Mises Wire

Home | Blog | The State Against Economic Law: the Case of Minimum Wage Legislation

The State Against Economic Law: the Case of Minimum Wage Legislation

January 22, 2007

Tags Capital and Interest TheoryInterventionismMoney and BankingProduction Theory

When it comes to matters such as the theory of evolution and stem-cell research, so-called liberals—i.e., socialists who have stolen the name that once meant an advocate of individual freedom—ridicule religious conservatives for their desire to replace science with the dictates of an alleged divine power. Yet when it comes to matters of economic theory and economic policy—for example, minimum-wage legislation—these same liberals themselves invoke the dictates of an alleged divine power. Their divine power, of course, is not the God of traditional religion, but rather a historically much more recent deity: namely, the great god State.

Traditional religionists believe that an omnipotent God came before all natural law and was not bound or limited by any such law, but rather created such natural laws as suited him, as he went along. Just so, today's liberals believe, at least in the realm of economics, that the State is not bound or limited by any pre-existing natural laws. In the case in hand, the State, today's liberals believe, is free to decree wage rates above the level that would exist without its interference and no ill-effects, such as unemployment, will arise. In this matter, the liberals have been as quick to cast aside whatever modest knowledge of economics they may once have had, as the traditionally faithful are quick to cast aside whatever relevant knowledge of physical cause and effect they may once have had. The traditionally faithful revel in the sight of a seeming miracle or even the mere report of a seeming miracle, such as a faith healer commanding the lame to walk, and on that basis abandon their knowledge of cause and effect in the realm of human anatomy and physiology. In the same way, today's liberals have been reveling in the report of increases in the minimum wage unaccompanied by increases in unemployment, and on that basis have abandoned their knowledge that increases in wage rates reduce the quantity of labor demanded and thus do indeed cause unemployment.

The liberals' faith healers in this instance are David Card and Alan Krueger, who are the authors of a book called Myth and Measurement: The New Economics of the Minimum Wage (Princeton, N.J.: Princeton University Press, 1995, 422 pp.). Their book is described by its publisher as presenting "a powerful new challenge to the conventional view that higher minimum wages reduce jobs for low-wage workers... [U]sing data from a series of recent episodes, including the 1992 increase in New Jersey's minimum wage, the 1988 rise in California's minimum wage, and the 1990-91 increases in the federal minimum wage...they present a battery of evidence showing that increases in the minimum wage lead to increases in pay, but no loss in jobs. 


Denial of the Law of Demand

Card and Krueger and the "liberal" faithful who are eager to embrace their message may not realize it, but when they claim that increases in the minimum wage do not cause unemployment, what they are denying is one of the best established propositions in all of economics, namely, the Law of Demand.

This law states that, other things being equal, the higher is the price of any good or service, the smaller is the quantity of it demanded, i.e., the quantity that buyers purchase, and that, by the same token, the lower is the price of any good or service, the larger is the quantity of it demanded, i.e., the quantity that buyers purchase. Since wages are merely the price of labor services, the Law of Demand implies that all government and labor-union interference that forcibly raises wage rates above the height at which they would otherwise have been reduces the quantity of labor employers seek to employ in comparison with what it would otherwise have been. It thus implies that the government's or labor unions' interference causes unemployment.

One major reason for the existence of the Law of Demand is that while people would like to buy more goods and services, their ability to spend is always limited by the funds at their disposal. Lower prices enable the same funds to buy more, while higher prices prevent any given amount of funds from buying as much. In order to overthrow the Law of Demand, one of the things Card and Krueger would need to be able to do would be to show how the division of a given-sized numerator (i.e., the funds people have available to spend) by a larger-sized denominator (i.e., the prices and wages they must pay) does not result in a reduced quotient (i.e., ability to buy goods and labor services). It should be obvious that this is simply impossible and that insofar as the Law of Demand rests on the laws of arithmetic, no statistical data can ever overthrow it. Rather, the statistical data must be interpreted in a way that is logically consistent with the laws of arithmetic and their derivative, the Law of Demand.

It is very easy to provide such an interpretation. This is because, contrary to what Card and Krueger appear to believe, the Law of Demand does not claim that every rise in a price or wage must reduce the quantity of the good or labor service demanded below what it was before the price or wage was increased. That would be true only if all other things remained equal. When all other things do not remain equal, the Law of Demand claims merely that higher prices or wages cause the quantity of a good or labor service demanded to be less than it otherwise would have been.

The economic history of the last 60 years illustrates this. Over this period, prices and wages rose from one year to the next and yet the quantity of practically all goods and labor services demanded also increased from year to year. For example, in the late 1940s, the price of a new house was $10,000; that of a good-quality new automobile, $1,000; that of a meal at a first-class restaurant, less than $5; a high-level executive job paid $15,000 a year; and the federal minimum wage was 75¢ an hour. Since that time, all of these prices and wages have increased many times over. And yet, from year to year, the quantities of practically everything demanded increased rather than decreased.

The explanation, which is perfectly consistent with the Law of Demand, is the continuing increase in the quantity of money in the economic system. In the late 1940s the quantity of money in the United States was well below $100 billion. The total annual spending that such a money supply could support was in the low hundred billions. Since then the money supply has increased to almost $3 trillion, which is capable of supporting total annual spending that is vastly larger.


