Friday, 30 August 2013

Why The Minimum Wage Is More Costly Than Beneficial

In my last Blog I proposed an interesting way that employment laws conceal hidden costs that impair those they are supposed to protect. On a more general level, what's also strange to me is the extent to which in everyday life things are often automatically assumed to be good, just because it's easy to focus on the headline-grabbing positives while overlooking, or not understanding, what lies beneath. When you hear that the law imposes a compulsory work break on employees, it sounds like a good headline-grabbing positive, because it appears to guard against employers denying people their rightful break time. But in reality, in a competitive market where supply and demand applies to labour as well as goods, no firm in the UK would last very long if they imposed a 'no breaks' policy on their staff (even if such a thing was legal) - so the law is largely superfluous in that matter. With that in mind, let's look at another policy in which a supposed headline-grabbing positive overlooks the hidden costs that lie beneath. I'm talking about the minimum wage.

In a famous parable in the second book of Samuel in the Old Testament, Nathan conveys to King David an illustration of a rich man who took away the one little ewe lamb belonging to his poor neighbour. David responded with indignation and disgust until realising that the illustration was actually an indictment against him for his actions regarding the death of Uriah the Hittite and the impregnation of his wife Bathsheba. Here's my own little parable for people (including a great many politicians) who think the minimum wage is a good thing overall.

In a town called Beansville there are lots of harsh winds that damage the town on a regular basis. When this happens there is always a regular group of volunteers (comprising 10% of the population) who on top of their regular jobs spend time clearing up the mess and repairing the damage, while the other 90% go about their business. Out of the blue the Mayor of Beansville declares that even more time needs to be dedicated to clearing up after the harsh winds, and that the people to take on this extra voluntary work should be the 10% of people in Beansville already volunteering.

If you told that parable to a minimum wage-endorsing MP he or she would almost certainly be outraged at the Mayor of Beansville's inequitable policy. But just like King David, the MP should be remorseful and contrite because the Beansville policy serves as a good indictment against the MP's support of the minimum wage. Here's why. Should we decide that the extra burden ought to fall on those people in Beansville already volunteering? Or should we decide that everyone else ought to muck in as well? I think most sensible, fair-minded people would agree that it should be shared more evenly, not all heaped on a small segment of that society. Why, then, do so many people support the minimum wage, when the policy is more or less as skewed and injudicious as the Mayor of Beansville's policy? Or to put it another way, if we're going to give low-earners a boost, why do so many people fail to realise that it is unfair to place the entire cost of that boost onto the small percentage of the population that employs low-paid workers? The prudent and fairest thing to do is to spread the cost among all of us - which can be done through a taxation that is passed on to low-earners in the shape of tax credit for low-earners, or probably even better, lower personal tax thresholds for low-earners. That in a nutshell is why the minimum wage is not a good policy overall - it unfairly heaps the burden on a small segment of society - a small segment, you may note, that is outweighed by a much bigger majority in terms of potential voters.

Consider some analogous examples; we don't expect the entire burden of our navy bill to fall only on a few people, nor our health bill, nor our parks, nor our roads and streetlights - we expect the cost to be broadly shared through taxation. The same applies (or should apply) to the minimum wage - if we want to do something for low earners we should share the cost. Let me state it in the most compelling way. Poundland, Bernard Matthews, McDonald's, Burger King, KFC and similar such businesses employ a few thousand low-skilled, low-paid workers in your region - all of whom are better off than they would be on the dole (which makes us all slightly better off). So Poundland, Bernard Matthews, McDonald's, Burger King, KFC and similar such businesses are all doing something for low-skilled, low-paid workers. What, on the other hand, have you or I done for low-skilled, low-paid workers recently? 'Not much' would be my guess - so if it's desirable to do something more for low-skilled, low-paid workers, maybe it's our turn rather than the turn of Poundland, Bernard Matthews, McDonald’s, Burger King, KFC and similar such businesses, who are already doing their bit.

