A Living-Wage Minimum Wage Will Not Materially Reduce Employment

Why The Claim That Raising The Minimum Wage Will Greatly Reduce Jobs Is Just Plain Wrong

DavidGrace
Apr 19, 2017 · 12 min read

By David Grace (www.DavidGraceAuthor.com)

There’s a simplistic, comic-book view of economics where a bunch of simple and mostly false statements are plugged together like a handful of Tinker Toys to yield a generally false conclusion.

It goes like this:

  • Raising the minimum wage always means higher labor costs.
  • Higher labor costs always mean higher product prices.
  • Higher product prices always mean lower product sales.
  • Lower sales always mean fewer employees.
  • Therefore, a higher minimum wage always reduces employment.

These simplistic notions do not match the way that real people and real businesses work in the real world.

In the real world the first three of these four statements are very often false and the fourth one is sometimes false.

We Must Remember That Employers Always Employ As Few Workers As Possible

Companies hire the smallest number of employees they need in order to manufacture enough product to meet demand.

Absent a machine that can do the job cheaper and just as well, if demand remains constant employers cannot fire workers because the company needs all those workers to produce the products that it is selling at a profit.

In other words, as long as the number of products each employee makes earns the company more money than the employee’s labor costs the company, the company has a profit motive to continue to employ that worker.

The only times that an increase in the cost of labor causes a reduction in employment are:

  • If the increased cost of labor requires an increase in price

AND ALSO

  • If that higher price causes such a decline in sales volume that the company now has more employees than it needs to produce the new, lower quantity of products demanded,

OR

  • If the increase in labor costs makes it both cheaper and equally effective to replace some of those employees with machines.

Increases in labor costs that

  • Do not materially reduce sales volume

OR

  • Do not make it more profitable to replace some employees with machines

do not cause a decrease in the number of employees.

Raising The Minimum Wage To A Living Wage Does Not Always Mean Higher Labor Costs

Most Companies Already Pay A Living Wage

Most companies employ between few and no minimum-wage workers. Increasing the minimum wage has absolutely zero effect on most companies’ production costs.

Approximately 60% of America’s employees are paid on an hourly instead of a salaried basis. It’s estimated that about 60% of hourly workers currently earn at least $15/hour. That means that only about a third of American workers earn less than $15/hour.

Those less-than-living-wage workers are concentrated in low-end industries such as restaurants, hotels, and the like so most industries would not be affected by the adoption of a living-wage minimum wage.

Many Companies That Would Have Higher Labor Costs Won’t Raise Product Prices

For any industry you have to begin with this question: What is the ratio of your minimum-wage labor costs to your product’s price?

An Example, Widget, Inc.

If your total costs to manufacture and market 1,000,000 widgets is $10,000,000 then your cost per widget is $10.

If your total cost for minimum wage labor is $1,000,000 (to produce 1,000,000 widgets) then minimum-wage labor costs you $1/widget and represents 10% of your product cost ($1/$10).

If you sell your widgets for $30 each then the ratio of minimum-wage labor costs to the product’s price is $1/$30 or 3.3%. Doubling the cost of your minimum-wage labor would, at most, only add $1 to the cost of your product.

Because manufacturers maximize profits, Widget, Inc. will determine whether:

  • Raising its price by that $1 to $31 will not significantly reduce its sales volume,

OR

  • Raising its price by $1 will significantly reduce its sales volume.

If Widget, Inc. determines that it won’t materially lose sales by raising the price by a dollar that’s what it will do, and the $1 increase in labor costs will have no material effect on the number of workers because it will have not have any effect on sales.

If Widget thinks that it will materially lose sales if it increases the price to $31 then it will keep the price at $30 and absorb the $1 cost increase out of it’s profit margin because it will make more money at $30 at the existing sales level than it will make by charging $31 and having a lower sales volume.

Since in either case the sales volume will not decline, Widget will still need all its workers to meet product demand and the $1 increase in labor costs will have no material effect on the number of its workers.

Only if the amount of the increased labor cost was greater than the company’s profit margin thus forcing it to institute a price increase and also if the price increase would lead to materially lower sales would this $1/product increase in labor costs lead to a decline in the number of Widget’s employees.

For Products That Are Not Price Sensitive, Higher Prices Do Not Lead To Lower Sales

High-End Products

Many high-end products are not price sensitive. If the labor-cost component of a Rolex watch increases by $20 and Rolex increases the cost of the Date Watch from $1,999 to $2,020 it would have zero effect on sales because people who are buying a $2,000 watch don’t care whether it is $2,000 or $2,020.

If a Le Creuset Dutch oven’s price increased from $370 to $380 because of an increase in labor costs it would have zero effect on sales volume because the buyers of that product don’t care about a ten dollar price increase.

Very Cheap Products With No Good, Lower-Priced Alternatives

Very cheap products are also very often not price sensitive. Generally speaking, the cheaper the price for a commodity item the less sensitive that product’s sales are to an increase in price, absent an easily available, equivalent, cheaper alternative.

