Price Floor the Minimum Wage

Price Floor

The minimum wage was created in 1938 with the enactment of the Fair Labor Standards Act. The hourly wage was initially set at twenty-five cents per hour. Today, the minimum wage sits at $7.25, up from just $5.15 in 2006. While some have pushed for the increases to the minimum wage, others have gone in the other direction and argued for the minimum wage to be repealed altogether. Both sides utilize a myriad of arguments, both economic and non-economic to justify their positions. I will argue that the minimum wage floor should not be repealed.

No matter what view of the minimum wage is taken, the floor represents a distortion in the price of labor, which for many businesses is one of their key inputs. In light of the near limitless other market distortions present in the United States, including ones that directly impact the cost of labor (ex. The structure of the health care system), it is unreasonable to single out the minimum wage for any particular scorn. However, any distortion will have an impact on the way the market functions. Deciding what to do about the minimum wage ultimately boils down to an examination of the benefits and costs of the floor.

The price floor impacts the cost of doing business for employers. In a perfect market, the worker's wage would be determined by the worker's productivity. If the minimum wage is increased without a corresponding increase in worker productivity, then more workers at the low end of the wage scale become unprofitable. The predicted result is a decrease in demand for such low end workers (Henderson, 2006).

This trend is often depicting with a gently sloping concave curve. The skin-deep analysis considers that demand for minimum wage workers would fall to zero if the minimum wage were raised to a sufficiently high point. It is worth considering, however, the point where the demand for minimum wage workers reaches its minimum. Minimum wage workers tend to be employed disproportionately in service industries. Their jobs cannot be easily offshored, so there is a demand floor for minimum wage workers. If the current demand is above that floor, an increase in minimum wage would result in a slight decrease in demand for minimum wage workers. However, the decease in demand is mitigated to a significant degree by not only the demand floor but by the lack of unskilled workers willing to fill minimum wage positions. In many parts of the nation -- current recession notwithstanding -- even fast food outlets must pay higher than the minimum wage to attract workers. Companies that benefit in other ways from higher wages are already paying those wages (Krugman, 1998)

For workers, an increase in the minimum wage means better wages for most. In areas where unemployment rates are already high, some minimum wage workers would not only lose their jobs but may have difficulty finding new ones. The hardest hit by unemployment are young workers.

This raises an interesting point about long-term equilibrium. If young workers struggle to find work at the minimum wage, more will be encouraged to further their education so that they can find jobs in sectors where jobs do exist. For companies, raising the minimum wage makes them less competitive on the world market. But American companies competing against China and the Third World on the basis of cost are doomed to lose anyway. Increasing the minimum wage forces American companies to adopt a differentiated strategy, competing on the basis of innovation, development, and creativity. This is the case in northern Europe and Canada, where minimum wages are more or less reserved for students. Over the long run, American companies are forced to turn to innovation and American workers are driven to improve their education. Only in the short run do you see suffering in terms of job losses among workers who refuse to upgrade their skills and companies who insist on competing on the basis of price against foreign firms with deeply-embedded cost advantages.

If the price floor were eliminated, the American economy would ultimately suffer. In the short run, firms would be able to hire more people, but at lower wages. This would create jobs, but would have a negligible impact on purchasing power as companies would not spend more on wages, just spread their wages around to more people. There would be significant downward pressure on real wages. For many firms, however, competing on cost is a non-starter. Manufacturing companies often cannot sell at lower prices than the Chinese if they paid their workers nothing. There is little economic value in winning the race to the bottom, at least not for an established economy.

For unskilled workers, the downward pressure on real wages would likely drive many to the welfare rolls. Aside from young workers, minimum wage workers are not the most motivated of employees at the best of times. Reducing their wages will convince many to drop out of the workforce altogether. Sadly, this will not come through an increase in skills. The shortage of workers will make it difficult for firms to expand. Those that do stay in a low wage environment are often caught in a vicious cycle of high turnover and low productivity (National Council of Churches, 2006). The psychological impact of a downward drift in the minimum wage would only serve to exacerbate that problem, as workers find themselves and their devalued. There is little incentive to work harder, if doing so will price them out of a job.