You might argue that our navy, health bill, parks, roads and streetlights are all public goods and services, which is why we pay for them in taxes, and that Poundland, Bernard Matthews, McDonald’s, Burger King, KFC and similar such businesses are privately owned and do not need subsidising. But that misses the point; those who support the idea of a better wage for low-paid earners (which seems to be everyone on the left, and a great many on the right) are doing so precisely because they consider it to be a public good, so the objection is remiss. And further, if you think low-paid workers are being ripped off by wealthy companies earning heavily from their labour, you'll pleased to know that one of the basic rules of economics is that the very nature of low-skilled labour is that it is easily transferable from person to person, and that because of the forces of competition, the wages of low-skilled workers are dictated by the marginal product of that labour.

It's true that the minimum wage has so-called positives (at least they're claimed to be positives by minimum wage proponents); it increases living standards for the poorest in society, and it increases the incentive for people to get back to work. But it does no good to simply endorse a policy based only on its qualities, without considering the negatives, and whether they outweigh the things in its favour. One might argue that the ill-effects of the minimum wage are more detrimental to the economy. The minimum wage has positives, but as well as unfairly loading the burden on firms that employ low earners, it also encroaches on low end business, it reduces job availability, and it often causes inflation of prices as firms try to recoup their losses on increased wages. A minimum wage does two further things. It shifts capital from employers in an unstable competitive market to low paid workers, and it induces some employers to let their staff go because they cannot afford the wages. If you’re getting £7 per hour and only bringing £6 per hour worth of benefits to your company, you’ll likely find yourself on the dole. If you are a lower paid man or woman going from here to there in different jobs, you will find less work available with every rise in the minimum wage – and the higher the rate the more unemployment. This might amount to a road block for young, unskilled workers and the unemployed – which is why tax credits are a more effective method because they target those who have children or high level benefits, and need high wages to make it worth their while signing off benefits, but who don’t have the skills or experience to command that kind of salary.

One of the other golden rules of economics is that if you limit the use of monies you limit transactions too, because money brings about increased opportunity for trade. Minimum wage restrictions are an example of constraining trade by indirectly discouraging the use of money against the natural 'invisible hand' mechanism of supply and demand. Here's a simple illustration to show why this applies to the minimum wage. If I want to pay someone to do my gardening for me at a rate of £4.50 per hour, the law says I'm not allowed to. Yet the law doesn't prohibit me from saving £4.50 by doing gardening myself for an hour. So the law is an imposition precisely for the person it's claimed to protect - the gardener who needs the £4.50 an hour - which, if I don't want to do the gardening myself, then only encourages cash-in-hand tax-avoiding payments. Income taxes have a similar effect. Suppose I am willing to pay no more than £12 per hour to have some work done, and the workmen at the lowest rates are willing to do the work for anything over £10 per hour. That being the case I should have success in finding someone to do the job. But once the Government imposes 20% income tax, things change, because now the most the workmen can earn from me is £9.60 per hour, which means they'd be unwilling to do the job for me. This can mean that we all forcibly pay more - but quite often it doesn't, it means we try to get things done cash-in-hand on the cheap, or do more ourselves inexpertly.

Obviously it's easy to extol the virtues of income tax, but as you can see, it provides a good analogue for how the minimum wage constrains trade, as it has negative effects beyond involuntary payments, despite being a beneficial policy overall. I can't say the same about the minimum wage - its negative effects outweigh the positives to the extent that it is a bad policy to endorse. These are what are technically referred to as invisible deadweight costs - they restrict trade and transfer of money, and they damage employment prospects - but yet they are always sold as headline-grabbing positives by politicians. I think we shouldn't be surprised, though, that the Government wants to unfairly heap the low-wage burden on a small segment of society that is outweighed by a much bigger majority in terms of potential voters. Invisible costs occurring for the sake of vote-winning visible benefits are music to most politicians' ears.

* Photo courtesy of