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The Incentives of the Minimum Wage

Tags Labor and WagesLegal System


The assumption that the minimum wage helps low-wage workers permeates public discourse on the topic. One of the most curious political phenomenon is how the idea of the minimum wage is mindlessly accepted by the public as a policy that undoubtedly helps the poor. This transformation of the minimum wage from a policy originally intended to keep minorities out of the labor force to one aimed at protecting marginalized workers has been a stunning political magic trick.

How We Frame the Debate is Important

Such confusion is partly caused by how minimum wage rhetoric frames the topic. Oftentimes people argue if businesses can afford to pay higher minimum wages to workers, if a law mandating a minimum wage is philosophically moral, or if increasing the minimum wage increases unemployment. However, we must be careful not to give the minimum wage credit for doing more than it is capable of. If an employer pays out $100 per hour in wages in total to their employees, then increasing the minimum wage from $10 to $13 per hour does not increase the total amount of wages paid to employees. It merely mandates that those $100 in wages be paid out in no less than $13 increments per employee. Thus, minimum wage laws can only change the distribution of wages paid out by employers, and, ironically, the change in the distribution is often in the direction of increased inequality between low-wage workers.

The Minimum Wage Only Addresses One Component of Salaries

Annual salaries have three components: hourly wage, hours worked, and non-monetary benefits. A person’s annual salary is calculated by multiplying their hourly wage by the number of hours they worked and adding the value of their non-monetary benefits such as health insurance. The practical problem with the minimum wage is that it only addresses the hourly wage component of total annual salary. The minimum wage mandates that a person must make a certain amount of money per hour but says nothing about the total amount of money an employer must pay out to their employees in total. Any mandated increase in hourly wage can be offset by a decrease in number of hours worked and the value of non-monetary benefits.

Is it possible for any government policy addressing salary to help poor people? A government policy aimed at helping poor people via salary would have to force businesses to increase the total amount of money it pays its employees as a collective. Otherwise, the policy is merely shifting the distribution of that money amongst workers rather than the total amount of money paid to them. Since businesses can keep their labor costs at an equilibrium by adjusting wages, number of hours, and non-monetary compensation accordingly, such a government policy would have to address all three components. Thus, this would require forcing businesses to hire workers at a higher minimum wage, use a minimum number of total hours of labor, and provide a minimum value of non-monetary compensation.

What would that policy look like? Instead of just increasing the minimum wage, we would also hypothetically have a law requiring businesses to hire each worker for at least 40 hours per week and provide a minimum level of health benefits (or other non-monetary benefits). Such a law would ensure that each worker’s total annual salary would increase and that businesses could not get around the minimum wage by decreasing hours or benefits. Unfortunately, we run into yet another problem. These laws say nothing about how many employees a business must hire.

Mandating Higher Total Salaries Would Require Tyranny

Thus, businesses could still get around paying out more money in total to their employees by hiring fewer workers. To address this, the government would have to engage in tyranny and pass an additional law mandating a minimum number of employees per business to ensure that the number of jobs available does not decrease. Yet, mandating that each company employ a certain number of workers would not guarantee a certain number of jobs available since the number of companies is still able to fluctuate.

Therefore, to truly mandate an increase in total salary paid out to low-wage workers in aggregate, the government would have to mandate a minimum hourly wage, number of hours, value of non-monetary benefits, number of employees, and number of businesses. Given that the two events are logically dependent on each other, the idea of the government mandating that a minimum number of businesses exist in the economy is as absurd as the idea that the minimum wage can increase the amount of money paid by employers to low-wage workers in total.

Businesses Do Have Fixed Labor Costs

The caveat to the conclusions of this thought experiment is they assume businesses keep their labor costs approximately fixed. It is hypothetically possible for businesses to respond by raising prices. However, we should not be focused necessarily on increasing the absolute amount of dollars paid out to low-wage workers but rather increasing the purchasing power of their annual salaries. If a significant number of businesses respond to minimum wage increases by increasing prices, then the purchasing power of the salary of low-wage workers will be reduced by price increases, making minimum wage increases ineffective.

The other possibility is that businesses decrease their profit margins to accommodate larger labor costs. However, if this were actually how businesses responded to increased labor costs, then we would expect the total compensation of low-wage workers to increase as a result of minimum wage increases. However, a ground-breaking study on the minimum wage increase in Seattle from $11 to $13 showed that the average low-wage worker experienced a $1,500 decrease in annual income due to the minimum wage increase. Additionally, a review of the minimum wage literature in 2006 indicates that 85% of the most robust minimum wage studies found negative employment effects due to minimum wage increases. Furthermore, the 15% that found insignificant or positive employment effects only focused on the restaurant industry or used data from a short time-span. Using the restaurant industry as a proxy for low-wage workers was proven to bias the disemployment effects of minimum wage increases toward zero by the aforementioned study in Seattle.

Ultimately, we need to change the questions we ask about the minimum wage. We should stop asking if workers deserve a “living wage” and start asking if the minimum wage actually helps workers obtain one.


Jordan Setayesh

Jordan is a 3rd-year Biochemistry and Cell Biology major at the University of California San Diego. He is co-founder of the volunteer organization San Diego Health Connect, a student researcher at Sanford Consortium for Regenerative Medicine, and co-founder of the non-profit Mukta.

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