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SEIFFE:  Another View Of The Minimum Wage

Monday, December 4, 2006

By Ralf Seiffe

Last week, Don Castella offered an excellent analysis of the macroeconomic effects of that counter-productive conceit of government called the minimum wage.  Focusing on the jobs that will inevitably be destroyed so that the Democrats and some misguided Republicans can feel good about themselves is a message that cannot be too-oft repeated.  But the microeconomic effects on businesses in Illinois are even more pernicious and the malignant effect on Illinois ’s workers is almost never discussed.  Here are some of those effects the Governor should consider before he signs the Illinois super-minimum wage bill.  

First, let’s start with the notion that all human beings are created equally.  In its most basic sense, this means that to the extent of their ability, all people want to improve their station and, given the opportunity, will undertake those actions necessary to improve.  This premise applies to the most conservative or liberal reader.  The difference in how best to accomplish the goal--either through rugged individualism or collective action largely defines one’s politics. 

Liberals often complain that there is a “gap” between high wage and low wage workers and that the gap exists because of some perceived social flaw that can only be rectified by government’s collective action.  The minimum wage is just such a program.  Supporters justify imposing their values on employers on the basis that without their sense of superior economic justice, employers would exploit workers with lower wages.  

In a perfect world, each worker would earn a living in exact correlation to his contribution in production, however measured.  In this way, the market would produce signals that individuals could observe and integrate into their economic activity.  In large economic systems with such well-defined market signals--the United States , for example—folks quickly adapt and the result is the vibrant economy we enjoy.  In other economies where the economic signals are not so evident or are polluted with impediments to economic success such as social standing, overpowering politics or underdeveloped transactional systems-- Mexico , for example--the economy doesn’t perform as well.  When two such different economies are physically adjacent, the behavior of human beings looking to improve their lot is perfectly predictable and the flow will be in one direction, only.  

A perfect compensation system doesn’t exist, of course, but the importance of market signals that contribute to creating the best possible economy and the highest standard of living are extremely important.  This concept is as important to smaller economic units, even tiny ones as it is to nations.  In fact, the smaller the economic unit, the more the relative importance of such signals.  Supporters of the Minimum Wage must believe that the workers their law supposedly helps are unable to comprehend these market signals and therefore will not--or cannot--use their own talents to improve their lot.  In fact, the imposition of a minimum hourly wage confuses the signals that low wage workers need to do better. Accordingly, the Illinois Minimum Wage hurts the very folks it was supposed to help.  

Let me explain.  

Consider the small family business, perhaps a McDonald’s franchisee.  This is a good example because some economists estimate that as many as a third of all workers did a stint at the hamburger chain at one time in life.  That so many of us spent time as minimum wage burger flippers yet have been able to become doctors or lawyers or even governors is a testament to the efficacy of those market signals and absolutely torches the minimum wage advocates’ implicit premise that working for the minimum wage includes a life sentence. 

Now, this small business is in a vibrant and competitive business environment in which potential customers have many choices for fast food.  Cost is an important discriminator for customers so the hamburger joint must pay attention to the prices they charge for their burgers and fries.  Labor expense is an important component in total costs so when the government imposes higher labor costs with the minimum wage, something must compensate.  The small businessman’s three most likely responses are to raise prices, hire fewer workers or to automate the production processes.  Fast food companies have employed all three strategies.  

Most analyses stop at this macroeconomic level and they do, in fact, completely demolish the arguments in favor of a government wage.  There is, however another dimension that is more granular and provides an improved understanding of the pernicious effect of raising the minimum wage.  

Return to the back of our mythical McDonalds where the staff is working at low-skill jobs for minimum wages or near-minimum wages.  The market insists that the store’s management must keep prices down so they have a huge incentive to keep their roster of workers lean and wages as low as possible.   But, it is impossible to operate with no labor and its quality varies.  A 16-year old just walking through the door will be less helpful than the kid who had started three months earlier.  She would know where to find the frozen fries are in the freezer and how hot the fryer should be to properly cook them.

In that world of perfect compensation, the manager would figure out the budget for labor and assign pay rates to reflect such differences--the fryer jockey would earn something more than the “new kid.”  Moreover, it is in the manager’s best interest to have two employees who know where the fries are and how to operate the fryer.  The question for the manager is how to motivate a 16-year old to learn those skills.  The question for Americans is how to make sure the youngster learns that learning is the way to a better life. 

One way is to create market signals that encourage the unskilled employee to learn, that is, to upgrade himself.  Wage differentials are a very good way to do this and the bigger the differentials, the more effective these market signals are.  When the 16-year old kid just off the street comes to work for $5.50 per hour as a sweeper, he will soon learn that the grill man makes, say $9.50 per hour.  Despite his public school education, he does understand that the 17-year old who actually does the flipping makes almost 75% more.  Unless he’s brain dead, the new kid will begin to figure out how to make the better money. 

It’s also important to establish as many steps as necessary for the average newcomer to comprehend what he has to do to make the transition from an entry-level position to a more responsible one.  For example, he might start as a sweeper for $5.50 but learns that he can earn another half-dollar an hour if he learns to run and clean the milk shake machine.  Perhaps getting that job will require him to read a five page instruction manual and be quizzed by the manager.  Having mastered that, he’s on deck for the slicer job and another 50-cent raise.  Effectively arranging each of these steps requires a wage differential to make it worthwhile to master even “bite-sized” levels of new skills.  The greater the differential between each step, the easier it is to establish an effective rewards system   Indeed, connecting good behaviors such as improving one’s skills set with economic rewards are extremely important lessons to teach our children.  Inculcating this notion is the best way for the United States to create its best possible future.   

Unfortunately, the concept of the Minimum Wage frustrates this on the microeconomic level.  If the State of Illinois insists that entry level workers be paid more, then it follows that more experienced workers be paid less if prices cannot rise or the lower wage jobs automated.  That’s because the market forces limit the total amount of compensation available to pay the entire crew. In our abstract example at a single store, assume there are only two workers.  If the $5.50 sweeper is now entitled to $7.50 because the Governor says so, the manager has no choice but to lower the higher wage levels--or at least limit future hires to less.  That limits or eliminates the manager’s prerogative to set wages that encourage better behavior at the time a youngster is most susceptible to that message.  

Don Castella properly identifies one type of the Minimum Wage victim--the kid who doesn’t get a job because his skills do not justify employment at the government’s new minimum price.  But there is another victim too. It’s the kid who “learns” that skills don’t matter much because the Governor will take care of making sure he has a “living wage”. Without a sharp differentiation of wages at the entry level, in fact one that does not provide a “living wage” for initial employments, there’s no reason to get better.  A system based on over-market entitlements, that does not provide incentives to improve, and whose benefits the government determines, sounds a lot like a new welfare system that’s been outsourced to large employers of unskilled labor.  The minimum wage is a vanity for our politicians but a mortal disservice to our most at-risk children.

© 2006 Ralf Seiffe

Ralf Seiffe advises business start-ups and product launches from Chicago, Illinois and is a political analyst and columnist for the Illinois Leader and Illinois Review.

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