poor, even though he’s making $250k/year, because everyone else on his floor is making $500k/year. They don’t compare themselves to the average person, they compare themselves to their colleagues, friends, family etc.

Now imagine raising the minimum wage to $9/hour. This would lead to a lot of people suddenly being unhappy with their salaries. The guy who was making $9/hour before the raise will  continue to make $9/hour – but now, he’ll be making minimum wage. For better or worse, there is a stigma that comes with being a minimum wage worker. Just the fact that you are at the bottom of the scale can make you unhappy, because it’s not the number of dollars that counts, but how much it is relative to everyone else. If everyone else makes more or at least not less than you, chances are you’ll be unhappy.

Basically, this will make everyone who makes close anything remotely close to $9/hour unhappy. Say you’re a clerk who makes $11/hour right now: You can feel relatively good about yourself, as you are after all making over 50 % more than the minimum wage. However, raise the minimum wage to $9/hour, and suddenly you’re less than 25 % more paid than the guy who sweeps the floor at McDonald’s. You may then demand a higher salary, which – because of the economic conditions – your employer most likely won’t be able to give you, and you’ll continue to earn your measly $11/hour, which you didn’t use to think was so bad, but which you now do.

This also goes for the guy making, say, $8.80 per hour. He’ll only get a 20 cent raise, but now he suddenly has “minimum wage worker” written all over his face (at least he’ll feel that way).

Going back to our clerk; assuming he gets his raise, this will create a ripple effect once those who used to be more well-paid than the clerk realize that they are making the same salary as the clerk (whom they view to be below them) – they will then demand higher salaries, and either they’ll get it or they’ll be unhappy with their pay (even though it hasn’t decreased in absolute terms).

Does this seem silly? In a way, it is. Sadly, this is how humans work. What makes conservatism superior to socialism is that rather than trying to create a “New human”, we realize humans are inherently flawed, and we try to create the best world possible, taking these flaws into account.

So does this mean we should get rid of the minimum wage altogether?

Not necessarily – there is no denying that there are some positives associated with having a minimum wage, though I won’t elaborate further on that now. Either way, getting rid of the minimum wage is not a hill worth dying on, and at this time it would be crazy to spend political capital on trying to get it abolished.

Instead, I would suggest Republicans attempt to compromise: Agree to link the minimum wage to inflation, but refuse to raise it from the current level. That would also make a lot more economic sense than raising it to $9/hour overnight.

That will do for now. Thanks for reading,

Photo credit: busyPrinting via flickr (Attribution 2.0 generic)

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