Blog Post

AEIdeas

Here’s a quick economic quiz about the labor market, with important implications for the $15 an hour minimum wage hysteria that is sweeping the country:

True or False? Unskilled employees compete against employers in the labor market for higher wages.

Answer: False

Economic lesson: Despite what we hear from labor unions and the “Fight for $15” crowd, employees compete not against employers for higher wages, but against other employees. And it’s also the case that employers compete against other employers for the best employees. It’s like that in every market: buyers (employers) always compete against other buyers (employers), and sellers (employees) always compete against other sellers (employees).

For example, if you’re in the market to buy a home, you’re competing against other home buyers, not against home sellers, to get the best (lowest) price. And the home sellers are competing against other sellers to get the best (highest) price. As a result, the more buyers competing for a fixed number of available homes, the higher the home sales prices; and the more home sellers competing for a fixed number of buyers, the lower the home sales prices, ceteris paribus.

Economic implications of a $15 an hour minimum wage for the labor market: Unskilled workers compete against other workers – especially skilled workers — for a limited number of available jobs at a given point in time. If the minimum wage is increased from $7.25 or $10 to $15 an hour, that will give skilled workers an advantage over unskilled workers, and will take away from unskilled workers the one advantage they currently have to compete against skilled workers – the ability to offer to work for a significantly lower wage than what skilled workers can command. And to the extent that we remove the wage advantage for unskilled workers, we reduce their ability to compete against skilled workers, and reduce employment opportunities for those unskilled workers.

Here’s an example: Suppose that an employer can hire two unskilled workers at $7.25 an hour for a total cost of $14.50 an hour and provide them with on-the-job training, or hire one skilled worker for $20 an hour, provide no training, and get the same hourly output as two unskilled workers. Given that choice, the employer hires two unskilled workers and saves $5.50 an hour in labor costs. Now suppose that the minimum wage goes to $15 an hour, which would require the employer to pay $30 an hour for two unskilled workers. In that case, the employer would switch to hiring one skilled worker at $20 an hour over two unskilled workers, and save $10 an hour in labor costs. Result of a minimum wage hike to $15 an hour? Demand for skilled workers goes up, demand for unskilled workers goes down, and employment opportunities for unskilled workers are reduced.

Economist Walter E. Williams has used the following example to illustrate the competition described above between unskilled and skilled workers by looking at the market for different qualities of beef (see examples here, here, and here). Suppose that hamburger sells for $4 per pound and sirloin steak sells for $8 per pound. Hamburger is a much lower quality variety of beef compared to sirloin steak, but can attract a significant number of buyers who choose hamburger over the higher quality option for the 50% savings in price. Likewise, many employers may choose lower quality, unskilled workers over higher skilled employees for the significant savings in labor costs.

But now suppose the government imposes a “$8 per pound minimum beef price law.” In that case, most shoppers who buy beef will then purchase more sirloin steak and less hamburger because the lower quality meat has lost it main weapon to successfully compete against higher quality sirloin steak – a significantly lower price that compensates for the lower quality. Result? Hamburger sales will suffer due to the “minimum beef price law” and sirloin steak sales will increase. Just like in the labor market, a $15 an hour minimum wage will remove the most effective weapon that unskilled workers currently have to compete against skilled workers – the ability to work for a lower wage. Result? Employment opportunities for unskilled and limited-experience workers will contract, while employment opportunities for skilled workers will increase.

Bottom Line: Much of the economic confusion about the $15 an hour minimum wage hysteria can be traced to the mistaken assumption that unskilled workers are competing against their employers to get higher and higher wages. That’s absolutely not the case. The economic reality is that unskilled workers compete against other workers to get higher wages, especially skilled workers, and ultimately against investments in labor-saving technologies and automation. If you understand and agree that a “minimum beef price law” would disadvantage hamburger sales and enhance sirloin steak sales, then you should also understand and agree that a $15 an hour minimum wage law would disadvantage unskilled workers and deny many of them the valuable opportunity to get an entry-level job and gain the skills, training, and experience that will put them on the path to a better and more prosperous economic future. At $15 an hour, many unskilled workers simply won’t be able to effectively compete against skilled workers and against automation, and we’ve therefore handicapped America’s most vulnerable workers by taking away from them the most effective strategy they have – the ability to offer to work for a competitive wage that is consistent with their lack of skills.

Update 3: From Walter Williams:

The steak example applies to any mandated minimum price. In the case of minimum wage laws, a mandated minimum lowers the cost of – hence encourages – the indulgence of racial preference in the labor market. Some might object to the validity of my example by saying that people are not the same things as cuts of meat. That is true – just as steel balls are not the same as people. However, although steels balls and people are different, both obey the law of gravity. The independent influence of gravity on a steel ball’s acceleration is 32 feet per second and its influence on a person is exactly the same. Similarly, quantities demanded for cuts of meat are influenced by the law of demand, and so are quantities demanded of a person’s labor service.

Update 2: Related quote from Milton Friedman:

The minimum wage law is most properly described as a law saying that employers must discriminate against people who have low skills. That’s what the law says. The law says that here’s a man who has a skill that would justify a wage of $5 or $6 per hour (adjusted for today), but you may not employ him, it’s illegal, because if you employ him you must pay him $9 per hour. So what’s the result? To employ him at $9 per hour is to engage in charity. There’s nothing wrong with charity. But most employers are not in the position to engage in that kind of charity. Thus, the consequences of minimum wage laws have been almost wholly bad. We have increased unemployment and increased poverty.

Update 1: In the related video below (“The Cruelty of the $15 Minimum Wage“), Don Boudreaux reminds us that “Taking away from workers an important bargaining chip, namely the ability to offer to work at a wage less than the minimum, is the cruelest thing you can do for a lot of these workers.”