Economics Lessons for Liberals: Minimum Wage

A year ago, the minimum wage went up from $5.15 to $5.85 per hour. Last week, it went up to $6.55. Next year, it will go up to $7.25. That’s more than a 40% increase in two years.

My friends on the left tell me that’s a good thing. What could possibly be bad about legislating raises for poor people? They’re absolutely incredulous that anybody could be against it. After all, it doesn’t come out of your pocket, so why should you begrudge it to others?

Economics for Liberals, Lesson #1. Profit is revenue minus expenses. If expenses go up, without a commensurate increase in revenue, profits go down. Profits are necessary to stay in business. In today’s economy, many businesses, particularly small businesses, are just hanging on. Small businesses hire a lot of minimum wage workers, because that’s all they can afford. They also generate less revenue than larger businesses, so they’re more sensitive to higher expenses. Smaller businesses are hit hardest by minimum wage hikes, and may find their profit margin squeezed so thin they can no longer sustain their business.

When we see a rash of local businesses closing their doors, my liberal friends always shake their heads and blame it on the encroachment of big chain stores. They prefer not to acknowledge the role that increased labor costs play in their favorite local businesses being unable to compete any longer. Yet they still defend every increase in minimum wage because they think it “helps poor people.” Meanwhile, as more local businesses go under, more minimum wage employees are left without jobs.

Economics for Liberals, Lesson #2. There are two only two ways to increase profits. Increase revenue or cut expenses. When faced with a significant increase in the cost of labor, a business has two options to recoup the immediate loss of profits. They can either lay people off or raise prices. Both have negative impacts on the economy. One causes unemployment and the other causes inflation.

Nobody likes to lay people off but, when labor costs go up by 40%, many employers are forced to cut their work force by up to 40% to offset the higher cost per employee. When an employee is given a raise based on merit, the expense is offset by the fact that their high productivity contributes to increased revenue. But, when legislation raises wages arbitrarily and unilaterally, there is no increase in revenue to offset the increased expense, so it’s an out and out loss to the business. Furthermore, a significant reduction in work force usually results in reduced revenue, so the small business is squeezed from both ends. First, they cut to the bone; then they raise prices to make up the difference.

In some businesses, cutting back on labor isn’t an option. For example, in agriculture, cutting back on labor would leave produce rotting in the fields. In such cases, the employer has no choice but to raise prices to offset the increased labor costs. Many basic materials, from which other products are made, are produced by low-skilled, low-wage workers. When the prices of those materials go up, due to increased labor costs, it drives up the prices of all the products that depend on them, directly or indirectly, creating a ripple effect of rising prices throughout the economy.

Economics for Liberals, Lesson #3. The real value of a dollar is its purchasing power. When prices go up, your purchasing power, and the value of every dollar you have, goes down. This is known as inflation. Rising labor costs aren’t the only cause of inflation, but even the most basic understanding of economics tells us they cannot help but fuel it. In the short term, the people at the bottom of the pay scale will have more buying power. But, as the ripple effect permeates the economy, everybody ends up having less. In an economy where inflation is already getting out of control, the last thing we need is to fuel it faster.

Raising the minimum wage results in higher prices, fewer jobs, and more businesses closing their doors. — But, if that’s true, why would our elected representatives continue to do it? They do it because most of their constituents have no understanding of economics, and more money always sounds good, so promising more money gets them more votes. And getting votes is more important than the economy.

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