Minimum-Wage Laws Cause Unemployment Even When More People Work

With such an enormous increase in the funds at their disposal, people are capable of buying larger quantities of goods and labor services even at today's sharply higher prices and wages. What is still true, however, is that if wages and prices had not risen as much as they have, the quantities of goods and labor services demanded would have increased by even more than they actually have, and thus that more workers would be employed than is in fact the case, with the result that unemployment would be less than it is. To the extent that the minimum-wage law has contributed to wage rates and prices being higher than they otherwise would be, it is responsible for unemployment, despite the fact that more people work today than at any time in the past.


Expenditure Shifting

A supporter of the minimum wage might argue that even though the total of people's ability to spend is limited at any given time, their ability to spend on any one particular thing or category of things is still capable of being increased—by the simple means of their reducing their spending for other things. This is certainly true. The total wages paid to unskilled workers might increase to some extent at the expense of the wages paid to skilled workers. The total of the wages paid to all workers might increase to some extent at the expense of expenditures for capital goods, such as the materials and machinery bought by business firms.

Nevertheless, an increase in any given price or wage operates to discourage the shifting of funds to purchase the good or service in question. This is because its higher price or wage requires a greater sacrifice in terms of alternative goods or services that must be forgone in order to purchase it. For example, if a worker must be paid $200 per week, all that his employment entails is forgoing the purchase of other goods or services worth $200. But if he must be paid $300 per week, his employment requires the correspondingly greater sacrifice of alternative goods or services worth $300. The growing magnitude of sacrifice of alternative goods and services is a major reason that a rising price or wage results in a falling quantity of the good or service demanded, i.e., it is a further major reason for the existence of the Law of Demand.

Furthermore, what is required to bring about an increase in expenditure on any one good or service or category of goods or services at the expense of expenditure on other goods and services is either a decrease in their supply or a decrease in their price, neither of which is compatible with support for a minimum wage. For example, if the supply of crude oil, or the services of physicians, decreased by 10 percent, the price might easily double, because of the high value that people would attach to each unit of the remaining supply. In this case 1.8 times as much would be spent in buying the good or service—i.e., the doubled price times the remaining 90 percent of the initial quantity. Unfortunately for the supporters of the minimum wage, a case of this kind still implies a significant reduction in quantity demanded and in employment. (And I will soon show that the reduction in employment will turn out to be far greater than thus far indicated.)

As stated, what is also capable of bringing about an increase in the expenditure on a given good or service at the expense of other goods and services is a fall in its price. A fall in the price of a given good or service can often so dramatically improve its ability to compete against other goods and services for the limited supply of funds in the possession of buyers that more ends up being spent on it at a lower price than at a higher price. The automobile and computer industries provide illustrations of this phenomenon.

At the beginning of the 20th Century, automobiles were as expensive relative to the average person's income as yachts are today. So long as that remained true, the automobile industry had to remain a minor industry. But as the cost of production and price of automobiles came down, a mass market developed in which the increase in quantity demanded far outweighed the decrease in price. The same story was repeated in the last decades of the 20th Century, as the price of personal computers radically declined and their quality greatly increased, with the result that another major new industry came into being.

It should be obvious that cases of this kind are of no help to the supporters of the minimum wage. For, when applied to labor, they rest on wage rates falling, as the means of expanding the quantity of labor demanded. The imposition of a minimum wage or of an increase in an existing minimum wage, works in the diametrically opposite direction. It reduces the ability of low-skilled workers to compete and thus forces them into unemployment.


Low-Skilled Workers Compete by Means of Low Wages

The relationship between the wage rates of the low-skilled and their ability to compete with more-highly-skilled workers needs elaboration. Lower wage rates are the means by which less-skilled workers compensate for their lack of skill and are enabled to compete with more-skilled workers. Imagine, for example, the case of two bricklayers, one of whom is able to lay twice as many bricks per hour as the other. Is there any way in which the less capable bricklayer can successfully compete against the more capable bricklayer? Yes there is. All he needs to do is be free to work at less than half the wage rate of the more capable bricklayer. In that case, the cost per brick laid is actually less using him than the more capable bricklayer.

But what is the effect of a minimum wage that sets the wage of the less capable bricklayer at more than half that of the more capable bricklayer? The effect is to prevent him from competing. It is to render his services more costly than those of his more-capable competitor and thus to force him into unemployment.

The essentials of this case are present in all instances in which some workers have less to offer employers in the way of skills and ability than other workers. For example, workers who cannot speak the native language are necessarily at a disadvantage compared with those who can. In a free market, they can overcome that disadvantage by means of being able to offer to work at sufficiently lower wage rates. Similarly, workers who do not know how to read, or cannot read very well, are necessarily at a disadvantage compared with those who can read or can read better. If they are to be employed, they need to be able to overcome these disadvantages through the offer of working for sufficiently lower wage rates.

