Thursday, July 12, 2012

Minimum Wage and Vacuum Cleaners

As it happens with many other economic fallacies, the one about the necessity of a "minimum wage" seems to withstand the most relentless of attacks by economic reality and economic theory, yet try we must to dispel the myth.

Most people of good conscience feel that the imposition of a minimum wage (sometimes called the "living wage") by government is justified because the morality of it is self-evident. Shouldn't a person obtain a wage that reflects fairly the labor he or she produces? For waking up early and going to work for 8 hours a day? How dare employers not compensate their employers for their exploitation?

In reality, minimum wage laws have the effect of keeping people unemployed for a longer time than they would otherwise, because most low-wage jobs are entry-level jobs usually filled by the young and the inexperienced and not by the heads of households that have to pay mortgage, utilities, wife, kids and the dog. There's really no good reason for pricing these folks above what the market is willing to pay for the production that they're able to trade, as doing so will keep them out of the labor market until they - somehow - obtain the skills and experience necessary to price their labor better.

Still, lots of people cling to the notion that imposing a minimum wage helps workers by allowing them a more "deserving" compensation for their labor. The reason they would believe this is that people apply their own subjective valuation as moral imperative, so it becomes easy for them to conclude that a wage considered (subjectively) "low" is in reality something that could only come as a manifestation of an immoral soul, from a selfish miser or a curmudgeonly misanthrope. Unfortunately, this muddling of morality and economics is what allows politicians to convince enough people of the moral case for imposing a minimum wage regardless of very real economic effects of such imposition, such as intervening on the voluntary relationship between two willing individuals; or regardless of the immorality of pricing someone's labor by fiat, not unlike imposing a price floor or a price cap on goods.

You probably have heard or read the counterargument that minimum wage laws do not really create unemployment because, after all, business owners would still employ someone rather than doing the work themselves. What is being ignored in that case is that employers make decisions at the margin, meaning that they will consider the marginal value of someone's labor compared to the cost of adding one more employee, and if the marginal cost exceeds the employer's expected utility for adding that one more worker, the employer will then abstain from hiring that one additional worker. There's also the fact that employers will consider the Opportunity Cost of doing the job themselves compared to having someone else doing it, and if the cost of employing an additional employee is higher than keeping the current number of workers or doing the work himself, then the employee will not hire any more workers and simply demand more productivity from his current workers. Worse, if the marginal utility of the least trained of his current workers cannot meet the cost of an increase in the minimum wage, then that employer could decide to fire that worker which automatically raises the unemployment level.

Let me give you an easy analogy to help you understand the role that Opportunity Cost and Marginal Utility play in making economic decisions related to the cost of labor:

There's little question that vacuum cleaners made by the Dyson company are possibly the best home vacuum cleaners ever designed and made. There's also little question they're possibly the most expensive vacuum cleaners in the market today, some going for as much as $500.00 USD. There are plenty of competing vacuum cleaners in the market that have not only a much lower price, they can arguably perform a decent job of cleaning carpets even if not at the same level of efficiency as a Dyson.

One can also say that the Dyson is a more productive machine than many other vacuum cleaners of similar capacity, even if being of an older design or of less quality, yet of a lower cost. However, for most homes, a lesser vacuum cleaner will do the job just as well. This is what in economics is called the law of Comparative Advantage: There are things one person of lesser-productivity can still do better for the cost than a person of higher-productivity. A young and inexperienced high school drop-out can probably wash a few less dishes per hour than a highly-educated efficiency expert, but the lower wage the inexperienced and young worker will obtain makes him more cost-effective for the required productive output than the highly-paid efficiency expert. The same can be said about the different vacuum cleaners compared to the Dyson. At the margin, a vacuum cleaner that does a decent job of sucking dust out of carpets but at a lower cost than a Dyson will have the economic advantage, and more people will likely choose the lesser vacuum cleaners for the (mostly) light-cleaning jobs. People that need a vacuum cleaner that packs a greater punch for a bigger job will most likely choose the Dyson.

Now, imagine that the Government decides to impose a Minimum Vacuum Cleaner Price that is only $10.00 dollars less than the price of a Dyson. Now there's no real advantage in price between the vacuum cleaners and the Dyson.

Do you think people would still choose the less productive vacuum cleaners over the Dyson? The problem is that the Government now made the Opportunity Cost of not choosing the Dyson much higher than it would have been if the prices of all the other vacuum cleaners be allowed to move up or down freely. People would thus, most of the time, choose the Dyson over the other vacuum cleaners even when the Dyson may really be too good for the job, only because it would now offer more value for the money compared to the other (suddenly) equally-priced vacuum cleaners. This would make the price of the Dyson go up because of increased demand, whereas the price of the other vacuum cleaners would not be allowed to go down despite the sudden lower demand, thus placing them at an immediate disadvantage in the market. People that cannot afford a Dyson before will not afford to buy ANY vacuum cleaner now, which means they will have to do without.

A similar phenomenon occurs because of minimum-wage laws: As the price of labor is not allowed to move freely, employers will end up choosing more qualified employees as their opportunity cost increases. Employers would end up bidding the price of more qualified employees above normal market price, leaving those less qualified with either a wage that does not increase with improving productivity or, worse, unemployed. If a person cannot afford an artificially expesive vacuum cleaner, he or she will certainly not afford an artificially expensive worker. Hence the unemployment rate among youths and the inexperienced, especially among minorities.

Some economists, especially those that subscribe to socialist ideas, will argue that the price for labor is different than the price for many other things. In fact, these economists are simply engaging in moralizing as there is no reason why labor - a commodity subject to the Law of Scarcity - would be suddenly immune to the Law of Supply and Demand. But the simply fact is that a wage is a PRICE, set by the two people making the deal of exchanging one commodity for another, in this case: labor for money.

An often-mentioned argument is that minimum wage increases have a positive effect on overall productivity. Economists on the left will even show the studies to prove it. But if you consider again the analogy of the vacuum cleaners, you will spot the basic fallacy in their conclusion, which is that if you stop buying the less expensive vacuum cleaners and buy the more expensive vacuum cleaners, the overall productivity of the sucking of dirt will improve considerably more. However, that does not mean all vacuum-cleaners suddenly became more productive, only that the only vacuum-cleaners being used now are of better quality than what you would see without the price floor. That certainly does not translate to more overall cleanliness since there will be considerably less vacuum-cleaners doing the job. Thus the improvement in productivity is only illusory, not unlike stating that you can improve the height of people by killing all the short people.

It is NOT easy to make a case against the minimum wage when people are so quick to give a moral spin to labor itself, so much in fact that some will even find the commoditization of labor abhorrent. But one important argument against minimum wage laws is that they will hinder and destroy the opportunity of many young and inexperienced men and women to find a job which not only allow them to earn a wage, but also give them the necessary skills required for future and more fruitful endeavors. Besides, it is immoral to hinder a person's freedom to SELL his labor at whatever price he or she deems acceptable, just like it would be immoral to force vacuum cleaner manufacturers to price their vacuum cleaners the same as a Dyson, for the labor is owned by that person and not someone else.

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