Image credit to H. Payne / http://danieljmitchell.wordpress.com.

“In truth, there is only one way to regard a minimum wage law: it is compulsory unemployment, period. The law says: it is illegal, and therefore criminal, for anyone to hire anyone else below the level of X dollars an hour. This means, plainly and simply, that a large number of free and voluntary wage contracts are now outlawed and hence that there will be a large amount of unemployment. Remember that the minimum wage law provides no jobs; it only outlaws them; and outlawed jobs are the inevitable result.”

-Murray Rothbard in Making Economic Sense.

The idea that the minimum wage is harmful to many workers was hardly controversial up until about the 1990s. The reality is, though, that the minimum wage is not only disastrous for the employment of low skilled or inexperienced workers, but also a terribly inefficient means of solving the problems it is intended to solve.

People today genuinely lack an understanding of the concept of value, and how value is determined. Additionally, money is so normalized in all of our regular lives that it is easy for people to forget how money came to exist, what it serves to do, and what it fundamentally is. Understanding these concepts is essential in seeing why the minimum wage is such a disastrous law.

The first concept that must be grasped is the determination of value. Back in the days of Adam Smith, society was baffled by something known as the “Water-Diamonds Paradox”, or the “Paradox of Value”. Quite simply, it explored why it was so that diamonds, while having virtually no utilitarian purpose, were valued so highly, yet water, which is necessary for life, was valued so little.

This conundrum went without any real explanation until the year 1871, when Carl Menger, the founder of the Austrian School of Economics, published his first work, Principles of Economics. The concept of marginal utility was first proposed and explained by Menger in this book. Marginal utility solved the paradox of value solved by pointing out that people value things in units, and not as whole concepts.

The value of a unit of a resource, according to Menger’s now widely-accepted subjective theory of value, is based on the needs which the person using it can satisfy with it. Specifically, the value is only that of the least pressing of the needs which can be satisfied with it. Essentially, Menger solved the paradox of value by making clear that while water overall is more necessary than diamonds, there is so much water available that there is generally water to spare after the most necessary of needs it can satisfy (such as drinking) have been satisfied. People are then free to use it for lower-priority uses, such as pouring over their heads when outdoors in the heat. If most people have already satisfied their most pressing needs for water, an additional unit of water is no longer relevant to those needs, so those needs do not determine its value. Diamonds on the other hand are far scarcer, and therefore people generally will not have diamonds left over after using them for whatever top-priority use they have for them.  This causes the price of diamonds to be much higher than the price of water. Indeed, if water becomes scarce, so that people’s ability to have enough drinking water is threatened, its price goes up (though hopefully not as high as that of diamonds!).

Now, what does all of this have to do with wages and labor? Basically, marginal utility applies to services as well as it does to goods. Look at jobs that generally pay about minimum wage. These jobs include grocery bagging, fast food cooking, and various other lines of work involving menial, repetitive labor. In other words, these are jobs that just about anybody can do. What this means is that the potential supply of labor for these jobs is extremely high, and that the marginal utility of each individual worker is very low. Therefore, the market value of each worker’s labor is inevitably very low as well.

Likewise, high-paying jobs that generally require many years of school, study and practice to perform well, medical practitioners for example, tend to pay much higher. This is because the supply of workers capable of performing those jobs is much lower, so the marginal utility of each individual worker capable of doing them is quite high. For best results, each individual worker ought to have the unrestricted right to negotiate their pay in return for their own time and labor.

The reason that this is so relevant is because if employers are forced to pay above a certain hourly wage, then they are less likely to give lower-skilled workers a chance. The law has stripped those workers of their most powerful tool, the right to work for a lower wage and thus compete to some degree with more skilled workers. This makes building a resume and gaining experience more difficult for those workers, and gives an unfair advantage to people who are already more well off.

For example, imagine minimum wage is raised, and two new potential workers enter the labor market and apply for the same job. One is from a very poor family, barely graduated from the local public high school, and has no job experience. The other is from a wealthy family and was able to attend a highly regarded private school, and graduated with honors. Perhaps this person even has some work experience by the time they finish high school, thanks to family connections. Both are willing to take minimum wage pay. Both might be equally competent at the job, since minimum-wage jobs are fairly straightforward. In all likelihood, the employer will chose to employ the worker from the wealthier family, as on paper, he is a much less risky investment. The first potential worker, though, clearly needs the job more. However, without the right to work for less than a certain wage, our needier worker is still unemployed, losing an important opportunity for both money and job experience. So, mandating the minimum wage doesn’t raise the value of low skilled labor. It only succeeds in incentivizing employers to hire workers that are likely less in need of work.

Another reason the minimum wage is an ineffective solution to the problems it is meant to solve, is because it effects so few people. In 2012, only 4.7% of all hourly paid workers were on minimum wage. Also, more than half of all minimum wage workers are under the age of 25, and are likely not the breadwinners of the family. Despite this, the minimum wage does have a serious effect on unemployment. That same year, 2012, the unemployment rate for teenagers ages 16-19 was 24.9%. Meanwhile, the national unemployment rate was 8.1% This means that the teenage unemployment rate was more than three times the national average for that year.

