Who Pays for the Minimum Wage?
If you just want the short answer, that’s easy. You do. We all do. If you want to understand why we all will be paying for the hike in the minimum wage (or if you want to explain it to your progressive friends), you may want to continue reading this commentary.
The Congressional Budget Office has done an estimate of the impact of the Raise the Wage Act of 2021 (S. 53) introduced on January 26, 2021. The CBO estimates that the increase of the minimum wage to $15 an hour by 2025 would reduce the number of people below the poverty line (on a net basis) by 900,000 but increase unemployment by 1.4 million people. The CBO further assumes that the move will have little impact on GDP and that the cost the higher wages will be borne by a mixture of higher prices and lower return on capital.
Ignoring the ethical question that it is okay to make life better for the approximately seventeen million people paid less than $15 per hour at a cost of making life much worse for 1.4 million people losing their jobs and all their income, we need to better understand the true purpose of forecasts such as the one made by the CBO. I worked for the US Treasury Department for fifteen years advising foreign governments on making and interpreting financial forecasts. And the one thing I know about forecasts is that the forecast will be wrong. And the further out into the future it goes, the more wrong it will be.
There are too many endogenous and exogenous variables involved in making forecasts of an entire economy to be accurate. There are tens of millions of economic actors in the United States making billions of economic decisions a year and it is impossible to estimate exactly how all those decisions will impact on the forecast. Add to that exogenous variables over which we have little control like natural disasters, pandemics, wars or the trade policies of foreign competitors and it is highly likely that the forecast will go sideways very quickly.
You also need to take into consideration the fact that trying to change the direction of a free market economy through government fiat will generate unknown and unintended consequences that can invalidate the assumptions used in making the forecast.
So why do we do forecasts in the first place? As time passes, we can observe the variations between the forecast and what actually occurred. That gives us the opportunity to investigate why the variation occurred and to better understand how the economy actually works. In the best of all possible worlds, we would use the new understanding to take remedial action to alleviate the unwanted condition. Unfortunately, the remedial actions most governments take are politically determined and rarely work. Like, for instance, when the scores of American students on the Program for International Student Assessment (PISA) are below the OECD average even though we spend more per pupil than any other country (except Luxembourg), the government response is to spend even more money.
So, what should we be looking for to go wrong in the CBO’s forecast of the impact of the increase in the minimum wage?
The most basic assumption that the CBO makes is that the wage increase is just a reallocation of cash flows and the increase of cash flow to low wage earners will be offset by a combination of higher prices to consumers and lower return on capital to employers (and, of course, the lack of cash flow to the newly unemployed). But these reallocations of cash flow will not be applied evenly across the country.
The increase in wages will not be accompanied by an increase in productivity. Employers can raise prices, take a hit on their return on capital, lay workers off or automate their operations in order to reduce the impact of higher salaries on cash flow. The CBO forecast estimates how much automation will occur. But automation has already been occurring rapidly, which you realize whenever you use a kiosk to order your happy meal. If they are wrong on this estimate the impact on unemployment could be much worse.
Large corporations generally have the ability to pass on costs more easily and will raise prices to offset wages. A lower return on capital would affect their stock prices so they will resist absorbing those costs and will pass them on to consumers. Companies that do not have the ability to pass on higher costs may have to take a hit. But which companies are we talking about? We are talking about retailers, restaurants and mom and pop stores. These are the same people that have been most severely impacted by the Covid pandemic and many have already closed. Increasing their costs so substantially in their weakened condition will force many more businesses to close. Unemployment, which is at already very high levels, could be much worse that the CBO is forecasting.
Raising consumer prices will, of course, impact inflation, but the CBO expects the inflationary impact to be temporary after the hourly rate stabilizes at fifteen. But minimum wages are often indexed to inflation and there will be political demands to continue increasing the minimum wage after it reaches fifteen dollars an hour. The CBO also assumes that only wages close to the $15 minimum will be affected. They may know economics, but they obviously don’t know psychology. The guy getting $20/hour supervising guys making $10/hour isn’t going to be very happy with token increases. He will want his salary increased to $30/hour (which is probably why the AFL-CIO is pushing for the increase). For numerous reasons, inflation in the US has been very low despite a very accommodative monetary policy. Much of that easy money has gone into assets such as art, real estate or the stock market. But if that easy money is diverted into consumption (as was the government’s original intent) inflation could explode.
Our friends on the left assume that once the minimum wage has been raised to fifteen dollars an hour (and assuming that none of the unintended consequences discussed earlier have occurred) that the lives of the working poor will have been permanently made better (and our elite limousine liberals can pat themselves on the back for having done a better job of taking care of the masses than those nasty conservatives). But economies, even socialist economies, are full of unintended consequences and head off in directions completely different than the direction envisioned by the policy makers.
Even though the low wage earners have had the cost of their labor increase, the value of their labor remains the same. There has been no increase in productivity. Over time businesses will adjust by adopting policies to compensate for those higher wages whether through reduced staff, increased prices or increased automation. Our friends on the left believe that employers will be willing to accept lower returns in order to pay for better wages. But employers are taking risks by opening businesses and hiring people and they need to be compensated for taking those risks. And if they are not adequately compensated, they will close that business. Entrepreneurs seeing the low returns of such businesses will not start new ones.
And where will all those closed and abandoned businesses be located? Most likely in the neighborhoods where the low wage earners live. They are the most vulnerable. They are the ones that have been hardest hit by the pandemic. They are the ones burned out when racial justice protestors turn into rioters. They are the ones that are robbed when the police are defunded. And it will be the low wage earners that pay the price.
Most low wage jobs are not meant to be permanent employment. They are entry level jobs and are meant to teach people entering the workforce the skills and attributes needed to qualify for better jobs. If you want to keep the low wage jobs for teenagers learning basic skills and not adults with families that need a living wage, then those mature adults need the education and experience to qualify for better jobs. They need to understand that dropping out of school, having babies outside of marriage and developing a criminal history are not the way to earn a living wage.
Poor people (whites as well as minorities) all suffer from similar traits and characteristics (as documented by Charles Murray in his book, Coming Apart) that keep them trapped in poverty. Changing the minimum wage won’t change those habits and their eventual outcome. The government cannot come in deus ex machina to alleviate their poverty which includes the poverty of spirit. Maintaining the fiction that their lives can be improved by some outside agency such as the government, instead of developing their own agency – their human capital – will only keep them entrapped in poverty and dependent on government and taxpayers for support.