A Thought Experiment
Published on May 16, 2005 By stutefish In Blogging
Let's say I own a small factory. The factory produces about $100[1] worth of widgets every day, and requires a crew of seven people to operate at full efficiency.

Let's also say that this factory operates in a country where it is customary to pay workers by the day, and that $10 per day is a low but acceptable wage.

Now, I could pay my seven workers up to $14 per day, and still make a $2 profit. Very tight margin, but at least there's some money left over for my investors, or for capital improvements, or for the company Christmas party, or whatever.

Now, let's say the government passes a law, requiring that all workers be paid a minimum of $15 per day. What happens?

The first thing that happens, the day I begin complying with the new minimum wage, is that my factory loses money: $5 per day, in fact. Not much, but it will add up quickly.

Why I Hate, #1: The minimum wage hurts the economy, creating deficits instead of surpluses for any employer on a tight profit margin. It punishes employers for being competitive or generous in their hiring and employee compensation practices. Thus, it is bad for both employers and employees.

Of course, I can't keep operating my factory at a loss each day. I need to make some adjustments.

One thing I could do is raise the price of my widgets, to cover the increase in my payroll costs. Of course, this would tend to nullify the value of the minimum wage in the first place. Sure, my workers get paid more, but--surprise!--their cost of living just went up, too.

Why I Hate, #2: The minimum wage promotes inflation. By increasing the operating costs for employers, it drives increases in the costs consumers must pay for goods and services. Pay raises are offset by price increases. Instead of a Better Tomorrow for my employees, they get inflation. And inflation is bad for the economy.

But as bad as inflation is, a price increase may be my best option. Let's see what else I can do...

Well, I can fire one of my employees. This brings my factory back into profitability--improves it, even, since I go from a $2 profit to a $10 profit.

Why I Hate, #3: The minimum wage promotes unemployment.

Of course, my profit margin just improved dramatically, from $2 before the minimum wage law to $10 after the minimum wage law. And my employees even got a raise (the ones I didn't have to lay off got a raise, anyway)! On the other hand, that profit increase isn't real, because the factory's efficiency just went down. Now, instead of having 7 workers producing $100 worth of widgets, I have six workers producing about $85 worth of widgets. In fact, at $15 per day, my workers cost me more than the value of the widgets they produce.

Why I Hate, #4: The minimum wage promotes massive unemployment by driving companies out of business. It also hurts the economy by making whole sectors unprofitable.

But maybe I can keep my factory in the black. Let's say I lay off my least efficient worker. Instead of a 14% efficiency loss, maybe I only have a 9% efficiency loss--that's the maximum I can afford, anyway. Now my factory is making $91 of widgets every day, but at least that's better than my payroll costs of $90 per day for my remaining 6 employees. I'm down to a $1 profit from a $2 profit before the minimum wage, but it's better than going out of business, laying off more employees, or driving inflation, isn't it?

Why I Hate, #5: The minimum wage harms the economy by reducing profits.

Summary:
1 The minimum wage increases deficits and decreases surpluses.
2 The minimum wage accelerates inflation.
3 The minimum wage increases unemployment.
4 The minimum wage puts employers out of business, hurting the economy and increasing unemployment at the same time.
5 The minimum wage makes employers less profitable, without improving the economy or the lives of employees (who must now work harder to keep their employer profitable; sure, they get paid more, but they have to work more, too. You could call this another kind of inflation.)

Question: What do I not understand about the minimum wage, that makes it such a great idea?




[1] After accounting for the cost of raw materials and support services like water and power, but not payroll expenses.

Comments (Page 2)
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on May 16, 2005
Thanks, anon, but I'm just some guy who can't figure out what the minimum wage does for me.

And don't tell me it keeps The Man from exploiting me. If that was the case, my current employer would be paying me the minimum wage right now. The fact is, my employer pays me much more than the minimum wage, by several orders of magnitude. The same is true for almost every job that doesn't involve unskilled laborers providing low-value goods and services (and in those cases, it's unskilled labor and low-value work product. How much do you think that's worth to anybody? (Answer: Not much; hence the low rate of pay.)).

