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 3)
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on May 18, 2005
wonderful artical, much more articulate than mine. Very well put.
on May 19, 2005
I think the problem here is that the minimum wage was too high. You said that $10 an hour was a low but acceptable wage. So a minimum wage of between $8 and $12 wouldn't cause any problems for you, or for pretty much anyone. Then you could still pay your workers $14, which in this world of yours looks like a decent wage.

on May 20, 2005
Heck Latour, why stop at $14 then? I say drop the hourly down to $8 and hire an Artist to decorate the Corporate Washroom with the extra cash.
on May 20, 2005
Hello

You've laid out your argument using macroeconomic principals to support a microeconomic ambition of "pure efficiency".
As such its too simplistic.

Im not about to argue that a minimum wage is neccessarily the most efficient in pure terms but you seem to have almost entirely disregarded the role of a government as social engineering device. When it comes to people, effectiveness is more important than efficiency and the whole point of an economy is too enrich the lives of the people who participate in it. Economies are for the people, not the other way around.

With respect to point #1. It would be a fundamental mistake to produce widgets in an economy where the cost of production, including labour, exceeded the price. In fact this is impossible as the price would actually be higher. Price being the intersection of what consumers are willing to pay and suppliers are willing to sell at for a given qty

Although you might wish to sell at a lower price, this does not make it the actual market price. If one ecomony can produce a good at a lower cost than another then that is its comparative advantage. A government artificially inflating the price of labour through the setting of a minimum wage does conceed comparative advantage to another ecomony but that again is a social engineering device. The government has decided that some goods are simply not worth manfacturing. Every ecomony in the world is seeking to produce higher value goods in full knowledge that this will mean a need to abandone or offshore lower valued goods.

If as a businessman you want to produce widgets then you first have to determine where you can feasiblly do so. It is not the economies fault/mim wage fault that a businessman chooses to produce in an unsustainable labour cost environment.

#2. Yes a minimum wage does increase inflation but i disagree that inflation is a bad thing. High inflation is a bad thing but not simple inflation. In fact in many cases a moderate level of inflation can be indicative a growing economy. With respect to what can you do? How about R & D to make your workers more productive such that you can produce more efficiently and thus sustain/turn a profit.

#3 I disagree with your third point. What about the flipside of the argument that people simply wont work for less than the minmum wage. This prodcues much more unemployment that the min wage does. I dont think you can argue that illegal immigrants will do it becuase by definition they are illegal and external to the system. This is also counter to your position in #1 of the *pure wage rate* [my words not yours]. If you're going to argue for a pure wgae rate then you really must be consistent and argue for a pure price. Where pure means actual.

We know for a fact that the developed world is piliaging the third. The actual cost of lifestyles is well beyond what we are really paying for it. Such that if we're talking pure then the market price of a given commodity would be much higher than currently paid so the minmium wage wouldn;t put people out of business/employment, the price of a good would. Not as many people could afford the things they currently buy therefore less would be sold therefore less employment.

If you extend your *government free* argument re:wage rate to the whole economy then things look very different to the ideas i think you were promoting.

#4 & #5 I think these points are much the same as above. You've taking a very negative approach to the cost of labour re:sacking and redundancy etc. Again what about R & D etc etc. What about the argument that some jobs are better suited to some economies than others. Its a poor form of economic organistion to have all economies producing the same goods. You seem to have overlooked trade entirely. I appreciate yours is a post on the min wgae but i dont see how you can argue your point in isolation from all the other variables of an economy.

And lets not forget that not one ecomony in the entire world has even been purely market driven....All economies use some form of centralised fiscal and monetary command mechanism to some degree. There is a very good reason for this and that reason is people, you and me. Purity is all well and good but at what cost?


All in all i disagree.
Thanks.
on May 20, 2005
bigrickstallion, thanks for the reply.

Your argument seems to have a fundamental flaw: My factory is profitable. I am a good businessman. I am enriching my own life, the lives of my employees, and the lives of my consumers, by producing my widgets. All my problems begin when the government, in a misguided attempt at social engineering, tries to artificially enrich us even more by imposing a minimum wage. As I have described, this has the opposite effect of impoverishing us all.

You're absolutely right: If the minimum wage makes my factory unprofitable, the only sensible thing for me to do is shut it down and write off whatever capital investment I've already made. Now that I have a business loan I can no longer pay off, and now that all my employees are out of work, please explain to me again how the minimum wage has enriched us.
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