Politics & Policy

$7 Problem

A higher minimum wage will cut back business profits.

I’ve always thought that the minimum wage was perfect liberal economics, in the sense that it perfectly encapsulates the liberal philosophy. Liberals see a problem: workers with low wages. Their solution: pass a law requiring those wages to be increased. What could be simpler?

The problem, of course, is that someone has to pay those higher wages and the money doesn’t come from the tooth fairy. The unstated assumption of minimum-wage advocates is that businesses employing low-wage workers are highly profitable. Therefore, the only effect of a higher minimum wage will be to cut back business profits.

It is further assumed that lowering business profits will have no economic effect and that business owners will not change their behavior in any way, such as by cutting hours or benefits. In short, the only economic effect of a higher minimum wage will be to make poor workers better off. How can any reasonable person oppose such a policy?

Recently, the Small Business Administration looked closely at the types of businesses employing low-wage workers. Not surprisingly, the bulk of them are small businesses, not big corporations. Among all minimum-wage workers, 54 percent work in businesses with fewer than 100 employees and two-thirds work in businesses with fewer than 500 employees.

Working in a small business is precarious because they are perpetually underfinanced and just a short step away from bankruptcy. According to the SBA, in 1998, there were 590,000 new businesses established in the U.S. Of these, 565,000 employed fewer than 20 workers. But there were also 541,000 firms that went out of business that year, and 512,000 had 20 workers or less.

In other words, although small businesses may create 75 percent of new jobs, they are also responsible for the vast bulk of job loss. That is why we must be especially careful when contemplating new burdens on small businesses. With so many of them close to edge to begin with, it often doesn’t take much to push them over, destroying many jobs in the process.

The minimum wage is like a tax on small businesses that reduces their ability to hire and raise wages. According to the SBA, there was slower wage growth among low-wage workers in small firms during times when the minimum wage was rising. Even among large firms, the probability of a low-wage worker being unemployed doubled after the minimum wage was increased.

Nevertheless, small businesses are a critical stepping-stone into the labor force for most workers. If one is young, poor, undereducated, or a member of a minority group, they are the most likely places one can get a job. According to the Bureau of Labor Statistics, someone with less than a high-school diploma is almost twice as likely to work in a small business than a large one.

The two most basic determinants of the wage a worker is able to command in the market are age, which is really a proxy for experience and maturity, and education. So it stands to reason that young people with little education are simply not going to be productive enough to justify a very high wage. That is why the bulk of minimum-wage workers are young and have low education levels.

According to BLS, in 2002, half of all workers earning just the minimum wage were under age 25 and a fourth were between the ages of 16 and 19. One third of all minimum-wage workers had less than a high-school diploma. Three-fifths of minimum-wage employees work only part-time, and frequently are students or others living in homes with high family incomes.

Nevertheless, minimum-wage jobs are not unimportant jobs. They are the first rung on the employment ladder for most workers. The experience they gain in such simple areas as showing up for work on time, learning to follow instructions and how to interact appropriately with customers, clients, and patients are critical to success in life.

That is why wage growth among those hired in a minimum-wage job is very high for those who stick with it. According to a new study from the Employment Policies Institute, median annual wage growth for minimum-wage workers is six times greater than that of workers earning more than the minimum wage. The BLS confirms this analysis, finding that 90 percent of workers hired at the minimum wage are earning more than the minimum after one year.

Unfortunately, despite a vast amount of research showing that raising the minimum wage is a highly ineffectual means of aiding the poor, the lure of simplistic solutions constantly beckons the intellectually shallow and unsophisticated. On June 18, Sen. John Kerry (D., Mass.), the presumed Democratic presidential nominee, proposed raising the minimum wage from $5.15 per hour to $7.


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