Does the Minimum Wage Stimulate the Economy?

There is a common argument in favor of the minimum wage. It goes something like this:

If we raise the minimum wage, workers will have higher wages. Thus, they will spend more on goods, and this demand will stimulate the economy.

There are a few problems with this line of thinking.

1) This assumes that the economy should be shifted toward consumption from investment. Since investment is geared toward the future, it is possible such a policy, if correct, could have the consequence of lowering the amount of goods in the future.

2) Even if the minimum wage is raised, for any sense to be made of this argument, the aggregate amount going to workers in wages has to be increased. If the basic argument against the minimum wage is right, that a price control on wages creates unemployment, then it is not necessarily the case that aggregate wage payments will initially go up, which is what is needed to “stimulate the economy.”

3) Ok, what if we drop, for the sake of argument, the claim that unemployment will cause aggregate wage payments to go down (or stay at the same level)? We have to immediately recognize that an increase in aggregate wages is still hard to stipulate. For example, if business A decides to increase wage payments, that’s less money it can spend on other factors of production, such as capital. In other words, it has to decrease payments to its suppliers, and these other businesses will end up reducing their own workers’ wages.

4) For aggregate wages to go up, then, it seems, that this money has to ultimately be taken out of payments to natural resources. Aggregate payments to natural resources has to go down. But an arbitrary allocation of money away from natural resources toward labor hampers the market’s function in economizing and allocating resources to their most highly valued ends. The  resulting allocation will be inferior to the market allocation, and goods of lesser value will be produced since a less efficient combination of resources will be employed in creating those goods. The minimum wage will have the unintended consequence of producing lower quality goods for the very people who want it, even if it increases their wages.

#4 is my own line of thinking – as far as I know, I have not seen it in other Austrian works I have read (I might simply not be very well read though!). What do you guys think about this?

Photo Credit: Annette Bernhardt via Compfight cc

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Posted on February 2, 2014, in Economics and tagged , , , . Bookmark the permalink. 5 Comments.

  1. Minimum wage laws are TYRANNY. They’re an attack upon both labor and management by a coercive and supposedly “do-gooding” Big Brother. Such laws hurt both workers and owners. People who advocate such economic slavery should be deported to North Korea, where they belong!

  2. “1) This assumes that the economy should be shifted toward consumption from investment. Since investment is geared toward the future, it is possible such a policy, if correct, could have the consequence of lowering the amount of goods in the future.”

    No, it doesn’t assume that at all. More spending by consumers could stimulate more investment.

    “2) Even if the minimum wage is raised, for any sense to be made of this argument, the aggregate amount going to workers in wages has to be increased. If the basic argument against the minimum wage is right, that a price control on wages creates unemployment, then it is not necessarily the case that aggregate wage payments will initially go up, which is what is needed to “stimulate the economy.”

    The potential effect on unemployment is smaller than the overall effect on wages. Also, if low wages are due to certain market failures an increase in the minimum wage can lead to an overall increase in employment.

    “3) Ok, what if we drop, for the sake of argument, the claim that unemployment will cause aggregate wage payments to go down (or stay at the same level)? We have to immediately recognize that an increase in aggregate wages is still hard to stipulate. For example, if business A decides to increase wage payments, that’s less money it can spend on other factors of production, such as capital. In other words, it has to decrease payments to its suppliers, and these other businesses will end up reducing their own workers’ wages.”

    Not so. First of all business revenue is not fixed. Higher wages for workers leads to more sales which means higher business revenue. A higher minimum wage could result in a smaller share of total income going to capitalists (via profits), but higher total income overall.

    “4) For aggregate wages to go up, then, it seems, that this money has to ultimately be taken out of payments to natural resources. Aggregate payments to natural resources has to go down.”

    Nope. First of all there isn’t a fixed amount of money in the economy – the supply expands via the banking system as production expands. And the economy is rarely operating anywhere near to full capacity, so there is scope to increase overall output. An increase in the minimum wage does not entail a reduction in overall purchases of natural resources. It may entail an increase in the share of total income going to low-paid workers, but not a reduction in total income.

    “But an arbitrary allocation of money away from natural resources toward labor hampers the market’s function in economizing and allocating resources to their most highly valued ends.”

