President Joe Biden in the state of the union address called for a $15 minimum wage along with pushing against and calling out corporations for spreading inflation. Raising the minimum wage, along with the fallacy that increased government spending brings growth, lies at the heart of the interventionist agenda.
As inflation begins to skyrocket, it’s useful to understand, that the rising minimum wage has played its respective share in this event. A total of 74 states, cities, and counties raised their minimum wage during 2021, according to the National Employment Law Project, which is still tabulating the number for 2022 but expects it to be about the same. In Arizona, for instance, the minimum hourly wage in 2022 is $12.80, up from $12.15 this year. It inched up only 15 cents for 2021. The minimum hourly wage for workers in Colorado is $12.56 today, compared with $12.32 last year. And the minimum hourly wage in California has risen to $14.00, up from $13.00
The case advanced for a minimum wage relies on the macroeconomic reasoning where an increase in wages would lead to a rise in disposable income, and this increased disposable income would lead to increased expenditures which, through the multiplier effect, would increase the overall aggregate demand of the economy.
While this logic may seem sound in isolation, it is fundamentally divorced from the wisdom that the economy is an interconnected web of markets where each individual’s life is affected by the actions of all other individuals and every action has an immediate visible, and many invisible, effects. Therefore, when the income of already employed workers increases due to the increase of the baseline pay, the interconnectedness of labor markets would put upward pressure on every other market, which in due course leads to increasing costs to producers.
This higher wage cost leads them to raise their prices, which lowers the purchasing power of consumers. Most employers who employ minimum wage workers have competitive gross margins where rising costs without raising prices to cause them to lose their prior profitability which is their cushion against ever-present uncertainty.
Rising prices has its immediate impact on less-skilled people who spend mostly on fast-moving and non-durable consumer goods. They would experience inflation and find their budgets (i.e., real incomes) reduced because the increased demand which is generated as a result of the artificially increased wages would find its way through the market where it would be greater than the real supply.
Then arises the problem of unemployment. Most people view minimum wage as a base for every wage; therefore, when the base is increased, all other wages would increase too. But if we keep in mind the interconnectedness of markets, this idea inevitably becomes a fallacy.
Employers in an economy are continuously seeking to attract workers from other employers by bidding up wages and benefits for them. The wage of a worker is not an absolute measure of his value, but an indication of his relative value to the employer due to labor’s scarcity in the face of the employer’s need, or demand. The employer seeks to pay the additionally hired worker in line with the additional productivity he would generate in the business.
The higher the general level of wages, the more the employer needs to bid to hire the additional worker, and the employer consequently must demand higher productivity. The minimum wage thus creates an obstacle over which the worker needs to jump to get the job in terms of his/her skill and productivity. This obstacle makes it more difficult for people to be employed as minimum wage increases, and as minimum wages are paid to either teenagers who are starting out their careers or to lower-skilled people. It becomes clear, then, that the higher the minimum wage, the more difficult it will be for them to get a job, which leads to a rise in unemployment in that demographic, which would otherwise experience lower unemployment.
While this effect of the interventionist scheme would be visible, there are also invisible effects that wouldn’t be noticed at first. These would take the form of decreased investment in growing areas with naturally high prices, while resources would be poured into artificially inflated sectors.
Prices play a key role in signaling coordination and efficient allocation of resources. When an object becomes scarce in the market, an increase in its price instructs consumers to economize on it while asking producers to employ their resources on increasing its supply.
But rising prices that take place due to an increased minimum wage destroy this efficient mechanism, as entrepreneurs must then invest where rising prices wouldn’t reflect true market conditions. This makes them lose out on profit opportunities by being misguided into spending on unprofitable areas.
Genuine market demand and scarcity still exist. The minimum wage thus acts as a signal which misdirects the employment of resources, leading producers to make inefficient choices and allocate resources erroneously.
Thus, an increase in the minimum wage causes unemployment for workers and makes consumers worse off as their real demands would remain unfulfilled, while the artificial price increase acts as a tax levied on them, reducing their purchasing power. Therefore, the call for doubling the minimum wage and expecting the companies to lower costs is a daydream which would hurt every sector of the economy, be it workers, consumers, or employers. At the same time, we should remember that the increased minimum wages which have taken place not backed by increases in real goods have contributed to the historic rise in prices seen today.