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Does Business Need Washington to Manage Wages?

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Tags Free MarketsInterventionismProduction Theory

01/15/2007Robert P. Murphy

Libertarians have been exasperated by the Bush Administration's supposedly laissez-faire policies that are anything but. Yet as enjoyable as it is to poke holes in the plans to "privatize" Social Security and so forth, there's nothing quite so fun as economic commentary from a good old-fashioned leftist. In this respect, Robert Reich's recent commentary on NPR didn't disappoint.

The former Labor Secretary under Clinton was discussing President Bush's offer to go along with the Democrats' plan for hiking the minimum wage $2.10 per hour, so long as it is accompanied by tax relief for small businesses. Reich would have none of this, claiming that the proposed hike in the minimum wage wouldn't burden small businesses at all. To defend this paradoxical claim, Reich offered three main reasons.

Reich's Reason #1: Businesses can pass the hike along to consumers.

In Reich's words:

[V]irtually all small businesses that pay the minimum wage compete in the local service economy. They're retailers, contractors, providers of elder care and child care, local hospitals. They don't compete internationally or even nationally. Their competitors are in the same city or town and all of them will be paying the same minimum-wage increase. So it's likely that the increase will be passed on to consumers.

Here Reich overlooks the fact that ultimately all businesses are competing for the consumers' money. It is certainly true that a hike in labor expenses will be much more tolerable for a given operation, so long as all of its direct competitors are given a similar handicap.

If all the hardware retailers raise prices 5 cents per item, that won't hurt any individual store's revenue as much as would be the case if a single store unilaterally raised its prices. Even so, the industry's revenue could still fall drastically, especially when foreign imports face no such burden.

Remember that the consumer can always choose to forgo a product or service altogether, or to produce it outside of the market. If the government hiked the minimum wage to, say, $50 per hour, this would annihilate the child care industry, as plenty of working parents would elect to stay home with the kids.

Reich is also simplistically ignoring the differential impact of the minimum wage hike on various small businesses. Some of them might be able to weather the blow fairly easily, by substituting out of labor and into more automation, or (as Reich suggests) by raising prices. But other small businesses enjoy no such luxuries, and will have to make hard choices should the Democrats' plan go through.

Finally, I note with some irony that Reich conveniently fails to complete his train of thought. Let us suppose for the sake of argument that Reich is correct, and that Bush's call for small business tax relief is unnecessary, since the increase will be passed along to consumers. Fine, fair enough. Even so, shouldn't we then couple the minimum wage hike with tax relief for consumers? Perhaps Reich's call for such cuts was edited out for reasons of space…

Reich's Reason #2: The minimum wage increase wouldn't be a minimum wage increase.

You may suspect that I'm misrepresenting Reich's claim. See for yourself:

Besides, it's not really an increase anyway. The current minimum wage was enacted 10 years ago, and inflation since then has eroded its value so much that the new proposed minimum is more like an inflation adjustment than a real increase. Most small businesses charge prices that have risen with inflation. So it's only fair that their employees' wages should rise with inflation, too.

Here Reich is quite openly conflating his notion of fairness with the entirely different condition of one number (namely, $7.25) being larger than another (namely, $5.15). He also adopts the typical political trick of using a moving baseline that biases the outcome in the direction he favors. This is how the government can "slash spending" and "gut programs" while federal outlays increase, or how "core inflation" isn't so bad after we've filtered out the volatile components (i.e., the ones that increase a lot). Using this approach, I could argue that Robert Reich multiplied by Ludwig von Mises is a decent economist.

Naturally, the free market economist would point out that small businesses are currently operating in an environment where the minimum wage is $5.15 an hour, and their prices reflect the real (inflation adjusted) magnitude of this regulation. The burden is indeed lower than it was ten years ago, but that doesn't mean businesses pocketed the annual gains with the steady creep of inflation. No, it meant that they could gradually hire more low skilled workers, and raise prices more slowly than otherwise would have been the case, because of the shrinking real minimum wage.

Now to "adjust" the regulation for inflation will simply force businesses to lay off some of those marginal workers and to restrict the quality of their products, not to mention hiking prices.

There is something even more fundamentally wrong with Reich's statement. He seems to think that there was something magical about the minimum wage of $5.15 an hour when it was set in 1997, and that returning to that level of hardship on small businesses is only appropriate.

But what is the basis for this judgment? Suppose Vladimir Putin answered conspiracy theorists by pointing out that the mysterious murders of a few journalists was no real hardship for the profession, because the percentage of such killings had declined drastically since Stalin's purges. Would Reich get behind that argument? If not, then so what if the Democrats' proposed hike merely adjusts the minimum wage for inflation? That's completely irrelevant to whether it would pose a hardship for small businesses (and also to whether it's "fair").

Reich's Reason #3: The minimum wage increase would actually help small businesses.

Before letting Reich speak in his own words, let us review lest the reader become lost. First, Reich argued that the minimum wage hike wouldn't hurt businesses because the damage would be passed on to another group. Then, Reich denied that the hike would be a hike. Now, in his third argument, Reich is claiming that the non-hike hike, the harm of which could be shunted to others, is actually not harmful. OK? Let us proceed:

In fact, a minimum wage hike may actually help small businesses. Evidence from states that have already increased their own minimum wages suggests that a modest increase convinces more people to enter the labor market — people like retirees, spouses or teenagers who wouldn't bother working at a lower minimum wage. For all these reasons, small businesses won't be harmed by the proposed minimum wage increase and don't need a tax cut.

Isn't that interesting? I bet there were a few small business owners who almost caused an accident while listening to NPR, so excited were they, to learn that higher pay attracted more workers.

Seriously, Reich's argument here is so silly that he can't possibly believe it. If a particular small business would benefit from the larger pool of applicants responding to higher promised wages, its owner doesn't need encouragement from Robert Reich (or Nancy Pelosi) to offer such wages. After all, most employers currently pay more than the government mandated minimum.

What's truly ironic is that this alleged benefit is reduced when the government forces every business to raise wages. For example, a business that currently pays $7.25 an hour (and yes, there really are such employers right now) can be far choosier with its employees than will be the case when all businesses pay at least that rate. But no worries: I'm sure such businesses will make up for the reduction in productivity by cutting product quality and raising prices.


It's been fun to watch the Republicans get government off our backs and bring some conservatism to the federal budget. But if Robert Reich's NPR commentary is any indication, we can look forward to some great yuks under the Democratic Congress, too.


Contact Robert P. Murphy

Robert P. Murphy is a Senior Fellow with the Mises Institute. He is the author of many books. His latest is Contra Krugman: Smashing the Errors of America's Most Famous KeynesianHis other works include Chaos Theory, Lessons for the Young Economist, and Choice: Cooperation, Enterprise, and Human Action (Independent Institute, 2015) which is a modern distillation of the essentials of Mises's thought for the layperson. Murphy is cohost, with Tom Woods, of the popular podcast Contra Krugman, which is a weekly refutation of Paul Krugman's New York Times column. He is also host of The Bob Murphy Show.

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