The Problem with the Minimum Wage
And a better alternative
In an era of divisive politics, the minimum wage is an easy sell. Why not force employers to pay people more? They can afford it, the saying goes. Raising the minimum wage and sticking it to the “man” makes a great political soundbite, but in reality, it’s a blunt instrument that does little to aid the poor. It may even leave them worse off.
They Can Afford it!
Minimum wage (MW) laws are often discussed in the context of lifting people out of poverty by paying a “living wage.” Lately, though, the MW has become a cudgel in a vindictive form of retribution against “evil” billionaires. Regardless of the motivation, MW laws have complicated effects on the economy.
Forgotten in this discussion is the actuality that many companies can’t afford to pay workers more, as they operate on razor-thin profit margins. Grocery stores, for example, survive on margins of just 2 percent. They only profit due to the sheer volume of product sold.
Raising the minimum wage, therefore, can place immense strain on businesses, particularly on smaller businesses that do not move that kind of volume. One might even argue that raising the minimum serves the interests of big corporations by eliminating weaker competition.
With such margins, something has to give. Indeed, the classical Econ 101 model would argue that we already have a minimum wage, one that is set by the supply and demand for workers in a market. More employees and lower demand, wages go down, fewer employees, and more open jobs, wages go up.
Simple economics also tells us that a price control, like a MW, distorts the market; either prices must rise and/or some people will end up unemployed. The issue is this Econ 101 view is overly simplistic. In many markets, we have a monopsony problem.
The Monopsony Problem
Monopsony is the opposite of a monopoly. Instead of one company controlling the supply of something, in a monopsony, one company controls the demand. In this case, the demand for workers. Monopsony is common in small towns where there might be one or two dominant employers who control the “market price” of wages. The dominant players can unfairly suppress wages below a market equilibrium.
In markets plagued by monopsony, a MW beneficially corrects market distortions. This is why research shows that raising the minimum wage may not cause as much unemployment or inflation, as previously thought.
Why not then double or triple the minimum wage? Would this not then eliminate poverty, improve livelihoods, with no negative consequences? Of course not, there is never a free lunch. A national, or even state-level MW law is a blunt instrument that forces a single price control across all industries, employee skill sets, and localities. Doubling or tripling the wage overnight, for example, would be economically catastrophic, and may leave employees worse off.
Some studies have found that raising the MW forces employers to think more strategically about employee scheduling. While they comply with the law and pay more per hour, they cut hours per employee, often just beneath the threshold required to provide benefits. In effect, raising the MW left many employees worse off.
In 2019, the CBO estimated that a federal minimum wage increase from $7.25 to $15.00 would reduce total employment by about 1.3 million workers and would only reduce poverty by half of a percentage point.
Sure, a modest MW hike might help some people in some circumstances. But as the data above suggests, it would do little to address poverty. The MW doesn’t alleviate poverty because most people in poverty do not work or work too few hours to benefit, while those that do work are at risk of losing their jobs because of it.
This is all to say that the effects of raising the MW are complicated and its usefulness debatable.
I have previously written how a Negative Income Tax (NIT), a form of UBI that provides an income floor for everyone, might replace most of the existing welfare infrastructure. But a properly designed NIT might also eliminate the need to have an MW altogether. Unlike the minimum wage an NIT could eliminate poverty because it is targeted in a way that the MW is not. It would also eliminate the welfare traps that keep people in poverty.
Now, an NIT would not be without its own issues. One concern is that the NIT might be “captured” by businesses in the form of reduced wages. But on the flip side, an NIT could actually prop up wages, giving workers more leverage over employers by raising their “reservation wage.” With a stable and predictable amount of cash in hand every month, employees would have more bargaining power without the need for unions. This may offset any corporate capture.
While an NIT might be a better way of assisting the poor, it’s not enough to dramatically improve people’s livelihoods. Instead of focusing solely on wages, it would behoove us to simultaneously address the cost of living. For example, zoning reform can drive down housing costs, healthcare reform could make healthcare more affordable, and ISAs could address spiraling tuition costs in higher education.
Unlocking the full productive spirit of the disenfranchised requires more than political soundbites, it requires confronting the deepest demons and powerful interests in society. It requires creative thinking and acceptance that while no policy is perfect, some are better than others.