Economics and the minimum wage

Most people think that economics is a highly mathematical science, abounding with spreadsheets and eyeshades and complex computer models.  That it is, but only because it tries to understand human behavior, a nearly unfathomable task. 

Economics is the study of how we humans decide to spend or save our hard earned money. It deals with demand and supply, and how business owners choose what to produce, and how much, depending on signals that they divine from consumers. It tries to understand what incentivizes job producers to hire workers and how to encourage them to hire even more.  But it’s all about human behavior, human thought, human decisions.

Government often tries to influence economic behavior.  They seek to assist the downtrodden, to regulate business, and to pick winners in new, exciting technologies. But do not neglect to recognize that government is a collection of humans who are governing humans and regulating businesses made up of humans.  So it is a true wonder that government seems to neither understand human behavior nor economics.

Here’s an example.  There is an ongoing effort to increase the minimum wage (currently $8.00 in Massachusetts).  The reasoning is that $8.00 per hour, or $16,640 per year, is not a “living wage”.  You may agree, or you may disagree.  Perhaps we should increase the minimum wage, or perhaps we should not.  But in any case, before making the decision, let’s try to understand what it’s all about. 

First of all, lets recognize that the minimum wage is paid to workers that are completely interchangeable. That is, they have no significant skills. If you are a minimum wage worker, it means that absolutely anyone can replace you. Once you have gained some expertise, such as how to operate a CNC milling machine, it is clear that not “absolutely anyone” can replace you, and you will earn significantly more than the minimum wage.

Now, a thought experiment.  Let’s assume that increasing the minimum wage is a good thing.  Further, we decide that it should be a very livable wage, so we set the minimum wage at $40 per hour ($83,200 per year). Let’s explore the consequences of this decision.

•  Imagine that your morning cup of coffee at Dunkin Donuts will now cost $8. 
• The neighborhood grocery store will install more self-checkout lines, reducing staff, and increasing unemployment.
• Manufacturing concerns will find that roboticized assembly lines are much more economically feasible, allowing them to shed workers.
• Service providers and call centers will determine that outsourcing of jobs overseas is increasingly prudent. Domestic employees can be dispensed with. 
• Overseas wages will be become drastically cheaper in comparison. Imports will increase, exports will decrease, and joblessness will inexorably creep up.
•  Students will determine that dropping out to earn this new, high minimum wage makes more sense than laboriously studying to learn new skills.

That’s pretty crazy, increasing the minimum wage to the point that it spawns inflation, demotivation, and increased unemployment.  Nothing good here.  But this is just a thought experiment.  What if we were to only increase the minimum wage to $10? The truth is, all of the above ills would still occur, but to a lesser, proportional, degree. 

Another way to attack the social issue of the minimum wage is from the other side.  Instead of artificially increasing the wages for unskilled labor, let’s increase the ranks of skilled laborers. By training and tutoring those at the bottom of the labor pool, we empower them to participate in our increasingly technical 21^st century economy. As a side benefit, this approach would result in workers with much higher, and well deserved, self-esteem and satisfaction. 

And by decreasing the supply of unskilled workers, we would, oddly enough, cause them to be in more demand with attendant higher wages.

That can’t be a bad thing.