The Destructive Minimum Wage

If you ask anyone what happens to demand for a good or service if price increases, they will logically tell you that demand decreases. Yet when it comes to the minimum wage (MW), proponents claim there is little to no effect on employment. Could it be? In every other market, higher prices results in less demand, yet in the labour market, government imposed higher wages have little effect?

Fast food workers in the US go on strike demanding a $15 minimum wage

In this post I will explain why most academic studies in economics are unreliable, how the service sector will be impacted by higher labour costs and other problems with the pro-MW argument.

Why academic studies are flawed

The mainstream economic profession believes that they can measure and predict the economic effects of policy change. They usually create regression models to test the effect of independent variables on dependent variables. In the real world, the economy is a dynamic environment with numerous forces acting on prices (inflation, interest rates, fiscal policy, consumer preferences, trade, weather and seasonality etc.). It is almost impossible to accurately model the behaviour of an economy comprising of millions of individual people and transactions. Yet the illusion continues because the mainstream economists see their field as a science like physics. Therefore, they embrace mathematical models to the detriment of dull archaic theory or praxeology.

Take this example of Andrew Leigh’s (now an Australian Federal Labor Party MP) study of Western Australia’s MW increases on employment. He concludes “After each if these increases, the employment to population ratio in Western Australia fell, relative to the Rest of Australia. Aggregating these six changes, the elasticity of labour demand with respect to the Western Australian statutory minimum wage is estimated to be -0.13. The employment impact is most substantial among younger employees, with the elasticity of labour demand for workers aged 15-24 estimated at -0.39.”

I do not want to dismiss the attempt at measuring the effect of an increase in the MW but we all know what the effect was going to be, this study was aimed at measuring the magnitude of the change.

Empiricism is useful to an extent; however I would always place praxeological theory above empirical or model driven evidence.  If the empirical results showed that increases in the MW actually increases employment, I guarantee there would be economists rejecting the law of demand and supply in the labour market. Unfortunately, these economists harm the integrity of economics by supporting preposterous claims to support a socialist political bias. I have always applied the common sense rule to economics which is just logic combined with fundamental principles such as higher prices results in less demand. Complicating issues just causes more spurious results and false policy prescriptions.

The service sector is not immune from higher labour costs 

The MW will affect industry sectors differently. For example, manufacturing workers are competing globally with foreign workers and capital. Any government mandated increase in wages will result in a loss of competitiveness ceteris paribus. However, the service sector is somewhat protected from competition because many services cannot be imported or exported. The classic example is haircuts because even though China has low labour costs it cannot export haircuts. Once again the free-market will always find a way to undermine government interference. We are seeing an increase in what is known as Labour-Capital Substitution, which is basically people being replaced by automated machines.

I went into Australia Post (AusPost) today and saw a newly installed self-serve machine. Yes even a government owned business is finally making the switch! I say this because the same self-serve machines have been in major supermarkets for a few years now. We saw this first in retail banking when bank tellers were being replaced by ATMs. Eventually banks are going to be entirely self-serve with a few staff on hand to handle more complex services. Going back a few decades, petrol stations had attendants who would fill your tank. Now that wages are too high, it has become self-serve which is a reduction in the quality of the service.

Behold the Postmaster9000

New Australia Post self-service machines

I would have used the self-service machines if it required no AusPost employee to finalise the lodgement. The first time I tried to send a parcel via registered post, it told me to wait for an Australia Post employee. It actually took me longer to use self-serve than just go to the counter and lodge it the old-fashion way.

Coincidentally, while I was standing in line one of the AusPost employees asked the elderly lady behind me if she would like to use the self-serve machines and this is what she said, "I don't want to put anyone out of a job". I felt like turning around and explaining to her the benefits of labour saving devices, the benefits of increased productivity and the fact that in a free-market economy there is always demand for labour... I decided to bite my tongue.

This display of economic ignorance by Luddites is pervasive throughout society. Never mind that despite centuries of technological advancement and machines replacing labour, we continue to prosper and that adoption of labour savings devices have not led to mass unemployment. This is the challenge that faces economists in explaining these matters to people who see the intended consequences and are blind to the unintended consequences. Of course it is not the fault of the economic ignorant, but it does epitomise the reason why economically destructive policies like the MW remain popular.

Early adoption of self-serve is slow to say the least

Clearly unskilled and low-skilled work will be under constant threat by machines that do not require sick leave, annual leave and will not ask for higher wages to work on weekends. The service sector is undergoing this paradigm shift and it will be Australia leading the implementation of machines and robots given the exorbitant cost of labour. This will be appreciated by consumers enjoying lower prices.

A different perspective

MW supporters always look at the policy from the workers perspective with phrases such as a “living wage” and “a fair day’s wage for a fair day’s work” tossed into the debate like a moral trump card. One just has to think of it from an employer’s perspective which is what most economists and other pundits who are pro-MW fail to do. When faced with a government mandated increase in labour costs, the business making slim profits has few options:

• The employer reduces costs by cutting the most unproductive staff and works existing staff harder
• The employer reduces staff and outsources/offshores the operation, or employs machines instead of labour
• The business becomes unprofitable and shuts down. The end result being less output (thus higher prices) and unemployed people
• In rare cases, the employer maintains profit margins by passing on the higher labour costs through higher prices, causing a lower quantity demanded. However, the industries that tend to employ unskilled workers usually have products which are very price sensitive or which have a high price elasticity

In all options either unemployment occurs or prices increase. I purposely looked at a business that is marginally profitable because more profitable business can absorb the cost. Cost absorption is negative because a less profitable business will find it more difficult to attract investment capital in the future and lower profits means the value of the business also declines.

One size fits all

The other problem with the MW is the one size fits all approach. For example, average wages in the Northern Territory or Tasmania are lower than average wages in New South Wales or Victoria given the higher cost of living in the latter states, yet they all have the same minimum wage. Clearly the minimum wage in Sydney is less of a burden than the same minimum wage in rural Tasmania. This is just one example of how a top-down approach or centrally planned economy causes inefficiencies to arise.

Neo-Marxist prejudice

The worst rebuttal I have heard is that without a MW, the unskilled will be paid $1/hr or a pittance as the greedy capitalist drives down the price of labour. This is a slippery slope argument, which will not occur. If the MW was removed, wages may fall but just like in any market, the price of labour will be supported by demand for that labour. Therefore, falling wages will increase demand and the market will find an equilibrium point at which all those who want a job can get one. It is possible that unskilled labour wages could drop to $1/hr but this is impossible in Australia due to the high levels of capital accumulation in the Australian economy.

To illustrate how capital accumulation benefits wages, imagine a hole needs to be dug and an employee has to use his hands to dig. It may take the employee an hour to dig the hole with his bare hands. Now imagine another employee who possesses a shovel and can dig the same hole in 6 mins. They produce the same result (a hole in the ground) and therefore they should get paid the same. However one earns the same payment 10 times faster because they have the shovel (capital). In this example the employee equipped with a shovel will earn 10 times the unequipped employee per hour.

The problems associated with the MW are numerous and are usually ignored by MW advocates. The effect of the MW is downplayed by academic studies employing econometric models. While economic models can estimate effects, they cannot be used to counter fundamental principles in economics. Even if industries face less competition, businesses will find a way to reduce costs to satisfy their customer’s preference for low priced goods and services. Finally, it is only a free-market naturally promoting capital accumulation that raises the purchasing power of wages.

I will conclude with this video which is a simple and easy to understand animation of how the minimum wage affects the economy: