The Minimum Wage's Dirty Little Secret; D. Laband

TREmEEMAN IDEASON LIBERTY The Minimum Wage's DirtyLittleSecret by David N. Laband T he current Administration and their pals in the Congress only too obviously think that boosting the minimumwage by 90 cents per hour over the next two years is good politics (ifbad economics). They are demon strably wrong. This battle plan for "help ing" lower-income Americans in the class warfare that dominates a partisan retro 1960s mindset is in reality a blueprint for failure and worse. The inevitable results of an increase in the minimum wage will be to further disadvantage the least-skilled, low est-paid workers in America and increase employment and earnings among the most skilled, well-paid workers. Let's start with the obvious: an increase in the minimum wage is not going to directly help many of the least-skilled workers. Only 4 percent of hourly workers in America currently earn minimum wage. These indi viduals bring few, if any, skills to the work place; they acquire job skills via on-the-job training provided by their employers. In the face of a 21 percent increase in their unit labor cost, some employers of unskilled labor will react by unhiring these individu als. No doubt, the individuals who do not get fired will appreciate the political effort as their nominal wages will increase. How ever, the unfortunate ones who end up in the David Laband is Professor of Economics at Auburn University in Auburn, Alabama.

ranks of the unemployed may feel differ ently. While this disemployment effect among unskilled labor of increases in the minimum wage is widely recognized among econo mists, what is not so apparent is that the employability of these workers has been diminished, by virtue of reduced opportu nities to develop job skills. It is harder to get a second job based on skills developed on one's first job, if one doesn't get a first job. This surely will result in an increased dura tion of unemployment among unskilled workers. The redistributive effects among unskilled workers of an increase in the minimumwage are, in the aggregate, trivial in comparison to the redistributive effects among more skilled workers and providers of capital. Consider the reaction of an individual who has been working for several months or years and who has developed job ~kills that an employer finds valuable enough'to justify paying him $5.15 per hour. After the pro posed increases are fully in place, this indi vidual willbe paid the same as someone with no job skills. From his perspective, there appears to have been no differential reward to acquiring his job skills. Upset about this, he petitions his employer (or his union petitions the employer) to raise his wages. In so doing, of course, another round of wage increase requests by workers earning $6.00 per hour will be touched off, and so on. In 567 568 THE FREEMAN • SEPTEMBER 1995 a nutshell, an increase in the minimum wage incites a ratcheting up of wages that affects millions of workers earning more than min imum wage.

There are three principal effects of this general increase in wage compensation: 1. Employers will tend to reduce non wage compensation in an effort to minimize their overall production costs. That is, em ployer-provided benefits are a casualty of increases in the minimum wage. 2. As labor costs (generally) rise, produc ers will hire less labor and more capital. There is no worse time for labor generally (and unskilled labor specifically) to contem plate an increase in the minimum wage than when technological advances are reducing the cost of capital. The high cost of middle management labor combined with rapid re ductions in the cost of computer-processed information was the drivingforce behind the corporate restructuring of the late 1980sand early 1990s that put hundreds of thousands of white-collar workers in the unemploy ment lines. 3. Although it may appear that ratch eted-up wages benefit lower-wage employ ees, the appearance is deceptive. In the long run, less-skilled workers are disproportion ately harmed by artificially induced in creases in wages. An example illustrates the argument.

Suppose the minimum wage rises from $4.25 per hour to $5.15 per hour (a slightly more than 21 percent increase). Assume that the increase does not trigger offsetting cuts in employer-provided benefits and that wages "ratchet-up" the labor force in an amount exactly equal to the increase in the minimum wage. That is, workers who used to •earn $9.00 per hour before the increased minimum wage earn $9.90per hour after the minimum wage has officially been raised; those who earned $18.00 per hour before earn $18.90 after, and so on. From the standpoint of employers, a 90 cent' per hour increase in wages represents a proportionately larger increase in labor costs of unskilled or low-skilled workers than of high-skilled workers. The increase from $9.00per hour to $9.90represents a 10 percent increase in labor costs; the increase from $18.00 per hour to $18.90 per hour reflects a 5 percent increase in labor costs.

If the productivity of labor has not changed at all (and none of the discussion of the benefits of raising the minimum wage even ,touches on the subject of productivity), employers have every incentive to substi tute more productive, higher-wage labor for less productive, lower-wage labor. Both the substitution of lower-cost capital for higher-cost labor and the substitution of higher-skilled labor for lower-skilled labor seriously mitigate any purported benefits of a hike in the minimumwage. With respect to the substitution of capital for labor, there is both a direct effect on labor markets and a resulting indirect effect. As firms increas ingly use machines in their production pro cesses, the production and management of the new technology require an increasingly skilledlabor force. This drives employers on the margin to favor highly.educated and skilled workers over less well-educated, less-skilled workers, since the former are more productive than the latter.

Separately, the differential (proportion ate) cost impact of a hike in the minimum wage causes employers to favor highly educated and skilled workers over less well educated, less-skilled workers; the former are less costly than the latter. Both tenden cies add fuel to the job-market emphasis on highly-educated, highly-skilled labor, to the detriment of the uneducated, unskilled com ponent of the labor market (Le., the very component liberal politicians and theorists profess so much compassion for, so much so that they claim this compassion defines the difference between them and their conser vative counterparts). Put bluntly, the politically sponsored in creases in the minimum wage are partly responsible for the much-ballyhooed in creasing income inequality in America, which politicians then claim demands cor rective action. This is a case of medicine causing a disease that politicians then seek to cure with more of the same medicine. A better course of treatment would be to fire the doctors. D A Matter of Principle Persuasion or Popularity?