As you can see, when left to itself, the forces of the free market are more generous in compensation than even the minimum wage. Of course, this has led some factions of the "tiny party hat for my behind" crowd to demand that the minimum wage become even more generous, in a laughable attempt to artificially recreate the success of the natural process. Laughable, of course, because the minimum wage causes the problems I've already mentioned.
on May 16, 2005
Stability, that is the key to a prosperous economy. Like you mentioned, when the economy is stable or expanding, the minimum wages are virtually useless since the wages grow with the market. However, in a restrictive scenario, employers CANNOT drastically play with the average wages and reduce them considerably under a reasonable amount. Such actions would bring serious dysfunctions everywhere. Employers must find other ways to control their costs, even if it mean to let part of their workforce go, in order to keep a stable internal demand and to keep stable prices.

The arguments that minimum wages are for philanthropic reasons (like to give more to the poor) are purely political.

Also since you seemed worried, reasonable inflation (usually considered between 1% and 3%) is not a bad thing, it’s normal. Deflation, on the other hand, is a catastrophic thing.
on May 16, 2005
J.E.:

I'm with you, that a little inflation is a good thing, or at least an okay thing. And I'm totally with you about deflation being the real killer.

But don't we have enough drivers of inflation, without the minimum wage? Especially since when the minimum wage drives inflation, it does so for no reason except to cancel out the supposed benefits of the pay increase.

In other words, rather than doing good for the worker, the minimum wage does nothing for the worker, and puts us at risk of excessive inflation to boot.
on May 16, 2005
Insightful, I find it ironic that Oregon (Where i'm from) has a a living wage (what they call it ) yet, you can't live on that, even if you buy the most basic items....

State--Rate
Federal $5.15


Alabama-- None
Alaska--$7.15
Arizona--None
Arkansas-- $5.15
California $6.75
Colorado $5.15
Connecticut $7.10
Delaware $6.15
District of Columbia $6.60
Florida $6.15
Georgia $5.15
Hawaii $6.25
Idaho $5.15
Illinois $6.50
Indiana $5.15
Iowa $5.15
Kansas $2.65
Kentucky $5.15
Louisiana None
Maine $6.35
Maryland $5.15
Massachusetts $6.75
Michigan $5.15
Minnesota $5.15
Mississippi None
Missouri $5.15
Montana $5.15
Nebraska $5.15
Nevada $5.15
New Hampshire $5.15
New Jersey $5.15
New Mexico $5.15
New York $6.00 (will rise to $6.75 on 1/1/06)
North Carolina $5.15
North Dakota $5.15
Ohio $4.25
Oklahoma $5.15
Oregon $7.25 (Wage rate will be indexed to inflation—adjustment will occur every Jan. 1)
Pennsylvania $5.15
Rhode Island $6.75
South Carolina None
South Dakota $5.15
Tennessee None
Texas $5.15
Utah $5.15
Vermont $7.00
Virginia $5.15
Washington $7.35 (Rate is indexed to inflation—adjusted every Jan. 1)
West Virginia $5.15
Wisconsin $5.15
Wyoming $5.15
on May 16, 2005
Here's why I like the minimum wage:

I'm starting university next year, and I need to pay tuition and other expenses. Plus they just jacked up tuition by 500 bucks, even though we are supposed to have a tuition freeze. That is why I like my $7.25 CDN an hour (Minimum wage in Manitoba). It would be a lot harder to pay for tuition on something like $4-6 CDN an hour.

And out of curiosity, how much money are you making at your factory?
on May 17, 2005
A thoughtful article Stutefish. One question kept popping into my head as I was reading it though. If the minimum wage is really that bad, then why has the US economy been so good (overall) since it was enacted?
on May 17, 2005
I think, especially after reading the article and some of the comments, that the minimuim wage is for 2 things:
1
To make sure employers do not abuse there workers and that the workers get a fair share rate for their work.
Just leaving it up to the market works for profesional jobs, but not the lower labor market. You will end up finding that a janitor will make 3.00 an hour even though the work load is easily considered higher than that. The argument of 'at least I am working' is actually how the abuse continues. You end up with people who work hard but move nowhere. is it not the American dream that says hard work pays off??? 10 years hard work at 3 dollars an hour?
2
Minimuim wages allow a set standard of equality for entry level employees.
You know you can not get paid less than this amount. You will not, one day, get a 1 dollar decrease of which would really suck.