    Minimum wages aren’t arbitrary – they have the specific aim of increasing low-paid worker’s wages to a reasonable level. You are assuming that ‘the market’ necessarily allocates resources to their “most highly valued ends”. This is clearly not the case if market failure exists, and denying the existence of market failures is the hallmark of a crank.

    Secondly your definition of “most valued ends” is highly misleading. Say for example you have a loaf of bread and two people: a poor starving person and a rich well-fed person. The rich-well fed person can afford to buy the loaf of bread while the poor starving person can’t. Does this mean that the rich well-fed person values the loaf of bread more than the poor starving person? According to your ideology, yes it does mean that. According to reason, no it doesn’t. Does it mean that by allocating the loaf of bread to the rich well-fed person instead of to the poor starving person, the market has allocated the loaf of bread to the “most valued ends” (the most valued ends being in this case filling the rich person’s already well-fed belly)? According to your ideology, yes it does mean that. According to reason, no it doesn’t. This is just a simple example, but do you see why your definition of “most valued ends” is circular? All you are saying is that more goods will be allocated to people who happen to have more money, but you are then deceptively adding a moral dimension by describing this as being a “more valuable” outcome than some other, more equal outcome.

    “The resulting allocation will be inferior to the market allocation”

    Again, you are assuming that market failure does not exist, and you are assuming that given market allocations are inherently ‘superior’. Think of my simple example above again. You are saying that allocating the loaf of bread to the rich well-fed person is superior to allocating it to the poor starving person. This is a purely ideological and indeed political assertion on your part. It really has nothing to do with economics, and more to do with moral or political philosophy.

    “The minimum wage will have the unintended consequence of producing lower quality goods for the very people who want it, even if it increases their wages.”

    There is no evidence that minimum wages lead to the production of lower quality goods at all.

    • Hi phillipe, thanks for the input. I only have a little bit of time though and can only make a few small comments in response at the moment.

      3. “Not so. First of all business revenue is not fixed. Higher wages for workers leads to more sales which means higher business revenue. A higher minimum wage could result in a smaller share of total income going to capitalists (via profits), but higher total income overall.”

      I think it is so. I am analyzing conditions in a short period of time, basically asking “what are the immediate effects of this policy action?” If the minimum wage is enacted, and businesses immediately give their workers higher wages, then these businesses, with their fixed revenue in this short time frame, will lower immediate payments to factors of production. These supplier businesses will then have less revenue with which to pay their workers. As such, an aggregate wage payment increase does not result.

      “Secondly your definition of “most valued ends” is highly misleading.”

      I think you are correct about this. The phrase “most valued ends” makes sense within an Austrian framework but does not necessarily apply properly to the everyday use of the phrase (and as such, can be misleading). As you said, a poor starving person may not be able to buy a loaf of bread that a wealthy person can. This does not mean that the wealthy person’s end is higher than that of the poor person’s. However, I’d advise you to refrain from making it sound too misleading. You state:

      “All you are saying is that more goods will be allocated to people who happen to have more money…”

      This may, occasionally be correct, but you cannot sum it up like that. The correct way to put it would be: All you are saying is that more goods will be allocated to people who are willing to give up more money in favor of those goods. This willingness to give up more money is a function of the amount of money they have, but not identical to it.

      • “If the minimum wage is enacted, and businesses immediately give their workers higher wages, then these businesses, with their fixed revenue in this short time frame, will lower immediate payments to factors of production. These supplier businesses will then have less revenue with which to pay their workers.”

        Not so. Businesses might make a lower profit margin as a result of the increase in the minimum wage, and in that sense there is a redistribution from capitalist profits to workers’ wages. But it wouldn’t make sense for businesses to reduce overall production, as this would simply reduce their profits even further.

        For example, if McDonald’s has to pay its shop-front employees a higher minimum wage, that might have an immediate impact on the company’s profit margin. But if McDonalds were to choose to reduce their total production of burgers (and as a result, reduce their orders to suppliers) that would leave them with even less profit overall.

        What they would actually do in response to an increase in the minimum wage is take the possible reduction in their profit margin whilst maintaining output at the same level. It would make no sense for them to cut back on production, if they are motivated to make a profit.

  1. Pingback: Archive: Minimum Wage | The Interventionist Paradox

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