Increased Minimum Wage, Decreased Economic Prosperity

Standard microeconomic theory shows that deviations of a price from its natural level bring forth bad results. In my experience, students most easily grasp the pernicious effects of price controls when phrased in terms of the minimum wage.

Long story short, the minimum wage acts as a price floor which stops people from selling labour services at a price below the mandated level. The final result is an increase in unemployment, partly from existing workers who lose their jobs and partly from new entrants to the labour market looking for a job but unable to get hired.

It’s really not a very difficult theory to comprehend.

Yet I’m always surprised at how few are able to apply this basic lesson. Take the recent protests in Thunder Bay in support of increasing Ontario’s minimum wage from $10.25 to $14 an hour as a case in point.

Amongst the arguments the protestors put forward, two stood out to me for their weakness in justification.

First, some protestors seemed to think that $14 was inherently “more fair” or “just” than $10.25. Prices are not about justness or fairness, they are about reflecting underlying conditions. A price doesn’t just come out of nowhere. Instead it is the result of the subjective demand someone has for an object, the resource constraints available, the substitute goods that the person could resort to instead, or the potential purchaser’s income level. Changing these general determinants of demand into the specific ones that affect the labour market, we can see that wages are the result of: 1) the productivity of workers, 2) the number of workers available, 3) the price of labour substitutes, like machinery or automated production processes, and 4) the incomes of the employers. (There are lots of other determinants, but this short list will suffice.)

Changing the price of labour does absolutely nothing to alter these determinants. Advocates of alterations to the minimum wage confuse cause with effect. The wage one earns is the effect of all of these aforementioned causes. Changing the wage will not have a positive effect because unless one of these determinants changes there is no reason why the wage should change.

The second prevalent argument at the protests was that higher wages would stimulate the economy. One protestor claimed that the increase in the minimum wage to $14 would stimulate the Thunder Bay economy by $5.1 billion!

Economist Livio Di Matteo did a little digging, and it turns out the “stimulus” in question is the sum of all Thunder Bay residents earning an extra $3.75 an hour. Unfortunately this doesn’t amount to stimulus; it just changes the distribution of income. Minimum wage earners, if they manage to keep their jobs, will end up a little wealthier and businesses will lose some money.

One of the best lessons from economics is that one should pay attention to the unseen effects of a policy. Often times this will be more important than those results which are obvious.

In minimum wage discussions, the unseen effects are two-fold. First are those people who are going to lose their job because of the increase in the minimum wage. If you thought it was hard to survive on $10.25 an hour, wait until you are earning nothing. Second, even those who keep their jobs are not stimulating the economy through their increased wages. To the extent that businesses will have to pay more money to workers there will be less money to invest. This means less growth, and fewer opportunities for people in the future.

Wages, like all prices, are not randomly created. They signal underlying conditions and as such are not inherently just or unjust; they just are. Changing the wage rate without doing anything to alter one of the underlying variables creating it cannot achieve anything positive, and will more than likely make people worse off. If these protestors are successful in achieving an increase in Ontario’s minimum wage, at the very least some of them will gain time to think about this simple lesson after they lose their job.

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3 Responses to “Increased Minimum Wage, Decreased Economic Prosperity”

  1. Rick Crawford says:

    A market sets the price of labor, not the value.

  2. Livio Di Matteo says:

    Hello David:
    One point – in my post the 5.1 billion dollars was the projected stimulus for all of Ontario's economy, not just Thunder Bay. That was not obvious in the way I phrased the sentence so my apologies. Cheers. Livio.

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