Wednesday, November 08, 2006

Minimum wages

How does something as logical as the effect of minimum wage on employment escape even the most intelligent individuals? Businesses seem to know and understand that raising minimum wages leads to higher unemployment. I have seen a lot of my students who do believe that when minimum wages are increased it leads to more employment. However, once they see the effect on the demand and supply diagrams they are amazed that it indeed leads to not only a reduction in employment but also unemployment of the low skilled workers the minimum wage legislation is meant to protect. The minimum wage issue is not as political in India as it is here in the US, although I am sure there is similar legislation somewhere. I wonder what reason is behind people supporting the minimum wage legislation. I am in a very libertarian school and do not know how undergrads are taught in other Universities here. Most Universities are more left leaning. Do they teach wrong economics? If they teach correct economics then how do students end up believing that minimum wage is good? I can believe that the other social sciences that emphasise a more human approach may teach the minimum wage legislation was good, but why would they talk about minimum wages in the first place? Atleast economics students should come out with the right idea about minimum wages. Then again we have proof of brilliant economists of not only promoting minimum wage legislation but showing inaccurate research of minimum wage increasing employment.

Lets take a minute to think this through. Lets say you and I run a small business employing about 20 people. The different tasks require varying levels of skills and that is the kind of employment we have; i.e., employees with diifferent levels of skills. We pay them based on their skills, and give bonuses once a year or so to those who perform exceptionally well. We also know that if we pay them lower than a certain amount they are going to find employment elsewhere. So we pay them enough and more to keep them happy in their current jobs. As owners of the business we have obligations to pay creditors, overheads and other expenses in addition to paying our employees. If we are prudent businessmen (which we need to be to remain in business) we will try to minimise our costs and maximise our profits. Now lets assume that due to minimum wage legislation we are forced to pay a higher amount that what we are currently paying to each employee. However our other costs remain the same and employees' capacity does not increase significantly because they are given 50 cents or so more every hour. Lets say on an average each individual gets $20 more every week, which means the additional cost to us owners is $400 a week. We are not producing more, so we are not making any more money than we did before the minimum wage was imposed. This means we are making less profits than before or maybe even making losses. So to remain in business, we have to cut costs, and the easiest thing to do would be to fire a couple of people or so and divide their work among the rest. Who would be fired? Those that contribute least to the company, in other words those with the lowest skills, because the ones with higher skills can take up additional responsibilities. The result, minimum wages which is intended to protect low skilled workers has infact led them to unemployment. Was it malice or greed that led us owners to fire those people? No!! We just wanted to remain in business. By doing so, we managed to provide employment for 20 people initially, and 18 after the minimum wage was imposed or increased. Who are the real losers? Those individuals the legislation intended to protect.

Why does this simple logic escape even the most brilliant minds?

1 comment:

jeremy h. said...

You clearly overestimate both the intelligence and attention span of the regular American.

Also, we are down to Two Smarties.