Who really decides wages?

Suppose that parents are currently paying babysitters \$7.50 per hour. Suppose that tomorrow Congress applies the minimum wage law to all forms of employment, including babysitting, and increases the minimum wage to \$15.00 per hour.

Does anyone suppose that all baby sitters would then see a doubling of their incomes?

Might not some parents, who had been treating themselves to dinner at a restaurant and a movie in a theater one night a month, respond to the increased cost of babysitters by instead picking up a DVD and a pizza on the way home from work? They could put the children to bed early and enjoy their special night on the sofa in their own living room. They would no longer need the help of a babysitter. In their case, the law reduces the income of one babysitter to zero.

Might not other parents, who had been willing to pay a fourteen year old neighbor \$7.50 per hour to babysit, decide at a rate of \$15.00 per hour they will now prefer an older babysitter? Perhaps they reason that the higher wage justifies insistence upon a babysitter who comes with a driver’s license, an automobile, and the ability to cook a meal for the children and to clean the kitchen afterwards. Someone receives the wage that Congress prefers, but it is not the lowest paid person that Congress had hoped to assist.

An increase in the minimum wage will not increase the incomes of those who employ babysitters. Parents who spend more on babysitters must spend less on something else. Perhaps some parents will continue to employ babysitters for the same number of hours, even after the legislature directs them to pay a higher wage. However, if they had also been paying young people to mow their lawns, they might find the extra money they need for babysitters by now electing to cut the grass themselves. Young people who babysit keep their jobs, while young people who mow lawns lose theirs.

In each of these cases, the legislature fails to deliver benefits to its intended recipients. People lose work and income. The result of the legislature’s action is the opposite of its stated goal.

Suppose that we invent a marvelous product. We discover that if we put a price of ten dollars on our product we can sell as many as we can make. If we charge more than ten dollars, no one will buy it. The only cost in the manufacture of our product is the cost of labor. One worker in our factory can make one item per hour.

How much should we pay our employees?

If we pay our employees \$9.99 per hour, revenue from sales will cover our costs and leave us with a little that we can invest in the development of new products or use to pay ourselves. If the law compels us to pay \$10.01 per hour, we will lose a penny on every sale. Losses will accumulate until we no longer have the means with which to pay our employees. Our employees will lose their livelihood. Our customers will lose access to a product from which they had been deriving a benefit. We will lose an outlet for our inventiveness.

Neither public authorities, directors of private industry, nor any other group of experts has the power to fix the value of labor. Customers determine the value of labor each time they choose to buy a product and each time they choose to walk out of a store with their money still in their pockets. When the legislature fixes the minimum wage at a level that exceeds the value of labor, it makes the employment of the least skilled workers, where and when it occurs, acts of charity.

The law does not (and cannot) require employers to pay a minimum wage. It only requires employers to pay a minimum wage to those whom they choose to hire. If the legislature requires firms to give to employees more than they get from employees, it should expect fewer decisions to hire.

In real life, not all of the customers who were ready to pay us ten dollars for our marvelous product will walk away if we tack a penny onto the price. However, suppose that we are paying our workers the minimum wage and selling our product to other people who also earn the minimum wage. Then, we raise prices and wages together. Higher prices bring in money that goes out in higher wages. We will only have succeeded in taking money out of one pocket and putting into another pocket on the same person. Our employees and customers are the same people.

Of course, every assessment of value contains a measure of imprecision and of uncertainty. Prices vary from place to place and over time. Even in one place and at one time different bidders, all of whom possess imperfect knowledge, will make different offers for the same product. For these reasons, prices in every market, including the market for labor, span a range. There is always room for negotiation. There is always a little wiggle room.

Maybe, if the legislature mandates higher wages, employers will be able to comply profitably. They might increase the price of their products without driving away customers. Consumers might agree that the real value of the product is a little higher than their previous estimates. Higher prices could yield greater revenue that in turn could underwrite increased compensation.

