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Minimum wages and economic theory

By Christopher Coyle
web posted June 28, 2004

The May jobs report was a welcome development for the Bush administration, providing evidence of a continued jobs recovery while giving Mr. Bush much needed good news in what has been a rough stretch for the president. Nearly a quarter million jobs were created last month with approximately one million created in the last three months alone. Presidential hopeful John Kerry, placed in the awkward situation of welcoming news which can not be amicable to his aspirations, acknowledged the positive news of jobs growth while continuing to drive home the point that "America is still in the worst job recovery since the Great Depression, with 1.9 million private-sector jobs lost in the Bush presidency." So what is the great idea that Mr. Kerry has to spark further growth in the labor market and increase employment? Raise the minimum wage to $7.00 an hour!

Mr. Kerry's latest proposal would increase the minimum wage from the current level of $5.15 an hour to $7.00 an hour by 2007. This is a great political ploy, promoting a core Democratic issue while seemingly helping millions of low-income workers get more money in their pockets. Yet, economically, the plan is an obvious fraud. Any factor of production, including labor, will tend to earn its discounted marginal value product, which is simply the revenue a resource will earn for a firm. By setting a minimum price above such a market-based wage, any worker whose labor earns less than the minimum wage will now be a loss to any firm which employs him. Consequently, a firm will not employ him. Thus, a minimum wage only creates a surplus of workers (i.e. unemployment). A policy intended to help poor workers by increasing their wages only succeeds in pricing them out of the market and thereby earning no wage at all. And yet, John Kerry continues to blithely assume that the wages of workers can be increased simply with a government decree. As some economists like to joke, if a $7.00 minimum wage would be of benefit to workers, that a $700 minimum wage would be a boon to them. But of course, no one advocates such an increase as the effects would then be blatantly obvious for all to see. An increase to $7.00 will produced exactly the same effects; the difference is only in degree, not in kind.

The question still remains as to why the minimum wage issue, which is shown to be inimical to the interest of low-income individuals, is still an effective political weapon. Obviously, many voters are not well-versed in economic theory, making minimum wage legislation seem like an appealing idea to increase the income of poor workers. This creates an opportunity for politicians, many of whom are not well-versed in economics in their own right, to demonstrate a supposed commitment to the well-being of the poor. Democrats, who usually have the support of lower-income groups, have traditionally done well with this kind of strategy of appealing to the poor with superficially sound, yet, in actuality, disastrous, proposals. Yet, Republicans are also guilty of using the minimum wage issue to gain support, or at least not lose support, for their own party: Mr. Bush, not to be outdone by Mr. Kerry, was said to be considering a "reasonable, gradual increase" in the minimum wage to counter the Democrats.

While politicians may plead ignorance on economic matters, despite the fact that they should be held to much higher standards due to the very broad, negative impact their decisions can have upon the rest of us, there is no excuse for economists who may support such measures. The fact that there is still some heated disputed on the topic only points to the disjointed nature of the science. An oft-cited example of the "success" of minimum wage legislation is the study by David Card and Alan Krueger on the effect of a state-passed minimum wage in 1992 on employment in the fast-food industry in New Jersey. Their conclusion was that the artificially higher wages increased employment in the industry.

Yet, the whole study is useless as to the truly important question that must be answered, that is, what is the effect of a minimum wage of employment? With that, economic theory is quite clear: the only result is involuntary unemployment. No empirical study is needed to confirm or deny this fundamental fact; they are only useful to determine the concrete conditions of a particular case at hand. In today's modern market economy, everything is so interconnected that it is difficult to isolate any one economic variable in an experiment or research study. Yet, it is precisely this isolation that rigorous economic thought can do. There is no fundamental disconnect between economic theory and economic reality. The irrefutable logic in terms of the analysis of minimum wages demonstrates the emptiness of the whole procedure of trying to prove empirically to the contrary.

In the end, a minimum wage is either meaningless (if set below the equilibrium wage rate) or detrimental to employment (if set above it). Such a policy will only hurt the very people they are intended to help, the very people who are most likely to be in dire need of a steady paying job. The fact that many citizens and politicians are ignorant of such things creates a situation where policies can be enacted in the name of strengthening the economy, yet only harming it. Of course, how can anyone expect them to understand such things when some economists themselves subscribe to the false notion that artificial wages above equilibrium has no effect, or can even increase, employment? The fact that such ideas are able to spread among the citizenry, politicians, and academics points to a disturbing trend among those with the power to bend and distort our economy and society. 

Christopher Coyle is the president of The Liberty Coalition at the University of Virginia.

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