In light of recent pressure to raise the minimum wage to $15, it is worthwhile to re-examine the thinking––or the lack thereof––behind minimum wage policies.
The basic assumption behind minimum wage laws is that, without them, workers who lack collective bargaining power would fall prey to “greedy” corporations looking to “exploit” them. But this belief is seldom thought through by its advocates. The truth is that minimum wage laws destroy bargaining power and prevent low-skilled workers from entering the labor force.
Workers Competing Against One Another
Imagine a worker seeking employment. Without minimum wage policies, this worker can out-compete other job seekers by selling his labor for a lower price (say, $7 an hour) than what competitors charge (say, $10 per hour). Because hiring him would cost a company less than hiring his competition, he becomes more attractive and thus improves his odds of landing a job.
This type of bargaining is what many black workers did with success prior to minimum wage laws, when black unemployment was lower than white unemployment. But the rise of minimum wage legislation changed that. Racist labor leaders realized that if they could establish a legal minimum wage, blacks and minorities would be unable to bargain in this manner and thus priced out of the labor market.
With the passage of the Davis Bacon Act in 1931, which decreed the first federal minimum wage, these labor leaders accomplished their goal. As this law economically disempowered African Americans,, black unemployment rose. Ever since, it has remained higher than white unemployment.
The Free Market Is Anti-Discrimination
Thus, ironically, minimum wage laws protect racism. To see this more clearly, suppose an employer prefers white employees. Imagine two candidates of equal productivity—one white and one black—apply for the same minimum wage job. In this case, the cost of hiring either candidate is $7.25. Discrimination carries zero cost.
But now assume there were no minimum wage, and that the black candidate would like to drop the price of his labor to $5. In this scenario, if the employer indulges his racist preferences, he faces the cost of the difference between the two candidates ($7.25-$5.00), or $2.25. In other words, the free market penalizes discrimination.
Today, however, minimum wage supporters do not seem to bother themselves with these facts. Instead, they argue that, as the above example shows, workers in the free market are left to bargain for lower wages, which is why minimum wage legislation is needed. But this objection reflects a lack of critical thinking, as it considers only half of the analysis.
Consider what happens when we take it one step further. If a worker sells his labor to firm A for $7 per hour when he’s actually worth $10 per hour, firm A reaps $3 an hour in profit. But by paying him less than he’s worth, Firm A risks losing him to competing profit-seeking companies.
Firm B, for example, can lure this worker away from firm A by offering him $8 an hour, and still reap $2 per hour in profit. But even this wage leaves room for competitors to gain. Firm C, for instance, could pay him $9 per hour and enjoy a $1 per hour profit. And with firms D, E, F, and G also in the market, competition will continue to bid up his wage until it approaches his worth: $10 per hour.
In other words, competitive free markets encourage companies to pay workers fairly. If a company does not, it risks not only losing its employees to competitors that do, but bad publicity, which may include a loss of revenue and even bankruptcy.
The Indirect Consequences Of Minimum Wage Policy
As this exercise reveals, minimum wage supporters tend to observe the direct and immediate consequences of their idea, but they do not bother to think through the indirect and longer-term consequences. The late Henry Hazlitt had a term for this tendency: “bad economics.” On the other hand, good economics considers all the consequences of a proposed course of action. Here’s Hazlitt:
The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences. The bad economist sees only what the effect of a given policy has been or will be on one particular group; the good economist inquires also what the effect of the policy will be on all groups.
Unfortunately, however, in an era when social media exacerbates our already-short attention spans, Hazlitt’s insight is unlikely to be heeded. Even more unfortunately, if the minimum wage is hiked to $15, it will harm far more people than it will help. The remedy is to encourage minimum wage supporters to fully think through the consequences of their proposal. The conundrum, however, is how to do that in 280 characters.