If pencils cost ten cents each and suddenly pencils cost fifteen cents each, a 50% price increase, then unless there were another, equivalent product available at a lower price, the sales volume of pencils would remain essentially unchanged because people who want a pencil don’t care that a pencil costs fifteen cents instead of ten cents. The five cents just doesn’t matter to them.

If the price of a cheap, fast-food burger rises from $.99 to $1.13 it won’t materially affect the number of burgers sold because the fourteen-cent increase will not matter to those people who buy fast-food burgers.

Fast Food Numbers

So, let’s talk about the effect of an increase in the minimum wage on those industries whose payrolls are materially composed of minimum-wage workers.

Even for industries that are heavily reliant on minimum-wage employees, such as fast-food restaurants, minimum-wage workers represent only a portion of all labor costs. Managerial employees, HR, accounting, etc. are already above $15/hour and comprise a material percentage of their labor costs.

Total labor costs for fast food restaurants including highly compensated employees are between 20% and 25% of gross revenue. Minimum wage labor costs probably equal less than 20% of gross revenue, but let’s say that for every $100 in sales, $20 goes to pay minimum-wage employees even though it may be less than that.

Let’s say that the average minimum-wage employee’s pay goes from $9/hour to $15/hour or an increase of 167%.

A Big Mac is $3.99. A McDouble is $1.39.

At 20% the minimum-wage labor component of a Big Mac is 20% X $3.99 or $.80 and for a McDouble it’s 20% X $1.39 = $.28.

$.80 X 1.67% = $1.34 — $.80 = A cost increase for a Big Mac of $.54 to $4.53

$.28 X 1.67% = $.47 — $.28 = A cost increase for a McDouble of $.19 to $1.58

A $.99 item would increase to $1.13.

Do any of the people who regularly buy the two for 99 cents Jack In The Box tacos care if they now cost $1.13? No.

The lesson here is that increasing the minimum wage by 167% only increases the product’s price by 20% for the industry that most heavily relies on minimum wage employees.

Put another way, even for major minimum-wage employers almost doubling the minimum wage only increases the product’s still low price by 20% which will have little to no effect on sales volume across the industry as a whole.

So, there are two take-aways here:

  • Even in an industry that relies very heavily on minimum-wage employees, a big increase in the minimum wage will have a relatively small human effect on the retail price of their already low-priced products, and
  • Unless there is a substitute product readily available that people like just as well and which is materially cheaper, an industry-wide price increase of 20% or 25% for a low-priced product will have very little effect on sales volume and thus very little effect on employment for the industry as a whole.

Lower Sales Volumes Sometimes But Not Always Reduce Employment

If you have three employees and sales fall by 10% you still need three employees because two employees won’t be able to produce enough product to meet demand. You may reduce some hours, but the employees will get more per hour for fewer hours and end up making the same amount as they did before the wage increase for less work.

If your business is seasonal and if demand falls by 10% in the slow season, it will likely be cheaper for you to keep your current workforce in place for a month or two than pay the costs of termination and then pay the costs of re-hiring.

If you’ve had problems finding low-wage workers either because your work is unpleasant (e.g. a chicken processing plant) or because you’re in a rural area where there are few semi-skilled workers, it may be better for you to keep your current, trained employees during a slow period, but with reduced hours, than fire them and face the difficulties of finding and training new employees at a later time.

Losing A Job With Employer A Doesn’t Mean That You Won’t Get A New Job With Employer B

There will be some cases where an increase in the minimum wage to a living wage will cause a marginal employer to cut some jobs.

For example, suppose you’re running a pet-grooming business in a small city. Let’s say that there are only enough customers in your city to support two pet-grooming businesses. Each of those businesses has a steady clientele. The business is static. Profit margins are narrow. Each business’ payroll is composed of 50% minimum-wage employees and minimum-wage labor costs are equal to 25% of gross revenue.

Let’s say that an average pet grooming session costs $100 of which $25 covers the cost of minimum-wage labor. Let’s say that the minimum wage increases from $10/hour to $15/hour or an increase of 150%.

Let’s say that your profit margins are already so slim that instead of absorbing the additional $12.50 in costs that you will have to cover the higher labor costs by increasing the price of a pet-grooming session from $100 to $112.50.

Let’s say that you employ ten minimum-wage employees and let’s also say that your customers are price sensitive and that your price increase will reduce grooming sales volume by 10% because some customers will go from a monthly grooming to an every other month grooming.

So, you fire one employee. You still need the other nine to service your remaining customers.

The opponents of a living wage will say, “See, that proves the living wage is a bad thing.”

No, it doesn’t. Their claim is based on the false assumption that the fired employee will never work again, that there are no other jobs available to replace this one lost job, but that’s not true.