I do believe that the minimium wage has lost its meaning. It is NOT a living wage nor is it a way to help poor people. I think it actually should not be increased, but it should still stand as a way of avoiding employer abuse and keeping a status quo standard of employement rates for anyworker.

Now if only employer wold actually have REAL entry level jobs, then a minimuim wage would be totally useless. Working 10 years at factory A would have to mean you would be earning more than when you started. I agree that an increase will only cause more damage, but an elimination won't work either. You will always have someone who will work for 50 cents a day but the question is, should they in a country like this?

Many say 'work hard and you will make it' but the reality is that there is another part of the formula and that is having the ability to reach an oppertunity (taking advantage of it is up to you). >50 cents a daydoesn't truly povide anyone with an opertunity to get anywhere.
on May 17, 2005
latour999: Yes, but are you actually doing $7.25 CDN worth of work every hour? If not, then you're imposing a hidden cost on your community, in order to finance your education. Of course you like the minimum wage; you're getting paid for work you're not doing, at the expense of everyone else

Also, did you mean my hypothetical factory (the values are given in the article), or in my real life job (I'm being paid at the upper end of the for my career, region, and experience).

Not_I: An thoughtful question. My answer is that the U.S. economy has a lot of strengths, which go a long way towards offsetting some of its weaknesses. That, and the minimum wage has never been truly egregious. Also, the minimum wage's effects generally happen in the very low-end job markets, where the work being done isn't worth even five dollars an hour. In many of these sectors--farming, for example--the minimum wage does not legally apply, for exactly this reason. So because the U.S. economy is well set up overall, and because the minimum wage isn't extreme and isn't always applied, the problems don't appear very big.

How much better could the economy be without it?

joeKnowledge: Thanks! You've made reconsider my opinions of the minimum wage. I think your arguments make sense for any work that's worth as much as or more than the minimum wage. My ananlysis addresses the problem that arises when the work being done isn't worth the minimum wage. If an employer only has $3/hour of work to give you, then a minimum wage won't guarantee that you get a fair share of the work. Instead it guarantees that your employer will be out of business and you'll be out of a job.

Regarding opportunity, it seems that there are hundreds of thousands of Mexicans who think there's a huge opportunity in coming to the U.S. illegally to do back-breaking manual labor for ridiculously low wages. Judging from the amount of money they send home each year, they're right, too.
on May 17, 2005
I still use a favorite response that I used years ago on a politician. I was back in Oklahoma, where jobs had dried up and where, frankly, you could live on less than minimum wage if it were legal for employees to pay it. The politician used the tired line "I have never met anyone against a higher minimum wage that is actually making minimum wage". After the speech, I introduced myself and said "now you HAVE"
on May 17, 2005
latour999: Yes, but are you actually doing $7.25 CDN worth of work every hour? If not, then you're imposing a hidden cost on your community, in order to finance your education. Of course you like the minimum wage; you're getting paid for work you're not doing, at the expense of everyone else


Well, I'm not producing goods, so it is hard to quantify my work (I can't say I make 3 $5 widgets an hour, minus $3 per widget for expenses, so that equals $6 an hour). How exactly would you quantify work that is not producing goods but still necessary, such as janitors, cashiers, waiters, etc.? I like to think that my services are worth $7.25 CDN an hour (about $5.80 US with the exchange rate), and it's not like I don't work hard. Plus they don't have to pay for health insurance up here because we have universal healthcare (and there's no union where I work), so since we have higher taxes to pay for healthcare, my real pay is less.

Also, if you quantify wages by how much goods you produce, assuming they involve approximately the same amount of labour, should the guy who makes inexpensive cars be paid less than the guy on the other side of the factory who makes the Ferraris?

Also, did you mean my hypothetical factory (the values are given in the article), or in my real life job (I'm being paid at the upper end of the for my career, region, and experience).


