Friday, January 19, 2007

The minimum wage debate

So, Congress is all set to raise the minimum wage to $7.25 an hour. Liberals say this is a long overdue raise for poor workers. Conservatives say it will lead to unemployment among the poor. Very few commentators are exploring the issue in any depth, except to reinforce one of those two views. Considering how many economists are part of this debate on both sides, that's a shame.

I'm not an economist, but I do have something to contribute: I have been privy to the balance sheet of a rather large company that does employ minimum wage labor. And I worked at that company through the previous minimum wage increase, so I can tell you how it was dealt with. Then I'll put in my two cents on what a minimum wage increase really means.

Back in the 90s, minimum wage was raised from $4.25 to $5.15, a much lower increase than the current one. How did my company deal? Well, first off, they raised prices. They didn't say it was in response to the minimum wage increase, but they did it at the same time and hadn't significantly raised prices in a few years. Secondly, we had to spend the same percentage of sales on labor as before, even though the wages of many of our workers went up. Now how did we do that? The price increase, alas, didn't increase our overall sales, as it turned off some customers. Tax increases tend to work that way as well, bringing in much less revenue than expected due to decreases in economic activity. So neither government nor business can just with themselves more revenue by decreeing it. So now we had to meet labor targets with higher wage employees and the same level of sales.

What happened? Well, contrary to the doomsaying of conservative commentators, we didn't fire anyone. In fact, I've known a lot of people who have worked for minimum wage or close to it, and never known of anyone who got fired because minimum wage went up and their boss could no longer afford them. But that doesn't mean there were no consequences. We cut back on hours. Everyone got a few less hours, and so their paychecks did not change despite the minimum wage increase. Congress meant to give poor workers a raise, but instead they got more free time.

Ah, but even that is not the whole story. You see, my company, like many large companies, seeks to subvert the bargaining process by not giving managers the power to give better pay to better workers. It's a great example of market failure. Big companies, rather than letting the managers decide how much each employee is worth, simply set wages for job descriptions and give stingy merit raises every six months to a year. After about five years, a good cook can make a whopping 50 cents an hour more than a mediocre cook. That tactic by large corporations helps hold wages down artificially, because there's no one to bargain with. Even if the employee says "Give me a raise or I'm quitting" all the manager can do is throw up his hands. It's out of his control. The guy that sets pay rates is so far up that he doesn't care. He doesn't know who is good and who is mediocre.

So what does that have to do with the minimum wage debate? Well, if minimum wage is raised, then they get the raise they deserved all along but couldn't get because of the strict pay scales of the company. So it benefits good workers who haven't been able to bargain for what they are actually worth. It does hurt poorer workers, because what a manager will do is cut the poor workers hours while leaving the good workers' hours the same, or even increasing them.

So what's my political position on the minimum wage? Really, I'm neutral. On one hand, the value of a product or service cannot be changed by legislation. If someone's labor isn't worth $7.25 an hour, he'll find himself priced out of the market. In that respect, conservatives are 100% right. But then liberals are right that the market is not necessarily efficient in every respect, especially at the micro level. Individuals and companies do different things to try to distort the bargaining process, and this sometimes shows results at the micro level. So many employees who actually are worth more than $7.25/hr are underpaid. So when minimum wage gets raised, they don't get fired or lose hours. It's only the people who aren't worth that much that get priced out. The mistake conservatives make is to assume that everyone makes what they are worth.

To further lengthen this post, that does not mean I subscribe to the idea that you can determine the worth of a worker. I can't say if a CEO is worth $400 million or if a delivery driver is worth $7.25. There is no objective way to measure worth, and I don't think the government should be in the business of trying to. What I can say is how much their services would be worth to me if I was paying for them. So when I say someone is underpaid, I'm referring to the fact that I, as a manager, would be willing to pay them more. So don't jump on me libertarians and conservatives. I'm only pointing out a type of market failure that those who haven't worked as or employed minimum wage labor may not know about.