Why Raising the Minimum Wage is a Bad Idea

After a great deal of controversy surrounding the implementation of the Affordable Care Act, debate in Washington has now shifted to another issue (like it has every other time the tide has turned against the Obama Administration): “income inequality”.  As has happened during other times of economic downturn, many in Congress (mostly Democrats) as well as President Obama are now pushing for, among other things, a raise in the current minimum wage rate (currently around $7.25 an hour).  They claim that doing so will help to  give a “fair” wage to those currently struggling to get by to take care of themselves and their families.  On the surface this may seem like common sense.  “Of course we need to make sure that workers make a fair wage and can take care of their families,” some of you may say.  Unfortunately, raising the minimum wage won’t help workers, it will only hurt them.  One fallacy that economists warn against is the idea that good intentions will automatically bring about good results.  Just because something sounds like a good idea doesn’t mean that it is.  This line of thought still rings true today because, while those in favor of raising the minimum wage may have their hearts in the right place, all they’re really doing is falling into this exact fallacy.

According to the Law of Demand, a lower price on a product will make people more willing to buy said product.  Conversely, the Law of Supply states that a higher price will make people more willing to produce that product.  Put simply, producers want to sell for the highest price possible and consumers want to buy for the lowest price possible.  These same principles can be applied to the labor market.  Companies (on the demand side) want to hire workers for the lowest possible wage and workers (on the supply side) want to be hired for the highest possible wage.  In a completely free market, wages will naturally come to an equilibrium point: the highest wage a company is willing to pay and the lowest wage workers are willing to take.  At a lower wage would cause workers to refuse to work and a higher wage would cause companies to refuse to hire people.  As a result, the market has to naturally come to a point that makes both parties as happy as possible or else the system would fall apart.  In a free market, this will always work, however, problems start to arise when the government institutes a price floor (minimum wage).

The problem with setting a minimum wage is that, no matter what the rate is set to, it fails to achieve the advertised goal.  If the minimum wage is set below the aforementioned equilibrium point, then it will have no effect on what companies pay their workers because they were already being paid a higher wage to begin with.  However, if the minimum wage is set above the equilibrium pint, it creates a gap between the number of workers a company would be willing to hire at that particular wage and the number of people willing to work for that wage.  As stated above, the higher wage causes an increase in the supply of labor because more people are willing to work for that wage.  But, at the same time, the demand for labor decreases because of the increased cost and, thus, companies have no incentive to hire new workers because the cost of adding an additional worker is higher than they are willing to pay.

The other problem with raising the minimum wage (or having one in the first place) is that it only causes workers to be laid off.  Before the minimum wage increases, companies are used to paying their workers a particular wage corresponding to the value the company places on the workers ability to produce (wage is at equilibrium).  When the minimum wage is increased, the price of labor is artificially increased, meaning that the company is now paying more money for the same labor despite making the same amount of profit.  As a result, the company has to find a way to compensate for this additional cost.  One option would be to raise the price on their products, but that would cause fewer people to buy their product and those that would buy it would buy it less often.  So, the only viable solution would be to fire workers so that they pay the increased wage to fewer people.  This means that an increase in the minimum wage will bring about higher unemployment figures and less productive companies.  Granted, that only applies if it’s raised above the equilibrium point–otherwise there won’t be any effect.  Even then there’s still no point in raising the minimum wage.

Some of you may ask, “Then, how do we help the workers who are barely making enough to get by, or are we supposed to just abandon them?”  To that I would respond let the free market take its course.  That may not seem like an immediate solution, but I assure you that if the government would stop interfering with the private sector, things would go much more smoothly.  When companies are free to produce with minimal government intervention, they can produce more of their product which lets them sell more and thus make more money to hire more workers and/or raise their current workers’ wage naturally.  You may say that my logic is flawed because companies would have no incentive to raise wages on their own, but as companies produce more (and make more money), labor becomes more valuable and as such, workers will want their wages adjusted accordingly.  If companies refused to raise wages, they would run the risk of having their workers quit.  In other words, greater output and profits by companies will naturally raise the equilibrium point, and allow the free market to do its job to improve the economy and wages.

Raising the minimum wage won’t do anything to help workers as many people claim.  It will either prove to be an ineffective waste of time because it will be set below market equilibrium or it will force companies to lay off workers because the price of labor will be artificially raised above equilibrium to a point where employers will be unwilling to keep the same number of employees.  Raising the minimum wage may seem like the right thing to do. But, in reality, it is a harmful approach to economic policy that has been tried before by the likes of Franklin Roosevelt and Jimmy Carter and failed in both cases.  Problems with “income inequality” don’t come from companies being greedy or an inherent unfairness in the system.  They come from the government making arbitrary wage and salary decisions and redistributing wealth the way it sees fit rather than letting the free market address these concerns.  So, if Congress really wants to help workers make a decent wage, it should back off and let free enterprise do the job for them.

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