Minimum-wage laws prevent all such workers, workers with disadvantages in skills and abilities, from competing. They condemn such workers to unemployment and thus deprive them of the opportunity to improve their skills and abilities by gaining work experience. In this way, despite all protestations of their supporters to the contrary, minimum-wage laws are the enemy of the disadvantaged.


Minimum-Wage Laws Also Cause Unemployment Indirectly

The extent of the harm minimum-wage laws cause is considerably greater than has thus far been explained. Its measure includes even those instances in which an increase in the minimum wage is accompanied for the most part by an increase in the funds expended in paying it and very little by any immediate unemployment on the part of those receiving it. Indeed, even if, contrary to economic law, it were somehow the case that a rise in the minimum wage were accompanied by such a shifting of funds from elsewhere, that exactly the same number of workers were employed at the now higher wage as were previously employed at the lower wage, it would still end up causing substantial additional unemployment among the low-skilled in comparison with what their unemployment would have been otherwise.

This becomes clear when it is realized that to the extent that funds are withdrawn from spending elsewhere in the economic system, namely, from spending on capital goods and the wages of more-skilled labor, corresponding unemployment is created in those areas. That unemployment could be overcome if wage rates in the rest of the economic system were free to fall. But under a regime of minimum-wage legislation combined with pro-union legislation, in which labor unions impose minimum wages of their own for the various grades of more-skilled labor, that fall in wage rates will be prevented. The result is simply that unemployment is created elsewhere in the economic system. (It should be realized that the influence of labor unions on wage rates extends far beyond the ranks of unionized labor. It extends to all non-union firms that want to remain non-union. Because in order to remain non-union, they must match the unions' wage scales.)

The more-skilled workers who become unemployed as the result of funds being shifted from the demand for their services to the payment of a higher minimum wage, will be able to become reemployed in other lines of work. Thus, for example, computer programmers, say, who become unemployed will be able to find other employment where their superior skills and abilities enable them to outcompete workers who have up to now been performing these jobs. These jobs, perhaps, may be those of mid-level managers, technical writers, salesmen for high-tech products, and the like.

The workers displaced from these lines must in turn now find alternative employment. To the extent that their skills and abilities are greater than those of the workers with whom they compete, they will succeed in finding employment. Thus they may end up working as bookkeepers, clerks, and the like. But now the less-skilled workers whom they outcompete will be unemployed and in need of finding other work.

What is present is a process of labor being shifted down into occupations of progressively lower levels of skill and ability. The process ends in the increase in the supply of labor in the occupations at the bottom of the various levels of skill and ability.

The larger number of workers now competing for jobs at the bottom could potentially all be employed in those jobs. But that would require a fall in wage rates to increase the quantity of their labor demanded. That fall in wage rates, of course, is precisely what the existence of the minimum-wage law prevents.

In the absence of the fall in wage rates, the workers who become unemployed are once again the comparatively less skilled. But in this case, which is that of the less-skilled workers in occupations already requiring only the lowest levels of skill, the workers who become unemployed are the lowest-skilled in the economic system.

Thus even if, however unlikely, the imposition of a minimum wage began in conditions in which it did not directly and immediately create any unemployment whatever, because of the shifting of funds from elsewhere to pay it, it would end up creating unemployment among the least skilled members of the economic system.

What is present in this analysis is merely an application of Henry Hazlitt's one-sentence summary of his great classic Economics In One Lesson: Namely, that "The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."

That lesson was apparently never learned by Card and Krueger and their supporters. Judging the short-run effects of an increase in the minimum wage in a given state, such as New Jersey or California, on the unemployment rate of low-skilled workers in that particular state, which is what Card and Krueger did, does not begin to address the effects of raising the minimum wage. To do that, one must consider the effects, long-run as well as short-run, on the whole economic system. When one does this, one sees that the minimum wage does indeed cause unemployment among the least—skilled, most-disadvantaged members of the economic system.


Overcoming Poverty Requires Repealing Minimum-Wage Laws Throughout the Economic System

The preceding analysis has an important implication concerning how people who are genuinely concerned with improving conditions for those who are least well off might go about actually achieving that goal. Namely, instead of imposing and raising minimum wages at the bottom of the economic ladder, repeal them throughout the economic system. To whatever extent the ability of labor unions to impose above-market wage rates for skilled and semi-skilled labor could be reduced, to whatever extent licensing-law restrictions on the number of people allowed to practice in the various professions could be relaxed, the number of workers employed in all these lines would be increased. The consequence would be that the number of workers forced to compete at the bottom of the labor market would be correspondingly decreased and their wages increased.

Throughout the economic system, human ability would be better employed. Overall production would be greater and thus prices on the whole would be lower. The poorest members of the economic system would earn more and pay less. Not forcibly imposed minimum wages of any kind but the abolition of such forcible impositions is the means to overcome poverty. Repeal minimum-wage legislation, pro-union legislation, and licensing legislation. That is what will help to eliminate poverty.


This article is copyright © 2007, by George Reisman. Permission is hereby granted to reproduce and distribute it electronically and in print, other than as part of a book and provided that mention of the author's web site www.capitalism.net is included. (Email notification is requested.) All other rights reserved. George Reisman is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics.

Follow Mises Institute

Add Comment