I was wondering if you were drawing a salary from your hypothetical factory as manager, CEO, owner, or whatever, and if it was higher or lower than that of your workers, who are making the widgets.
on May 17, 2005
I'm relieved to discover that so far, Gideon's pessimistic prediction has proven false, and nobody is telling me how stupid I am.


umm, I don't remember saying this...were you meaning GUY'S response, right below mine? Just curious.
on May 17, 2005
latour999: Goods or services. The easiest way to determine the value of your work is to ask a bunch of people how much they'd be willing to pay for your work. If you can find someone who's willing to pay you $7.25/hour CDN for your work, great. But if you can't, then the minimum wage is forcing your employer to lose money so long as he employs you (i.e., he's giving you more value for your work, than the value you're giving him by doing your job). If he's paying you exactly the minimum wage, it's a safe bet he thinks you're overpriced, and would gladly pay you less if he could. Note that this might not be through any fault of your own, but simply because the job you do isn't very much in demand, for whatever reason.

Janitors, cashiers, and waiters all are necessary for the operation of their respective businesses. Their wages reflect how necessary they are.

Labor is only one component of the value of work. A guy who spends all day making papier-mache rabbits is putting in a lot of effort, but I'm not about to pay him the same rate I'd pay a guy who spends all day managing the finances of a Fortune 500 company. If you want to survive by providing goods and services to other people, then you have to accept that the value of your work is determined by your customers, not by you. You're welcome to spend all day doing work that's valuable to you, but if nobody else wants or needs it, don't expect to get paid much.

Let's assume, for the sake of argument, that my salary is $150/day--ten times what I'm paying my workers. As it turns out, I'm more interested in having an inefficient business, and in going out of business altogether, than I am in paying my employees well. Of course, this means that the real problem isn't the minimum wage at all, but that I'm an asshat. And that problem gets solved right away by me going out of business (either through sheer incompetence or through having a competitor who's willing to take a mild pay cut in order to outperform and underprice me). So what's your point?

Or we could assume that my take-home pay is the net profit from the factory. After paying minimum wages to my workers, and after laying one of them off, I'm getting $1/day. My hope is that by living extremely lean (my wife's two part-time jobs are what keep our children clothed and our dog's rabies shots up to date) for a few years, while paying my employees (relatively) well and keeping factory performance high, I can increase the profits over time and one day see my major capital investment pay off in a better tomorrow for not only my employees and my customers, but for my family and myself as well. Again, what's your point?

Gid: Yeah, Guy's post. Sorry about that. And either way, still relieved.
on May 17, 2005
WRONG!
The tiny pennies you spend on the minimum wage isn’t what makes your factory not profitable it is the ungodly amount of money all your CEO's CFOs and other high paid workers make.
All management should be paid based on incentives no more of these huge golden parachutes, no more huge annual salaries, NO MORE and all the sudden instead of saving 10 or 20 dollars a year you save hundreds of thousands a year.
But will this happen? no you wont cut your own salary so pretend that Joe Work a day making 7.50 an hour working 50 hours a week is to blame when you take home more in a month that he will all freaking year,

The Best and Worst Bosses
Forbes.com
“The heads of America's 500 biggest companies received an aggregate 54% pay raise last year. Some of these chief executives really earned their pay. Some didn't. Some did so bad they should have paid their shareholders”

Oh yeah these people should talk about whether to pay the peons who actually produce something $5.50 an hour or 6 buck, give me a break!
on May 17, 2005
keithpup, here's your break: We're not talking about CEOs of Fortune 500 companies, here. This article is about Joe Smallbusinessman, who's operating on a tight margin already.

Bad laws often prevent government from doing good things. So do corrupt politicians. Behold a sample dialogue!

STUTEFISH: Bad laws are a problem. Let us discuss it.
KEITHPUP: Yeah! Only, let's talk about corrupt politicians instead!
STUTEFISH: You want to change the subject, write your own damn article already.
on May 18, 2005
Keithpup: Would it be correct to assume you think these "Highly Paid Workers" burn their piles of money -- or just bury it forever? Assume for a moment, they do not. Then: Don't their savings & investments create easy credit, creation of new employment, and production of luxury goods that would not otherwise be possible? Then again, do you think that luxury goods should be done away with altogether? I think the people gainfully employed making the fittings for Bill Gates next Luxury Yacht or Jet would disagree with you.

On another slant -- where does population growth fit into the minimum wage scenario?
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