Mises Wire

The Consequences of California’s New Minimum Wage Law

The law that establishes California’s minimum wage rate at twenty dollars per hour is purportedly aimed at uplifting the state’s working poor. The role of economics is to evaluate such claims through economic theory and empirical evidence. In mainstream economics, commonly taught in introductory college courses, the conventional analysis indicates that such laws may lead to heightened unemployment only if the new minimum wage exceeds the market wage. While this insight is important, it does not tell the full story. This limitation stems from the assumptions inherent in the labor market model, which presume that firms and workers are homogeneous.

However, the real world does not conform to this assumption of homogeneity. Each market participant is different, and each, unlike a stick or a stone, makes numerous sink-or-swim decisions daily. In chapter 4 of his bookMan, Economy, and State, Murray Rothbard breaks down market participants into submarginal, marginal, and supramarginal categories.

Submarginal buyers exit a market when the prevailing price exceeds their willingness or ability to pay, while marginal and supramarginal buyers continue to participate. The latter two are willing and financially capable of paying prices surpassing the market rate. The crucial difference in them lies in the fact that supramarginal buyers are either more willing or more financially resilient to absorb price hikes compared to marginal buyers. An event like a government intervention or an economic shock that drives a price upward will cause marginal buyers to exit, thereby increasing the population of submarginal buyers.

Similarly, submarginal sellers have exited a market when the prevailing price is below their reservation price, while marginal and supramarginal sellers continue to participate. This is a result of the latter two having reservation prices below the market price. The crucial difference lies in the fact that supramarginal sellers have cost advantages due to their incumbency or economies of scale, which results in them having reservation prices that are lower than marginal sellers. Events like a government intervention or economic shocks that drive prices downward cause marginal sellers to exit, thereby increasing the population of submarginal sellers.

In labor markets, firms are buyers of workers’ services, workers are sellers of these services, and the price of the service exchanged is the hourly wage rate paid to workers. In California’s fast-food industry, supramarginal buyers are typically large, low-cost firms capable of substituting labor with automation and benefiting from ample access to low-cost credit. Marginal buyers of labor are often small, high-cost employers operating on tight margins. Submarginal buyers of labor include recently shuttered businesses or entrepreneurs on the cusp of opening their first location.

Supramarginal sellers in this industry are workers whose reservation wages are substantially less than the market wage. Marginal sellers are those whose reservation wage is just below the market wage. Submarginal sellers are those who are not participating in the labor market because the market wage is below their reservation wages. A marginal worker in this market could be young single parents who need a wage sufficient to provide for their families. A supramarginal worker could be individuals in the same situation but without kids, allowing them to accept positions at lower wage rates.

Disaggregating labor supply and demand and conducting thought experiments allow one to understand how California’s twenty dollar minimum wage, which exclusively applies to fast-food restaurants with more than sixty locations, negatively affects poor communities, has no impact on workers in high-income communities, and actually benefits the large, low-cost employers.

In well-to-do localities like Huntington Beach, California’s new minimum wage is roughly equal to the market wage paid to fast-food workers but exceeds that in poor localities like those in Oakland. When the market wage is at least the minimum wage rate, there is no effect on employment or the size of the labor force. However, when the opposite is true, people (submarginal employees) will enter the labor market seeking employment if the new minimum wage rate exceeds their reservation wage. At the same time, small high-cost firms with tight margins (marginal buyers) will exit this labor market if they have no other means to reduce production costs. With the former effect swelling the size of the labor force and the latter shrinking the employment level, unemployment rises in poor communities.

Unemployment in poor communities won’t be the sole consequence of California’s new minimum wage policy. To understand the potential outcomes in areas where prevailing wages significantly trail the twenty dollar minimum, consider this hypothetical: Picture entrepreneurs of color, whether native-born or immigrants, who have built restaurant chains spanning over sixty locations in poor communities, paying the prevailing rate of fourteen dollars per hour. Due to limited purchasing power in these neighborhoods, these eateries price their offerings just high enough to maintain typical economic returns, around 5 percent profit. However, with the introduction of the twenty dollar minimum wage, their labor expenses surge by approximately 43 percent. As hiking prices isn’t feasible in these circumstances, given the aforementioned constraints, restaurant owners are forced to explore cost-saving measures. Unfortunately, this may lead to compromised quality or increased reliance on automation.

However, the feasibility of automation is hampered by elevated interest rates, regional financial institutions facing challenges, and declining support from major banks for small enterprises. Consequently, in a bid to save costs, restaurants might trim staff or turn to processed ingredients over fresh ones. With the Affordable Care Act mandating health coverage for at least 95 percent of full-time employees in businesses with fifty or more full-time equivalents, they may also opt for cheaper part-time labor over higher-cost full-time workers. As these alternatives often result in lower food quality or service standards, residents might dine out less, preferring home-cooked meals over compromised experiences. If these cost-saving measures fall short, regional chains might close locations to shrink their size to below the sixty-location threshold, hampering their expansion into wealthier neighborhoods and hindering their pursuit of the American dream.

The unintended costs of this well-meaning legislation will be borne by residents of low-income California neighborhoods, including reduced job opportunities, unemployment, fewer dining choices, and stunted business growth in areas where these ventures originated. Meanwhile, life in wealthier neighborhoods will remain largely unaffected. Ultimately, the beneficiaries of California’s policy are established, low-cost, highly automated firms like McDonald’s, as the law limits potential competition in the future.

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