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“Living Wage” Hurts the Poor

BY LEN CABRERA / MAY 7, 2019

Anyone who has ever taught in a classroom can tell you how frustrating it is when someone just doesn’t “get it.” You try every different approach you can to get someone to understand a basic concept, but if the student can’t figure it out, they can’t get anything else that comes after.

Dealing with “living wage” advocates is equally frustrating. There are many economic models that show why an artificially-mandated wage is bad. The basic supply and demand graph most people learned in high school shows that a price floor set above the market price results in a decrease in quantity demanded. For a minimum wage, that means some people will earn a higher wage, but there will be fewer people earning it (or decreased labor hours negating the higher wage).

Typically, the jobs affected by minimum wage are low-skilled, entry-level jobs. Those who can’t work because of the minimum wage will not be able to gain work experience and will end up in an unemployment trap created by the minimum wage law intended to help them.

There are plenty of cities and states run by politicians who don’t know basic economics, or at least who suspect their constituents don’t understand economics, so they promise to raise the minimum wage to get elected. This provides great case studies to back up the economic models. CNBC reported on a survey of 173 restaurants affected by recent minimum wage increases that showed 64% of the restaurants reduced employee hours and 43% eliminated jobs.

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The supply and demand graph demonstrates this with a picture, but if you prefer math, you get the same result whether a firm’s objective is to minimize costs or maximize profits. In either case, businesses prosper when all inputs to production (typically simplified to labor and capital) have equal marginal productivity per dollar (in other words, all inputs experience the same increase in productivity for each dollar invested in that input). If anything changes the relationship, the firm will take actions to restore the equality. A higher wage for the same work doesn’t increase productivity, so the business will shift its input balance to rely more on capital. (You can see the math here.)

McDonald’s has been doing just that in anticipation of a minimum wage increase. That’s why  McDonald’s said it will no longer participate in lobbying efforts against raising the minimum wage, according to CNBC. McDonald’s has protected itself by installing self-order kiosks and automated cooking machines that will give it an advantage over its competitors if labor costs increase. 

When you understand the economics, you’re less susceptible to the emotional rhetoric of those who want to raise the minimum wage. Unfortunately, since they don’t understand the economics of price controls, they don’t realize that their policies actually hurt the people they claim they want to help.

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