One might argue that such a thing should be expected, as teenagers are far less likely to need to work than adults are. However, if a person is not looking for a job, then they are not counted as unemployed by the Bureau of Labor Statistics. These statistics only reflect the unemployment of people actually looking for work. Therefore, it is significant that the unemployment rate amongst teenagers is greater than three times the national average. Teenagers are the least likely to have enough job experience to command more than a rather low wage. They have had the least amount of time and opportunities to build a resume and thus, thanks to the minimum wage, suffer from exceptionally high unemployment.

Next, we must explore, broadly, the concept of money. Its history, its function, its merits, and more. In the first civilizations, the barter system was used as the primary means of exchange. This was rather inefficient though, because in order for an exchange to take place, one needed to first find somebody who had what they wanted, but also wanted what they had. Eventually, to overcome this awkward situation, the market developed gold, an early form of currency.

Rather than exchanging the actual goods and services, people exchanged gold as a representation of them. Let us say person A wanted a cow, but person B, who was willing to sell them a cow, was in need of a pig. With currency, an exchange could be made even if person A could not offer Person B a pig in exchange for the cow. Person B would sell his cow to person A in exchange for gold, because person B knew that with they gold, they could buy a pig.

The establishment of the gold standard carried with it its own problems. For one, gold was awkward to transport due to its weight and bulk. Another problem was that there were many things that had market values equal to either extremely small amounts or tremendous amounts of gold. Both made the exchange of gold for goods and services problematic. While gold represented the real wealth, paper bank notes were issued to represent the gold in the same way. This was helpful because a bank note could be written out for any amount of gold, no matter how large or how small. They were also considerably easier to carry around and to keep track of.

Unfortunately, today our natural means of exchange, the gold standard, has been abandoned. Not by any demand in the market, but because the state found it to be too much of a hindrance on its own growth and power. Now, our money is printed by fiat and manipulated by a central bank.¹ However, the basis of money remains the same.

When people work for money, they are not simply working for pieces of paper. They are working for what that paper represents-real wealth, the goods and services available in the market, all of which have their own natural market values. Simply put, the market value of this real wealth cannot change by the decree of any centralized body. While it is true that employers can be forced by such an authority to provide their workers with more pieces of paper per labor hour, that will not actually increase the value of their worker’s labor, since that is set in advance by the market. If it is to be made so that the amount of wealth that backs $7.25 is to back $10.00, or any other dollar figure, the value of the real wealth the worker is being compensated for (i.e. the labor of the worker) will remain unchanged. Instead, the buying power of the dollar figure associated with that amount of wealth that will suffer.

Some, such as Jillian Berman, a writer for the Huffington Post, have gone so far as to claim that raising the minimum wage would in fact create more jobs, as she stated in her 2013 article entitled “$10.10 Minimum Wage Would Actually Create New Jobs: Study.” Berman says in this article,

During the initial phase-in period, the U.S. economy would grow by about $22 billion, EPI [Economic Policy Institute] found. The growth in the U.S. economy would result in about 85,000 new jobs, according to EPI.

The information presented by Berman in her article could not be an accurate representation of how the minimum wage functions, as it contradicts very basic undeniable truths about how people behave. For if it were true that raising minimum wage would create more jobs, then that is to imply that an increase in the price of labor would translate to an increase in demand for labor. Berman is suggesting that people actually prefer to pay more rather than less, which we all know for certain is false. A study is not necessary to show that claim is false, as such a thing is obvious a priori. If a study seems to contradict an a priori truth, it is far more reasonable to think that there was something unusual going on in the study than not that the a priori truth is no longer true. Professor Hans-Hermann Hoppe addressed this in his 1995 work Economic Science and the Austrian Method, where he wrote the following:

…regarding the consequences of minimum wage laws or an increase in the quantity of money. An increase in unemployment and a decrease in the purchasing power of money are consequences which are logically implied in the very description of the initial condition as stated in the propositions at hand. … it is absurd to regard these predictions as hypothetical and to think that their validity could not be established … other than by actually trying out minimum wage laws or printing more money and observing what happens.

To use an analogy, it is as if one wanted to establish the theorem of Pythagoras by actually measuring sides and angles of triangles.

As we all know, the minimum wage is a heavily debated topic today. Unfortunately, many who seem genuinely concerned for the well-being of the workers take the position that we should raise the minimum wage, something that in practice would be entirely contradictory to their intended goals. Of course, a great many voters are economically illiterate, as is virtually all of Washington, judging by their policies. With respect to the minimum wage, as is all too often the case, good economics is bad politics.

Notes

1. To learn more about the disastrous effects of this, see Austrian Business Cycle Theory, “An economic theory developed by the Austrian School of economics concerning how business occur. The theory views business cycles as the consequence of excessive growth in bank credit, due to an artificially low market rate of interest.” (Ludwig von Mises, Manipulating the Interest Rate)