If you increase the wages of a quarter to a third of the workers in your community by 50% what are they going to do with that money? Put it in the bank? Donate it to charity?

No, they’re going to spend it on food, clothing, auto repairs, entertainment, and other consumer items. Restaurants, retail stores, hotels, supermarkets, etc., the kinds of places that hire low-skilled workers, will see a material increase in sales and all those businesses are going to have to hire more workers to service those increased sales.

While the increase in the minimum wage may reduce some jobs in some marginal businesses it will also add more jobs in other businesses.

Money doesn’t disappear. When it doesn’t flow to one place — dog grooming, it flows to other places — movie theaters, super markets, pizza joints.

The net result of putting a great deal more money into the hands of low-wage consumers will be an increase in sales by those low-end consumer businesses that employ low-skilled workers.

Boundary Issues

To be really effective a living-wage minimum wage needs to be nationwide. When it only applies to only one city or one county then people living near the boundaries will cross over into neighboring jurisdictions to get lower prices thus putting local businesses at a disadvantage.

At the very least, the living-wage minimum wage needs to apply to an entire state in order to minimize boundary problems.

Why Have A Living Wage?

A fact of life in an industrialized country is that families are not going to be allowed to starve or live in the park or go entirely without access to medical care. As much as the Libertarians would like to have a pure sink-or-swim society that’s not going to happy in this country.

Once you accept that fact, you have to realize that either the taxpayers are going to pick up the bill for the living expenses of unskilled or low skilled workers who are paid food-stamp wages or employers are going to pay a living wage.

Either tax payers are going to fund food stamps, Section 8 housing, Medicaid, Obamacare subsidies and the like or employers are going to pay a living wage. In real-world terms, that’s the choice. Pick one.

Right now, employers’ labor costs for unskilled workers are being subsidized by taxpayers in the form of government-funded entitlements and welfare programs. This system allows employers to make bigger profits on cheap labor and shift the cost of feeding, housing and providing medical care for their employees to the taxpayers.

This system not only distorts the free market by subsidizing the products produced by food-stamp-wage workers over other products produced by companies that pay a living wage, it also results in a bigger government and it is inefficient.

Every time the obligation to support low-skilled workers is pushed onto the government, taxes have to be levied, programs enacted, bureaucratic rules and agencies are created to collect and then disburse the tax money, and recipients have to deal with the bureaucracy. Expensive and inefficient.

A substantial portion of that tax money disappears into the funding for those government agencies and eventually only some of it makes it way to the citizens it is intended to help.

And that process interferes with the consumers’ freedom to choose their products. Certain products, fast food, low-level hotel rooms, etc. are made artificially cheaper because a substantial portion of the costs of feeding, housing and providing medical care to those businesses’ employees has been shifted to the taxpayers.

If those employers were required to pay a living wage and provide major-medical insurance coverage the cost of those products would rise in relation to the cost of other products whose workers’ living expenses were not being subsidized by the taxpayers.

If the consumer was required to pay the true cost of all products, if taxpayer-subsidized products weren’t competing with other products whose labor costs were not being subsidized, then the market would work as intended with the consumer being free to price compare apples to apples and oranges to oranges.

A living wage has nothing to do with being nice to people. It has to do with workers being paid enough to run their own lives without government handouts and without taxpayers being required to subsidize the living expenses of working people with full-time jobs.

It has to do with less taxes, smaller government, free-market pricing for products, the workers’ freedom to earn and spend their own money and the consumers’ freedom to choose between competing products that are priced at their true cost of production instead of at a subsidized cost of production.

For a more detail discussion of these issues, see my article:

Raising The Minimum Wage Has Little To Do With Helping People. Its Real Value Is As A Tool To Reduce Welfare And The Size And Cost Of Government

Summary

For most employers raising the minimum wage will have a zero to small effect on overall product prices.

For companies selling very low-cost and very high-cost products a large increase in the minimum wage may increase product prices but it will have almost no effect on product sales volumes and thus almost no effect on the number of employees.

For solidly profitable companies, an increase in the minimum wage will be absorbed rather than reflected in a higher price because the company will make more money by maintaining its current sales volume at a still profitable price than by increasing prices and losing what would otherwise be profitable sales.

Some marginal companies with already narrow profit margins who are selling very price-sensitive products will raise prices and will experience some decline in sales and some reduction in employment, but those relatively few lost jobs will be overbalanced by and replaced by the larger number of new jobs that will be created to meet the increased consumer demand generated by the large increase in the disposable income of minimum-wage workers.

Other Articles On The Minimum Wage & Jobs

The Capitalist Case For A $15 Minimum Wage (Bloomberg.com)

New UW Report Finds Seattle’s Minimum Wage Is Great for Workers and Businesses

–David Grace (www.DavidGraceAuthor.com)

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Graduate of Stanford University & U.C. Berkeley Law School. Author of 17 novels and over 200 Medium columns on Economics, Politics, Law, Humor & Satire.

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