Similarly, higher wages might motivate workers to respond with greater effort. If higher productivity follows higher wages, then higher wages do not necessitate higher prices on the goods sold.

However, for better or worse, no committee of experts in the capital city can compare price against value better than the numerous and widely distributed players in the market. None can assess the value of labor better than free and independent bidders in that unending auction. Legislatures vote infrequently. Employees and employers negotiate with one another every day. Government’s experts can only hope to capture averages of prices in periodic statistical surveys. Producers and consumers see how the very particular costs they bear change each day.

Proponents of an increased minimum wage have written about what workers need and what they deserve. Some argue that markets should not determine the value of labor, because people matter more than markets. That is a substitution of wishes for facts. They have largely avoid arguments that might convince us that the policy they favor can give, rather than just promise, workers what they need and deserve.

Proponents presume that government has the power to increase incomes, but propose only to raise wages enough to alleviate poverty a little. They do not propose increases sufficient to lift the poor into the ranks of the middle class or the wealthy. Implicitly, they acknowledge the power of markets and the practical limitations on the power of government. If \$7.25 per hour is too little and \$1000 per hour is too high, how does the legislature determine which figure in between is the right minimum wage? Apparently, they look to see what firms that need help are offering and what people who need work are accepting. Then, presuming possession of superior expertise, they tweak the numbers that the market has provided.

Advocates of an increased minimum wage assert that increases in the past have not resulted in increased rates of unemployment. We should expect that small increases in wages will affect unemployment only a little. Lawmakers have not attempted large increases. Although a decade elapsed between the two most recent changes to the federal minimum wage, wages rose without prodding by Congress during the interval, and the new minimum closely matches what employers are already paying workers in the lowest ranks. Even when a modest increment causes no measurable economic harm, it has the bad effect of perpetuating an exaggerated view of government’s ability to produce affluence by managing the affairs of citizens.

In enacting laws to regulate wages, legislators simultaneously expose their naive understanding of economics and exercise their political astuteness. An increase in the minimum wage delivers immediate, concentrated, and visible benefits. By contrast, the costs are diffuse, delayed, and difficult to quantify. The small fraction of the population whose pay jumps a day after the passage of the law will know whom to thank. The larger number who suffer disappointment in a search for employment will not know the reason for their difficulties, because many factors affect employers’ willingness to hire. Costs can exceed benefits and still legislators win more votes.

Many of the most privileged students in our country’s colleges actively seek out internships. Some internships pay a modest wage. Others pay nothing. At twenty years of age, they possess little skill or knowledge, but much energy and drive. They know that by discounting the price of their labor at the outset of their careers then can justify demands for high salaries later. The minimum wage law denies the least privileged citizens the same kinds of opportunities. If the law allowed them to sell their labor at a price others are willing to pay now, they too could advance rapidly. (See, for example, the move “The Pursuit of Happyness.”) For this reason, Nobel laureate Milton Friedman called the minimum wage law the most racist law in America.

I have built my arguments around examples that portray ordinary people buying, selling, and working. Of course, I recognize that parents incur little risk of prosecution by being cheap to a babysitter. I can do a favor for a neighbor and he can give me some little compensation for my time without either of us inviting public scrutiny.  The same concerns that guide individuals in private transactions also influence decisions of large organizations.

Ironically, some of the most ardent backers of a legislatively mandated minimum wage also energetically defend the freedoms of mutually consenting adults. They just do not allow that freedom might encompass the choice of one neighbor to spend an hour raking leaves out of another’s backyard in return for five dollars.

Young Americans learn in school that the Constitution of the United States enumerates, divides, and limits the power of government. The Supreme Court once held that the Constitution grants to Congress no authority to tell free citizens how much they must pay their neighbors. No amendment since that ruling has created such an authority. Only the membership and opinions of the Court have changed.

I have argued that the minimum wage law does not work, but conclude here with this brief reference to principles of good government. Economic and political freedom are inseparable.